ACTIVITY BASED
MANAGEMENT
By : Riya Dhiman
Ravinder Dutt Sharma
INTRODUCTION
The profitability of a particular product or market, product pricing policies, and
investments to support production are issues that extend beyond accounting to the
areas of corporate strategy, marketing, and finance. The cost to produce a product
or to perform a service would not matter if enough customers were willing to buy
that product or service at a price high enough to cover its cost and provide a
reasonable profit margin. In reality, customers purchase a product or service only
if they perceive an acceptable value for the price. Management, then, should be
concerned about an equitable relationship between selling price and value.
Activity-based management (ABM) is a business process model that focuses on
controlling production or performance activities to improve customer value and
enhance profitability.
DEFINITION
Activity based management (ABM) is a method of internal analysis that identifies
business activities within a company then evaluates them based on the costs incurred
by the activities and the value added by the activities. The idea is to analyze the
activities related to the company’s operations. In addition, it is used to identify
opportunities to improve efficiency and profitability.
Robert S. Kaplan and Robin Cooper define ABM as:
"Activity-Based Management (ABM) is a discipline that focuses on the
management of activities as the route to improving the value received by
customers and the profit achieved by providing this value. It draws on Activity-
Based Costing (ABC) as its major source of information."
ABM help companies to
• Produce more efficiently,
• Determine costs more accurately, and
• Control and evaluate performance more effectively
OBJECTIVES
1. To reduce costs by identifying and eliminating non-value-adding activities.
2. To improve processes by streamlining workflows and enhancing operational efficiency.
3. To increase profitability by focusing on more profitable products, services, and
customers.
4. To enhance decision-making by providing accurate cost and performance data for
informed choices.
5. To enhance customer value by prioritizing value-adding activities that improve
customer satisfaction.
6. To allocate resources effectively by focusing on activities that align with strategic goals.
•
COMPONENTS
Activity-Based Management (ABM)
comprises several components that work
together to analyze and improve
organizational activities and processes.
Each component contributes to optimizing
costs, enhancing efficiency, and driving
value creation.
1. Activity analysis
A primary component of activity-based management is activity analysis, which is the process of studying activities both to
classify them and to devise ways of minimizing or eliminating the activities that increase costs but provide little or no
customer value.
Activity analysis is the process of identifying, describing, and analysing all the activities within an organization. The
objective is to determine which activities are necessary and how they contribute to the overall business goals. In Activity
analysis, identification of activities into value adding and non value adding is made and efforts are made to eliminate the
non value adding activities.
Role in ABM:
Classifying activities: Activities are classified as value-adding or non-value-adding.
Improvement focus: Identifies inefficient or redundant activities that can be reduced or eliminated.
Mapping activities: Provides a clear picture of how work is performed, linking activities to specific products or
services.
Example:In a manufacturing company, activity analysis might involve identifying activities such as procurement, production
scheduling, machine setup, and quality inspection, and determining how much each activity contributes to the final product
2. COST DRIVER ANALYSIS
The factors that cause activities to be performed need to be identified in order to manage activity costs. Cost driver analysis
identifies these casual factors
Companies engage in many activities that consume resources and cause costs to be incurred. All activities have cost drivers,
cost drivers are defined as the factors that have direct cause and-effect relationships to a cost. Many cost drivers can be
identified for an individual business unit. For example, cost drivers for factory insurance are value of property, plant, and
equipment; number of accidents or claims occurring in a period; and inventory size. Cost drivers are classified as either
volume-related (such as labour or machine hours) or nonvolume-related (such as setups, work orders, or distance travelled),
which generally reflect the incurrence of specific transactions.
Potential Cost Drivers for Shipping Cost
LEVELS OF COST
Traditionally, cost drivers were viewed as
existing only at the unit level: for example,
labour hours or machine time expended to
produce a product or render a service. These
unit-level costs are caused by the production
or acquisition of a single unit of product or
the delivery of a single unit of service. Other
drivers and their costs are incurred for
broader-based categories or levels of activity.
Th ese broader-based activity levels have
successively wider scopes of influence on
products and product types. These levels are
• Batch,
• Product or process, and
• Organizational or facility.
