Activity-Based Management (ABM) Details

Activity-Based Management is classified into operational ABM and Strategic ABM:

  • Operational ABM: Involves classifying a firm's activities to improve efficiency and visibility of costs. It involves cutting costs without compromising the overall value of the product.
  • Strategic ABM: This is the management decision process utilizing Activity-Based Costing information to decide which products to develop, the activities to use, and identifies the most profitable customers to focus on.

Many organizations use Activity-Based Costing in managing the profitability of products and pricing decisions. Yet, Activity-Based Costing is more important than an accounting process used to determine the profitability of products. Activity-Based Costing is a powerful management tool. It is useful in rethinking the products, services, and market strategies in an organization. The Activity-Based Costing process is critical in identifying the activities and drivers that drive efficiency in an organization.

Operation Activity-Based Management involves analyzing costs through activities to provide more relevant information for decision making. You might decide why machine set up costs are high and place measures to increase efficiency or stop activities that do not add value. Firms can position their products at the right price points while not eliminating the low margin products as their demand could be interlinked.

Activity-Based Management enables the cost per unit of the product to be measured more accurately. It gives the managers the need to identify the optimal level of production to meet the market demand.

The initial stages of Activity-Based Management are much similar to Activity-Based Costing:

  • Identify the activities performed by the firm.
  • Calculate the cost of each activity.
  • Identify the cost driver of each activity.

Management should use judgment to identify which activities are significant to the firm's operations. There are many activities performed on a day-to-day basis. Narrowing the most critical in terms of cost and value is important; examples of necessary activities could be machine setup or scheduling production jobs.

Staff may be asked how much time they spend performing certain operations? Answering this question will enable the apportioning of the factory cost to the relevant activity. Having this information is critical in assigning the cost of each activity to the product accurately. The cost driver is a factor that causes the activity to keep varying during production. It might not be directly linked to the volume of output, as is the case in traditional Costing. Activity-Based Management's overall objective is to enhance the operational and strategic objectives of the firm.

Example of Activity-Based Management (ABM)

Implementing Activity-Based Management needs the involvement of all stakeholders in the firm. It is a radical departure from the old management system, where decisions were made at the top and cascaded down. It is important to engage all stakeholders, from the CEO to the shop floor staff, identify the drivers of costs, and put initiatives in place for continuous improvement.

Firms that adopt the Activity-Based Management system are likely to find challenges in educating employees at all levels on the mechanics and Activity-Based Management principles. Staff members have to understand thoroughly, what the organization is seeking to achieve, and how they can use Activity-Based Costing in their day-to-day jobs. They must be convinced it is a worthwhile venture. Organizational culture, therefore, plays a pivotal role in the success of Activity-Based Management.

Chrysler is among the companies that adopted Activity-Based Costing in 1991. It saw its margins falling and used Activity-Based Management to reverse it. This system has generated a lot of benefits by simplifying product designs and eliminating non-value generating activities. More than two-thirds of Chryslers assembly and manufacturing plants use Activity-Based Management. It has helped it in managing costs, enabling them to achieve long-term strategic objectives. The automotive giant has also made enormous strides in improving its operating efficiency and quality. The savings have been far higher than the cost invested.

Significance of Activity-Based Management

Firms use Activity-Based Management to reduce costs. Activity-Based Costing plays a critical role in identifying the various components driving the production overheads variable and fixed cost. Managers can trim the cost per unit by utilizing the most efficient methods to produce products based on Activity-Based Costing information.

Using the pricing of products, managers can analyze pricing strategies more accurately by utilizing the Activity-Based Costing data to re-prize or eliminate loss-making goods. Understanding the cost drivers' enables managers to better position products, develop designs, and price them accurately.

It is useful in influencing the operational and strategic planning of an organization. It is driven by target costing, optimal resource allocation, continuous improvement, and performance improvement. It can also be used by organizations launching new products into the market.