Activity Based Management

Why is this important?

  • Public and private organisations need to understand their activity costs and the net profitability of their products, services and customers.
  • Over 80% of companies do NOT know the true profitability of their different products and customers!
  • Traditional accounting systems are designed primarily to satisfy external reporting requirements.  Rarely do they provide timely and meaningful information to business managers or operating staff.  As such they fall short in providing information to help managers understand the dynamic cost characteristics of their business.
  • However, ABM is not a replacement for traditional reporting systems.  ABM augments and builds on the information available within companies' accounting systems.
  • The information provided by ABM is vital for making decisions about in-house and outsourced operations and deciding which products, services and customers are net contributors to the organisation and thus how a future corporate strategy should be structured.

What is Activity Based Management?

In recent years, the complexity of business has grown.  Not only has the nature of what needs to be costed grown but the importance of deciding between alternative pricing policies, channels of sales and which customer/products/channels are profitable has increased business complexity significantly.  In addition, many organisations have seen a growth in overhead costs as a result of the effort to grapple with the demands of business.  It is this complexity that has overwhelmed basic traditional accounting practices and driven the need for a different perspective.  Activity based management (ABM) is one solution to the need for a new perspective.

Without ABM, business managers are having to make decisions, often based only on gross margin figures.  ABM improves decision making by determining which products, services and customers actually consume the overhead.  Defining and costing the business processes using ABM identifies opportunities to reduce Non Value Adding (NVA) activities, thus contributing to the overall performance of the business.

You might sometimes hear the acronyms ABA, ABC and ABM.  The first is Activity Based Analysis, the second Activity Based Costing and the third Activity Based Management.   ABA has its roots in defining the activities carries by an organisation and refers to the collection and analysis of operational and activity data.  ABC is concerned with the allocation of costs to products and customers by the proportion of activities they have consumed.  ABM is the development and implementation of management plans to improve efficiency and profitability based on an understanding of activity costs.  ABM takes the strategic view and assesses what lessons can be learnt and what decisions can be made from ABA and ABC.  Often however, these definitions are not maintained and the three acronyms are used interchangeably to describe the subject.

Activity Based Management is a simple concept, yet many companies find it difficult to implement.  Too many articles address the benefits but little exists on 'how' to do it.

Activities are the key to a business.  In 1991 CAM-I linked the product costing view of a business on the vertical axis and the process view on the horizontal axis.

The CAM-I cross shows the relationship between ABC and ABM:

  • ABC quantifies profit streams ? Strategic direction
  • ABC identifies cost reduction opportunities ? Increased profits
  • ABC shows where costs are being driven into the business ? Complexity
  • ABC helps to understand the dynamics and processes ? Business characteristics
  • ABC provides information for quantified decision making ? What-if modelling
  • ABC aligns with total quality and Continuous Improvement

Aphelian Consulting follow a well-defined series of steps in all ABM projects.  This is how the overall process flows.  The time taken to complete the process depends on the available personnel, availability of data, project objectives, level of analysis required and priority within the business.  However, all projects follow a near identical process which has proven its value in each assignment.

The early stages of the project initially deliver interesting information about the business but this is soon replaced by more commercially useful data on all aspects of the business.  However, it is not until the ABC model is completed at the end of the process that the critical business data is revealed.  Only when the model is complete will the profitability information by product, service and customer be available.

Another way of looking at a typical ABM project is in terms of workload and team morale.  Let's take workload first.  At the start of the project we introduce the terminology and explain the fundamentals of ABM.  Next the search for data commences and initially this is readily available from the existing systems.  Soon though the shortcomings of traditional accounting systems becomes evident and more work is needed to find representative data about the organisation so that it can be modelled.  The workload thus increases while the computer model is established.  Once the model is complete, the workload drops away and the task of checking the model and then analysing the results ends the projects.  Where morale is concerned, this starts off high at project kick off.  As the workload increases and no results are available to show for this hard work, the feeling in the team tends to decline.  This is only temporary however as the results of the modelling reveal the power of ABM and the team sees ways of improving the organisation.  The projects always end on a high as the team seeks ways of making use of the information from the project.

There are many ways of presenting the data from an ABM project.  Careful choice is needed to select the representations with the most impact and ease of understanding.  Below are two typical outputs.  The first is a comparison of an organisation's gross margin figures that came from the accounting system and alongside these the net margin figures calculated by ABM.  The net margin figures are the more accurate as they include an accurate allocation of the overhead costs which the gross margin figures exclude.  As you look through the information and the way it is presented, please consider the differences between the gross and net margin figures and how these do not differ in a consistent way. 

How we can help

We use a proven methodology for activity based management that starts with the organisation's costs and produced net products, service and customer profitability.

A key element of the approach is the creation of a set of business activities which are costed to produce organisational process costs.  For example, this can show that the cost of the invoice processing process is £10,000 and if 1,000 invoices are produced, that the cost to generate a single invoice is £10.  This information is so useful as a spur to process improvement, cost reduction and informed decision-making.

The outputs from the ABM projects that we have run have been truly amazing.  In addition to the tangible benefits, we have found that projects of this nature produce results in the areas of the business that are not so easy to measure - for example inter-departmental co-operation, understanding how the business operates, understanding the need to manage.  Many organisations still view the success of a project based on its tangible, hard deliverables.  Putting to one side the intangible benefits, one of our companies reported annual savings of over £900,000 on the basis of the project undertaken with us.  Now isn't that something worth considering?