3. Activity-Based Costing (ABC)
Meaning:
Activity-Based Costing (ABC) is a costing methodology that assigns costs to products or
services based on the activities required to produce them. ABC allocates indirect and overhead
costs to activities rather than arbitrarily spreading them across all outputs.
Accurate cost allocation: Provides a more precise understanding of how activities
consume resources, leading to more accurate product costing.
Identifying cost efficiencies: Helps identify areas where costs can be reduced without
sacrificing quality.
Profitability analysis: Enables detailed analysis of product, service, and customer
profitability by accurately tracing costs to activities.
Example:
In a software development firm, ABC can assign costs based on activities like project
management, coding, testing, and customer support, instead of using a flat overhead rate.
4. CONTIONOUS IMOROVEMENT
Continuous improvement refers to an ongoing effort to enhance products, services, or
processes. It focuses on incremental improvements over time or breakthrough improvements
all at once.
Process optimization: Encourages continuous evaluation and refinement of activities to
reduce costs and increase efficiency.
Innovation: Promotes finding new ways to enhance the effectiveness of value-adding
activities and eliminate waste in non-value-adding activities.
Cultural shift: Installs a mindset of constant improvement in the organization.
Example:
A retail company might continuously analyse its order fulfilment process to reduce delivery
time and cost through automation and better inventory management practices.
5. Operational Control
Meaning:
Operational control in ABM focuses on managing day-to-day operations to ensure that activities are performed
efficiently, effectively, and in alignment with organizational goals.
Role in ABM:
Monitoring performance: Tracks the performance of activities in real-time and compares them to
established standards.
Corrective actions: Identifies when activities deviate from performance benchmarks, triggering
adjustments to bring operations back in line.
Resource optimization: Ensures that resources are used efficiently to meet operational targets and avoid
waste.
Example:
In a logistics company, operational control might involve monitoring the activities related to fleet management
and taking action when fuel consumption exceeds expected levels.
6. Quality Management
Meaning:
Quality management in ABM is about ensuring that activities meet the desired standards of
quality and contribute to the production of high-quality products or services.
Value-adding focus: Encourages the reduction of defects and inefficiencies, ensuring that
activities are aligned with customer expectations.
Continuous quality improvement: Identifies activities that impact quality and seeks to
enhance them over time.
Cost of poor quality: Helps in identifying activities contributing to rework, defects, and
customer dissatisfaction, allowing for cost reduction.
Example:
In an automotive company, quality management would involve analyzing activities like
assembly, inspection, and testing to ensure that vehicles meet safety and performance
standards.
7. Business Process Improvement (BPI)
Meaning:
Business Process Improvement is the systematic approach to helping an organization optimize its underlying processes to
achieve more efficient results.
Example:
In a healthcare facility, BPI might involve improving the patient admission process to reduce wait times and improve
patient satisfaction by automating certain administrative tasks.
8. Performance Measurement
Meaning:
Performance measurement in ABM involves setting benchmarks and key performance indicators (KPIs) to evaluate the
efficiency and effectiveness of activities.
Monitoring activity performance: Provides a means to measure how well activities are performed, whether they
meet cost, time, and quality expectations.
Informed decision-making: Helps management make informed decisions based on activity performance, ensuring
alignment with business objectives.
Tracking improvements: Monitors the effectiveness of continuous improvement efforts by comparing actual
performance against goals.
TYPES
Operational ABM • Strategic ABM
Operational ABM focuses on improving the efficiency of day-to- Strategic ABM focuses on long-term decision-making and aligning
day business operations by managing activities and reducing activities with the organization’s overall strategy. It aims to create
costs. It aims to optimize current processes, control costs, and competitive advantages by analysing which activities contribute the
improve operational performance. most value and making decisions about which products, services, or
customers to prioritize.
Characteristics:
Characteristics:
Short-term focus: Concentrates on immediate improvements in
Long-term focus: Emphasizes aligning business activities with
operational efficiency.
strategic objectives to ensure long-term success and profitability.
