R Joswa Caxton (13MM08)

Activity Based Management

ABM : Concept
Value Added Analysis Tree
Value added activity
Strategic activity
Support activity
Value added analysis in manufacturing
Syllabus
ABM: CONCEPT
A procedure that originated in the 1980s for analyzing the processes of a business to
identify strengths and weaknesses. Specifically, activity-based management seeks out
areas where a business is losing money so that those activities can be eliminated or
improved to increase profitability.
ABM analyzes the costs of employees, equipment, facilities, distribution, overhead and
other factors in a business to determine and allocate activity costs.
Investopedia: Activity-based management can be applied to different types of
companies, including manufacturers, service providers, non-profits, schools and
government agencies, and ABM can provide cost information about any area of
operations in a business. In addition to improving profitability, the results of an ABM
analysis can help a company produce more accurate budgets and financial forecasts.

Definition of ABM
Activity-Based Management (ABM) manages activities to improve the value of
products or services to customers and increase the firms competitiveness and
profitability.
ABM draws on ABC as its major source of information and focuses on the
efficiency and effectiveness of key business processes and activities.
Using ABM, management can pinpoint avenues for improving operations,
reducing costs, or increasing values to customers.
By identifying resources spent on customers, products, and activities, ABM
improves managements focus on the firms critical success factors and enhances its
competitive advantage.
BRIEFING ABM
ABM supports business excellence by providing information to facilitate long-term
strategic decisions about such things as product mix.
ABM allows product designers to understand the impact of different designs on
cost and flexibility and then to modify their designs accordingly.
ABM is more than an accounting tool; it's a system for continuous improvements.
The real value and power of ABM comes from the knowledge and information that
leads to better decisions and the leverage it provides to measure improvement.

BRIEFING ABM
ABM classification
ABM
Operational
ABM
Strategic
ABM


It enhances operation efficiency and asset utilization and lowers costs;
Operational ABM applications use management techniques such as
activity management, business process reengineering, total quality
management, and performance measurement.

ABM classification :Operational ABM


Strategic ABM attempts to alter the demand for activities and increase
profitability through improved activity efficiency.
Strategic ABM focuses on choosing appropriate activities for the
operation, eliminating nonessential activities and selecting the most
profitable customers.

Strategic ABM applications use management techniques such as process
design, customer profitability analysis, and value chain analysis.
ABM classification : Strategic ABM
ABCs Horizontal view of Org.
The cost of activities and business processes;
The cost of non-value-added activities;
Activity-based performance measures;
Accurate product/service cost (cost objects);
Cost drivers.
Outputs of ABM
The cost of activities and business processes
The basic output of the ABM system must be to provide relevant cost
information about activities.
The cost of non-value-added activities
A non-value added activity is an activity that is considered not to
contribute to customer value or to the organization's need.
This is defined as waste. Identification of waste is valuable to
management.
This crucial information output provides a focal point for improvement
efforts.
Outputs of ABM
Activity-based performance measures
In addition to cost information for business processes and activities, the
ABM system must report information and data on activity performance.
Knowing the total cost of activity is insufficient to measure activity
performance.
Activity measures of quality, cycle time, productivity and customer
service may also be required to judge activity performance.

Outputs of ABM
Accurate product/service cost (cost objects)
Because products and services consume resources at different
rates and require different levels of support, costs must be
accurately determined.
Cost drivers
A cost driver is any factor that causes a change in the cost of an activity.
An activity may have multiple cost drivers associated with it.

Outputs of ABM
ABM MODEL

ABM MODEL - Cost Accounting Management-
International (CAM-I)
Steps in ABM Implementation
Analysis of activities
Identify value-added and non-value-added activities
Analysis of critical activities
Compare activities with benchmarking
Improvement of activities
Reduce the time or effort required to perform an activity
Eliminate unnecessary activities
Select low-cost activities
Sharing of activities
Steps in ABM Implementation
Performance measurements
Identify the root cause of the problem
The 5 whys - Fix the problem, not treat
the symptom
Estimate cost and cost savings
Evaluate results

Steps in ABM Implementation
Activity Analysis
To be competitive a firm must assess each of its activities based on its need
by the product or customer, its efficiency, and its value content.

