Application of Activity-Based Management (ABM) in Performance Management
Activity-Based management or ABM is the modern business management approach that challenges traditional top-down management styles. The traditional approach is business management has been to allocate resources to divisions and appraised on a top-down basis. ABM as the name suggests focuses on all business activities from inputs to the outputs and even beyond that.
In ACCA Advanced Performance Management (APM) exam, different views of performance measurement and management are discussed in Section E and one of them is activity-based management. Here we would like to go deeply on this topic which can help you prepare well for the exam.
What is Activity-Based Management
Activity-Based Management in relation to the Activity-Based Costing can be defined as:
“The total implementation of Activity-Based costing information in business processes with an aim to produce same level of efficiency using the same resources”
It’s pertinent to define Activity-Based costing that forms the basis of ABM as:
“The approach to the costing and monitoring of activities involving resource consumptions and final costing”
In simple terms, ABM is the practical application of Activity-Based costing method. The traditional costing approach focuses on overhead costs associating each cost with the production only. ABC in contrast defines that not all product costs or broadly business costs can be associated with product manufacturing.
The business needs to define the cost drivers and define the costs associated with direct production and management of business separately. The emphasis on cost drivers and activities provides insights into the product direct and indirect costs. Activities can be defined from the product design step through the raw material acquisition, manufacturing process, operational efficiency, and final product output.
The flexible approach of ABM provides useful information on changes in activities at source and costs associated with the changes. As the application of cost drivers or activities can be broadened to any business function, the ABM provides greater information on total business management.
The focus of Activity-Based management is on identifying and managing the cost drivers and activities. Unlike the traditional costing approach of cost reductions, the ABM focuses on cost identification and managing the costs and then reduction. For example, a key emphasis of ABM is on production waste minimization and reduction of labor idle hours. This leads the organization to identify the accurate cost identification with product manufacturing without comprising the product quality.
The ABM aims to meet customer expectations keeping the best quality product with minimum resource allocations. ABM is the method of measuring and controlling the performance of activities through comparison of cost allocation and consumption.
Strategic business management requires useful information with measurable metrics. ABM identifies activities in all business processes that consume resources e.g. human resources or raw material. ABM focuses to measure these resources allocated to carry out the activities. These inputs go through a process and produce output i.e. products or services, which can be measured and changed.
The ABM approach aims to provide useful information to the top management about the activities’ resource allocation, their best utilization, and performance measures. With this approach, ABM puts management in a position to assess the product competitiveness in the market, as well as internal control measures to enhance performance. The holistic approach of ABM aims to cover all aspects of the business from product designs through to the output and meeting customer expectations.
Activity-Based Management in Practice
Modern manufacturing is machine-based, automated, and intensive; which means the overheads costs form a significant portion of the cost per unit. Machines can be efficiently utilized by both modernization and skilled enhancement of the laborers.
ABM focuses on continuous process improvements from input resource acquisition through to the production and sales. The whole process of Activity-Based management is linked and adapts a total quality management approach in each business process. The ABM is an approach, which started mainly with manufacturing companies; however, it can be implemented for any business including the service businesses.
The ABM approach in practice can be implemented in the following work-through flow.
Stage 1: Identification of Cost-Drivers and Activities
Activities mean the business processes that affect the product price or quality in any way. These activities involve the procurement of input materials, tools and machinery, human resources, sales and marketing, and after-sales activities. The aim at this stage is to identify the activities that affect the product or service design feature meeting customer expectations.
Each activity requires resources i.e. human and financial, meaning each activity drives costs. The initial stage requires the identification of these activities and cost drives that affect the product’s total cost and pricing decisions. At this stage, the aim of the ABM process is to clearly identify the business activities that incur costs related to product manufacturing and affecting product costs i.e. overhead costs.
Stage 2: Allocation and Evaluation of Cost to the Cost-Drivers
The second stage of ABM implementation is to assign the costs to each cost-driver. These costs include direct costs of manufacturing and indirect costs or overheads. The ABM approach stresses that overhead costs with modern manufacturing form an integral part of total product costs. The overhead absorption of costs is assigned to each activity, in contrast to the traditional costing methods.
The ABM approach differs from the traditional costing methods in a way that it absorbs all product overhead costs. For example, it includes direct material costs, indirect labor, and quality control measures as overhead expenses. All of these costs are absorbed per activity-based. For instance, the operational supervisor’s inventory control and quality assurance manager’s trips are included as activities and the cost is spread over each trip. The ABM approach includes each activity that adds value to the product or business process or provides valuable information for decision making.
Stage 3: Control and Performance Monitoring
The first aim of performance monitoring is the identification or non-value activities driving costs. In other words, it includes the elimination of waste e.g. idle labor hours or idle machine hours.
Performance monitoring requires measuring the cost of each activity and comparing it against the benchmarked budgets or standards. As the market competition requires fine adjustments for product costing, each cost-driven activity should be identified and measured.
This focus of performance measurement includes all activities from input resources, manufacturing or operations, and marketing and sales. The performance controls then allow the management to exhibit corrective actions.
Operational Activity-Based Management
The ABM approach in operations is the efficient allocation and utilization of resources in operations. This relates to maximum resource allocations to the value-addition and waste minimization. Managers divide activities into essentially two categories of value adding and non-value adding activities.
The Operational ABM approach is to maximize resources for the activities adding values and minimizing or eliminating non-value adding activities. This approach is also in line with the total quality management method that focuses on continuous business process improvements. Any activities incurring costs are allocated new targets and controls are implemented to reduce these costs or achieve production within the allocated budgets.
This process of cost identification allows management to prioritize resources and perform the cost-benefit analysis for each activity. It allows management to control the cost allocation for the most important business process and reduce costs on non-value adding activities.
The Activity-Based approach also allows management to identify the process improvements in each activity. For example, ABM may provide insights to the top management about the potential cost-benefit analysis on replacing a production machine. The ABM would than analyze the replacement cost of the machine and operational efficiency that can increase the total production level.
Strategic Activity-Based Management
The ABM approach aims to offer top management relevant information on product and resource management. The ABM approach offers strategic decision making insights mainly on product and customer profitability. As the ABC allocates costs accurately to each cost unit including overhead costs, it allows management to forecast product profitability.
The inclusive approach adopted by the ABC method apportions the overhead costs in full to the product manufacturing, which allows the true cost calculation and analysis of profitability. Overhead cost absorption means that reducing the production levels only may not yield the cost savings.
The ABM focuses on the identification of cost-drivers, i.e. the activities that incur costs. The top management then makes decisions on whether these activities should continue or not based on the cost-benefit analysis. The same is true when it comes to customer analysis; the ABM allocates all overhead costs to the customer profiles that enable management to decide on customer profitability. The strategic information on cost drivers, activities identification, cost allocation, and process improvements forms the basis of long-term business planning and controls.
Activity-Based management is a comprehensive business understanding approach. Organizations adopting the ABM reap rewards of greater business process understanding and improved strategic decision making.
The focus of the ABM approach remains on offering critical insights to the business managers on key business activities and cost associated with them. Performance measurement and continuous process improvements then become integral parts of the ABM approach.
ABM was tested in ACCA APM exam before. In APM March 2019 exam, a question dealt with issues around the introduction of activity based management but it was the most poorly answered question of the three in this exam with many candidates generally lack of deep understanding of this topic.
Hope this article can develop your understanding of ABM in your ACCA APM exam.
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