Process optimization: Identifies inefficiencies, waste, and non- Value creation: Concentrates on enhancing value for customers and
value-adding activities in current operations. improving the company’s market position.
Cost reduction: Aims to lower the costs associated with business Resource allocation: Involves high-level decision-making about
processes without compromising quality or customer value. where to allocate resources, which products or services to focus on, and
which customer segments to target.
Performance measurement: Monitors activity performance using
Profitability analysis: Helps in understanding the profitability of
metrics like cost, time, and quality to ensure processes are running
different products, services, and customers by considering the costs of
efficiently.
activities that support them.
DIFFERENCE BETWEEN ABC AND ABM
Aspect Activity-Based Costing (ABC) Activity-Based Management (ABM)
Definition A costing method that assigns A management approach that uses activity-
overhead costs to products and based information to improve business
services based on activities. processes and decision-making.
Primary Accurate cost allocation to products Managing and optimizing business
Focus and services. activities for improved performance.
Objective To determine the true cost of To enhance operational efficiency and value
products and services. creation.
Time Short-term, focusing on cost Long-term, focusing on continuous
Horizon measurement. improvement and strategic alignment.
Decision- Supports decisions related to pricing Supports broader decisions about resource
Making and cost control. allocation and process improvement.
ADVANTAGES DISADVANTAGES
1. Improved Cost Management: ABM helps organizations 1. Time-Consuming: ABM can be time-consuming and
identify and analyze activities and allocate costs based on the resource-intensive. Especially in the initial stages when
resources consumed by each activity. This provides a more activities and processes are analyzed and mapped. This
accurate picture of the true cost of producing products or can be a disadvantage for organizations with limited
providing services, which can lead to better cost management. resources.
2. Increased Efficiency: ABM can help organizations to 2. Costly: Implementing ABM may require significant
identify areas of inefficiency in their processes and activities investments in technology, training, and resources,
and make improvements to increase efficiency and which can disadvantage smaller organizations with
productivity. limited budgets.
3. Enhanced Customer Value: ABM can help organizations 3. Complexity: The complexity of ABM can be a
identify which activities add value to their customers and disadvantage for organizations that are not prepared for
which do not. By focusing on value-added activities, it. Identifying and analyzing activities is complicated
organizations can increase customer satisfaction and loyalty. and requires specialized skills and knowledge.
4. Better Decision Making: ABM provides a more accurate and 4. Resistance to Change: ABM may require changes to an
detailed view of an organization's operations, allowing for organization's processes and culture, which can be
better decision-making based on data and facts rather than difficult and meet with resistance from employees who
assumptions and guesswork. are comfortable with the status quo.
TIME DRIVEN ACTIVITY
BASED COSTING
• Time-Driven Activity-Based Costing (TDABC) is an advanced
costing methodology that builds upon traditional Activity-Based
Costing (ABC). It aims to provide more accurate cost information by
simplifying the process of estimating costs and enhancing the
understanding of resource consumption over time.
• The solution to the problems with ABC is not to abandon the concept.
ABC model has been revised to TDABC.
• In the revised approach, managers directly estimate the resource
demands imposed by each transaction, product, or customer rather
than assign resource costs first to activities and then to products or
customers.
For each group of resources, estimates of only two parameters are
required:
• ➢ cost per time unit of supplying resource capacity
• ➢ the unit times of consumption of resource capacity by products, services,
and customers.
At the same time, the new approach provides more accurate cost-driver
rates by allowing unit times to be estimated even for complex,
specialized transactions.
Time Driven Activity Based Costing (TBABC) is a costing method that uses the time
required to complete each step in a process to produce a product or deliver a service.
The cost of a product or service is determined by multiplying the total time required
to complete a series of process steps by the capacity cost rate, whereas the capacity
cost rate (expressed as a cost per unit of time) is determined by the total cost of
capacity supplied (such costs include personnel; benefits; management; occupancy;
utilities; equipment costs; and allocated indirect and overhead spending) divided by
the practical capacity of resources (expressed using a unit of time) within a given
time period.