REASON FOR ANALYSIS
It is required to meet the specification of the product or service or satisfy
customer demand.
It is required to sustain the organization.
It is deemed beneficial to the firm.
Activity Analysis
Activity Analysis: The Heart of Cost Reduction
1. Activity elimination
2. Activity selection
3. Activity reduction
4. Activity sharing
Activity Analysis Can Reduce Costs Four Ways:
Value Added Analysis Tree
Analysis and
Classification
Value-
added
Activities
Nonvalue-
added
Activities
Activities
Reduce or
Eliminate
Continually Evaluate
and Improve
Value Added Analysis Tree
Activities that augment accuracy
That are necessary or required to meet
customer requirements or expectations.
That enhance purchased materials or
components of a product.
That contribute to customer satisfaction.
VA & NVA
That are critical steps in a business process.
That are performed to resolve or eliminate
quality problems.
That are performed upon request of a
satisfied customer.
That you would do more of, if time
permitted

A value-added activity is one that, if eliminated, would affect the accuracy and
effectiveness of the newscast and decrease total viewers as well as ratings for that time
slot.

Activities that augment delay
Can be eliminated without affecting the form, fit,
or function of the product or service.
Begin with prefix re (such as rework or
returned goods).
Result in waste and add little or no value to the
product or service.
Are performed due to inefficiencies or errors in
the process stream
VA & NVA
Are duplicated in another department or add
unnecessary steps to the business process.
Are performed to monitor quality problems.
Are performed due to a request of an unhappy
or dissatisfied customer.
Produce an unnecessary or unwanted output.
If given the option, you would prefer to do less
of.

A low-value-added activity is one that, if eliminated, would not affect the accuracy and
effectiveness of the newscast. The activity contributes nothing to the quest for viewer retention
VA & NVA
Activity Performance Measurement
Activity Performance Measurement
1. Efficiency
2. Quality
3. Time
Three Dimensions of Activity Performance
Operational Measures for Quality
1. Defects per unit
2. Number of defective units per total units produced
3. Percent of external failures
4. Pounds of scrap per total pounds of materials issued
Operational Measures for Efficiency
Output per materials
Output per labor hours
Output per persons employed
Output per kilowatt hours
Operational Measures for Time
Three Major cost elements:
1. Development costs: planning,
design, and testing
2. Production costs: conversion
activities
3. Logistics support costs:
advertising, distribution, warranty,
etc.
Planning Design Testing Production Logistics
100

90


75


25

Cost Commitment Curve
Life Cycle
Cost %
90 percent of life-cycle
costs are committed at this
point
Activity improvement
Integrating and linking ABM with existing performance measurement
systems, improvement initiatives, reward systems, value-based and core
competencies
Ensuring that system design specifications take into account techniques
such as benchmarking
transferring ownership of the system to line management;
Implementing and emphasizing continuous improvement;
Training managers on how to use the ABM information
Activity improvement
The Strategic Management
ABM and The
Strategic
Management
Process
Customer Profitability Analysis
Customer Profitability Analysis
Customer profitability analysis uses
activity-based costing to determine
the activities, costs, and profit associated
with serving particular customers.

Customer Profitability Analysis
Orders
small
quantities.
Orders
frequently.
Often
changes
orders.
Required
special
packaging.
Demand
fast
service.
A costly customer
Identify most profitable customers.
Manage each customers costs-to-serve to a lower level.
Establish a surcharge for or re-pricing expensive costs-to-serve activities.
Reduce services for high cost-to-serve customers.
Introduce new products and services.
Improve the process of customer service.
Offer discounts to gain more volume with low costs-to-serve customers.
Select customer mixWhat types of customer should we market to? What
types should we not market to?
Choose types of after-sale services to provide.
Customer Profitability Analysis
Identifies activities and cost drivers to service customers before and after
sales, not including product costs.
customer-specific activities include:
Order processing costs.
Billing, collection, and payment processing costs.
Accounts receivable and carrying costs.
Customer service costs.
Return or allowance processing costs.
Restocking costs, Selling and marketing costs.
Customer Cost Analysis
Customer unit-level cost resources consumed for each unit sold to a
customer
Customer batch-level cost resources consumed for each sales
transaction
Customer-sustaining cost resources consumed to service a customer
regardless of the number of units or batches sold
Distribution-channel cost resources consumed in each distribution
channel the firm uses to service customers.
Sales-sustaining cost resources consumed to sustain sales and
service activities that cannot be traced to an individual unit, batch,
customer, or distribution channel.
Customer cost analysis

Focus on critical needs
Get top management support
The main cost system
Consider a separate model
The existing information system
The implementation team
Start with product costing
Guidance on implementing ABM
Case study :

