Activity based Management Concept, Rational, issues, Limitations

Activity-based management (ABM) is a way of identifying and assessing business activities by utilizing activity-based costing to conduct a value chain analysis or a re-engineering exercise to enhance strategic and operational choices in a company.

The foundation of activity-based management is that goods consume activities, and activities consume resources. To be competitive, managers must understand: (i) the activities involved in producing goods or services, and (ii) the associated costs.

To minimize the cost of a product, managers will most likely need to adjust the activities that it consumes.

Activity-based costing is an approach for estimating the cost and performance of activities, resources, and cost items. Specifically, resources are allocated to activities based on consumption rates, whereas activities are assigned to cost objects depending on consumption. ABC understands the causal linkages between cost drivers and activities.

Activity-based management focuses on managing activities to improve customer value and profitability. ABM covers cost driver analysis, activity analysis, and performance assessment, using ABC as the primary data source.

In layman’s terms, ABC is used to answer the query “What do things cost?” While ABM, using a process approach, is concerned with what causes drive costs to arise. Using ABC data, ABM focuses on how to redirect and optimize resource use in order to maximize value for consumers and other stakeholders.

Model Cost Driver Analysis: To manage activity expenses, identify the causes that cause the activities to occur.

Activity Analysis: Activity analysis is the process of determining the activities of organizations and their centers that should be used in activity-based costing. Based on the costs and advantages of the choices, the activities are classified into activity centers. Furthermore, it determines value contributed and non-value added activities:

Value-added activities are those that are critical to the successful completion of the process.

Non-value-added activities are those that provide no benefit to either internal or external clients. Indeed, these actions do not improve product quality; rather, they have a negative influence on product or service costs and pricing since they generate waste, cause delays, raise total value, and so on.

Performance Analysis entails identifying a suitable metric to assess the performance of the activity centers.

Importance

Performance Measurement: In order to compete effectively in the market, most organizations now focus on activity performance by measuring the efficiency and effectiveness of operations.

Cost Reduction: Activity-based management allows the business to identify expenses associated with activities and discover methods to cut costs, including eliminating the whole activity if it adds no value to the goods.

Business Process Reengineering comprises reviewing and revamping the organisation’s processes and workflows in order to improve performance and achieve excellence in business operations. It entails making major changes to the way the company presently functions. ABM helps to improve the efficiency and effectiveness of corporate processes.

Activity-Based Budgeting: ABB provides a framework for anticipating the input necessary to meet the budgeted level of activity. A comparison is done between actual and estimated outcomes to identify activities with substantial deviations from the budget, indicating a potential decrease in input supply.

Benchmarking is the practice of comparing the goods and services given by a firm to those of other companies. It tries to discover methods to enhance the firm’s goods and services.

Issues and Limitations

The problem with ABM is that it assumes that all of the benefits and costs of a cost item can be quantified in monetary terms. For example, the results of an ABM study may lead management to the conclusion that the workplace should be demoted to a lower-grade property in order to save money; nevertheless, a nicer office space is beneficial for drawing new employees to the organization.

Similarly, using ABM to strategic thinking might be challenging. The issue in this case is that a new strategic direction may be prohibitively costly in the near term, but offers long-term payback possibilities that are difficult to assess using an ABM study.

For the two reasons stated above, the information provided by an ABM analysis cannot be utilized to drive all management choices; rather, it is knowledge that may be incorporated into the overall framework of how a company should be run. Thus, it is one of a number of decision-making instruments available to management.

Risks

A danger with ABM is that certain activities have implicit value that is not always represented in the financial value contributed to any product. For example, a highly attractive environment might help recruit and keep the finest employees, but it may not be seen as providing value in operational ABM. A client that represents a loss based on committed actions but generates leads in a new market may be classified as a low value customer by a strategic ABM approach.

Managers should understand these principles and utilize ABM as a “common, yet neutral, ground, providing the basis for negotiation.” ABM may provide middle managers with a grasp of the expenses incurred by other teams, allowing them to make choices that benefit the whole business rather than just their own bottom line.