COST OD PRODUCT/SERVICE = Total time required to complete a series of
process × Capacity cost rate
CAPACITY COST RATE=
Steps for Time-Driven Activity-Based Costing
Estimate Determine Calculate Analyze Reporting
Define Assign Monitor
Identify Resource Time Products and and
Resource Costs to and
Activities
Groups
Capacity Requirem
Activities
or Service Optimiz Decision
Costs ents Costs Update Making
e
Benefits of TDABC over ABC
• Saves time and resources spent on surveying employees.
• TDABC is effective on a large scale.
• Managers can easily update their time-driven ABC models to reflect changes in
operating conditions.
• TDABC model also enables managers to find out the excess capacity.
• TDABC can accommodate the complexity of real-world operations by
incorporating time equations.
LIMITATIONS OF TDABC SYSTEMS
[Link] Collection 2. Subjectivity in 3. Limited Scope
Challenges Time Estimates of Cost Drivers
5. Training and
4.
Skill
Implementation
Development
Complexity
Needs
Data Collection Challenges
TDABC requires accurate estimates of the time required for each activity, which can be difficult
to obtain. Organizations may face challenges in collecting this data, especially if processes are
complex or vary significantly. Inaccurate time estimates can lead to incorrect cost allocations and
misinformed decision-making.
2. Subjectivity in Time Estimates
The accuracy of TDABC relies heavily on the assumptions made about time requirements for
various activities. These estimates can be subjective and may vary depending on individual
perspectives or experiences. If different departments or teams have different views on how long
tasks take, it can lead to inconsistencies in cost allocation.
3. Limited Scope of Cost Drivers
While TDABC focuses on time as a primary cost driver, it may overlook other important factors
that contribute to costs, such as material usage, overhead variations, or fixed costs. This narrow
focus can limit the comprehensiveness of the cost information provided and may not capture the
full complexity of cost behavior.
4. Implementation Complexity
Although TDABC is designed to simplify the costing process compared to traditional Activity-
Based Costing, its initial implementation can still be complex and resource-intensive.
Organizations may need to invest time and resources to identify activities, estimate time
requirements, and set up the necessary systems for tracking and analysis.
5. Training and Skill Development Needs
Implementing Time-Driven Activity-Based Costing (TDABC) often requires staff to develop
new skills and understanding of the methodology. Employees may need training to accurately
estimate time for activities, utilize the system effectively, and interpret the resulting data. This
training can incur additional costs and may lead to a temporary dip in productivity as staff adjust
to the new processes.
EXAMPLE
Suppose, the total expenses of a customer service department in a company amount
to $ 560,000. The actual quarterly quantities of work as well as the time spent by
employees on each of the three activities in the department are as follows :
Activity % Of Time Spent Activity Quantity
Processing customer orders 70 49,000 orders
Handling customer 10 1,400 inquiries
inquiries
Performing Credit Checks 2O 2,500 credit checks
Activity % Of Time Spent Activity Quantity Assigned cost Cost-Driver Rate
Processing customer 70 49,000 orders $392,000 $8 per order
orders
Handling customer 10 1,400 inquiries $56,000 $40 per inquiry
inquiries
Performing Credit 20 2,500 credit checks $112,000 $44.80 per credit
Checks check
TOTAL 100 $560,000
• Now suppose the total time available with 1 employee in a quarter is
25,000 minutes. If total number of employees are 28, then the total
time available with them is 700,000 minutes for one quarter. The
optimum time to complete the activities is given as follows:
Activity Optimum Time Activity Quantity
Processing Customer 8 minutes per order 49,000 orders
Orders
Handling Customer 44 minutes per 1,400 inquiries
Inquiries inquiry
Performing Credit 50 minutes per credit 2,500 credit checks
Checks check
COST DRIVER RATE= $560,000/700,000 = $ 0.8 per minute
Activity Activity Optimum Time Cost-driver Total Cost Total Time Used
Quantity Rate Assigned (min)
Process customer 49,000 orders 8 min $6.40 (0.8*8) $313,600 392,000 (49000
orders * 8)
Handle customer 1,400 inquiries 44 min $35.20 (0.8*44) $49,280 61,600 (1400 *
inquiries 44
Perform Credit 2,500 credit 50 min $40 (0.8*50) $100,000 125,000 (2500 *
Checks checks 50)
TOTAL $462,880 578,600
TOTAL $560,000 700,000
SUPPLIED
EXCESS $97,120 121,400
CAPACITY
Practical Applications of Time-Driven ABC
• The Hunter Company, a large, multinational distributor of scientific products with over 20 facilities, 300,000 customers,
and 460,000 product SKUs, processes more than one million orders each month. Hunter already had an existing activity-
based costing model that had been built with the assistance of an external consulting team. The insights revealed from the
model were extremely informative but many in the company questioned if the view was worth the climb. Their main
complaints can be summarized as follows:
• The model had been difficult to build and maintain. With more than 1,000 activities, the monthly survey of department
staff of where they had spent their time was complex and costly. Also, tracking the driver quantities for each activity and
customer was difficult.