G. E. Mustill (GEM)
G. E. Mustill (GEM) is a small company with 0.5 million annual
turnover.
It employs about 20 people and is located in Essex, England. The main
products of GEM are four types of machines ( viz. sander, splitter, shaper
and foiler) for the picture framing industry.
The foiler and sander machines are produced in different numbers of
heads varying from 1 to 6.
They produce machines in standard specifications and according to
customers requirements.
The company manufactures only 22% of parts of the machine in-house
and purchases 78% of parts from subcontractors and suppliers.
The assembly of all these parts is the main activity of the company
About GEM
The company works in a traditional way and all activities are performed
manually.
Information provided by an ABC system is used to find the opportunities of
improvement in organization at the activity level.
The analysis of activities involves classification of activities into value added
and non-value added and then compare these with that of the world class
company or the best practices.
Benchmarking with the best practice offers avenues for improvement in
value-added activities.
This also explains how management can use the cost drivers as the
performance measures and control the volume of cost drivers.
The ideal cost object is `products that are sold to customers. The cost of all
activities is calculated in a similar way to that of parts
About GEM
In this case study the problem is approached in three steps

Analysis of activities
Compare activities with benchmarking
Performance measurements
Approach
Marketing:
The annual cost o f marketing is 23 330 which is divided equally between
four types of machines.
Then, this amount is divided by eight because the annual sale of a four-head
foiler is eight machines. Therefore, the marketing cost for this product is
729.06.
Inventory carrying cost:
The cost driver for inventory carrying is the stock value.
The total s tock value in GEM is 20 000. For a four-head foiler, the stock
value is 1600. Hence, the inventory carrying cost for this machine is 491.20.
General analysis
Engineering support:
The cost driver for this activity is the time spent by the engineering support
staffs for a particular product.
For this machine, a total of 80 h is spent by the engineering staffs and hence
the cost of engineering support activity is 1480..
Assembly:
The assembly of the machine is per-formed manually.
The cost driver for assembly activity is the labour hours and the volume of the
cost driver is 82 h. This leads to the total assembly cost as 886.42.

General analysis

The total cost of a four-head foiler
ABC provides detailed information about the company and its activities
Analysis of activities
Once the cost of each activity is calculated, the next step is to identify the
value-added and non-value-added activities
Analysis of activities
It may not be possible to eliminate or reduce all nonvalue-adding activities at the
same time. The key is then to focus on the critical activities which form a major
portion of the total cost.
Analysis of activities
Purchasing:
World-class companies have a direct link with suppliers and subcontractors by the
electronic data exchange (EDI) system, and it places orders automatically
whenever materials are required.
This leads to a reduction in ordering cost, lead time and overall purchasing cost as
compared with that of manual order processing. Hence, there is room for
improvement in the purchasing activity of GEM.
Assembly:
The assembly activity is performed manually in GEM. Compared to an automatic
assembly activity, there are many chances of improvements.
The cost of automation should be justified based on the labour cost and response
time including tangible and intangible costs and benefits. .

Compare activities with benchmarking
Material handling:
The movement of materials between these stations is the cost driver. It is
possible to reduce this movement by using multipurpose machines (AS/R S,
robots, AGV s) to perform various operations.
The movement of materials can also be reduced by changing the layout of
machines. .
Machining operations:
GEM uses very old machines to perform basic activities like drilling, milling
etc. and these are labour intensive.
These machining operations can be compared with that of the CNC machine
tools.

Compare activities with benchmarking
Non-value-added activities are clearly identified. In GEM, the inventory
carrying activity is the major nonvalue-added activity which should be
eliminated.

However, it is difficult because the purchasing cost of the present system
will increase as the company places more purchased orders with the
objective to reduce inventories. Therefore, it indicates that the
purchasing activity should also improve.

The comparison of this purchasing activity with the best practice
(purchasing using EDI) indicates the scope for improvements.

Performance measurements
The costing at part level or subassembly level helps the
management in a make or buy decision. The analysis of
activities to identify value-added and non-value-added
activities and benchmarking at the activity level direct
improvement efforts in the right direction.
Conclusion
Implementing Activity-Based Management: Avoiding the Pitfalls : Institute of
Management Accountants (IMA)
DEVELOPING AND PROMOTING STRATEGY : Activity-based Management
An Overview : CIMA Technical briefing
Activity-based management in a small company: a case study by A.
GUNASEKARAN, R. MCNEIL and D. SINGH (PRODUCTION PLANNING &
CONTROL, 2000, VOL. 11, NO. 4, 391 399)
ACTIVITY-BASED COST MANAGEMENT - An Executives Guide by Gary
Cokins, publication : John Wiley & Sons, Inc.
Reference
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