• The model did not reconcile with actual financials since activity cost driver rates had not been updated recently.
• Despite the already large number of activities, the model was still not considered accurate enough. It did not reflect
several important differences between orders. To increase accuracy, more activities would have to be added, and
employees would have to be re-interviewed. Also, an additional data extract to track the quantities of the new cost drivers
would be required.
The existing ABC approach was not easily maintainable, and thus not sustainable. The company called in a
software/consulting company to help it implement the timedriven ABC approach.
The time-driven approach led to the following changes:
For a department, such as the inside sales department, the previous ABC model required employees to estimate,
each month, the percentage of their time spent on their three activities: customer set-up, order entry, and order
expediting. In the time-driven approach, the ABC team estimated the time required to perform each activity.
For example, the activity to set-up a new customer took 15 minutes. Since a field already existed within
Hunter’s ERP system that identified whether a customer was new, assigning a customer set-up cost to a new
customer became a simple transaction. For order entry, the team learned that every order took about five
minutes to enter the basic order information, plus three minutes for each line item on the order. Again this was a
simple calculation to implement since the ERP system already tracked the number of line items for each order.
Finally, the team learned that order expediting was triggered by a request by the customer to rush the shipment,
resulting in an additional 10 minutes of time to coordinate. The order included a field that identified it is a “rush
order.” The project team could write a simple equation to estimate the Inside Sales Department time required for
each order received:
Inside Sales Process Time = 15*[New Customer] + 5 + 3*[Number of Line Items] + 10*[Rush]
The Inside Sales Department cost for the order was obtained by multiplying this time by the cost per minute of
Inside Sales Department resources. This process was replicated in each department to arrive at the total cost of
producing, handling, and fulfilling the order.
The Hunter Company identified the following benefits from shifting its ABC model to the time-
driven approach.
1. It reduced the number of activities to maintain. It transformed 1,200 activities (e.g., set-up new
customer, enter orders, expedite orders) to 200 department specific processes (e.g., the equation
used to estimate Inside Sales Department time). Also, it could easily update the resource cost of
each cost center and departments so that its process costs were accurate and current.
2. Its cost estimates were more accurate since they were based on actual observations of
processing time and actual transaction data, not subjective estimates on where and how people
spent their time
3. It was easier to increase model accuracy and granularity, when wanted, for high cost and
heterogeneous processes. Adding more elements to the time equation enabled managers to easily
add more variety and complexity to the model when required. This enabled managers to identify
customers, and processes where improvements could be made.
4. The model was easier to validate. The calculated total process time, based on all transactions in
a period, could be reconciled to head count (resources supplied during the period). If the total
process time exceeded the actual resources supplied, managers received a signal that some of
their unit times were likely too high. If total calculated process time was well below the time
supplied, but employees felt they were working at or beyond capacity, managers learned that
some of their unit times were under-estimated or employees were working less efficiently than
anticipated.
5. The model provided explicit information on processes operating at or beyond capacity, and those
operating well below capacity. Managers could take action to relieve bottlenecks expected to persist
in future periods, or act to reduce capacity in departments where any unused capacity was expected
to persist for several periods into the future.
Today, it takes two people, two days per month to load, calculate, validate and report findings,
compared to the 10-person team spending over 3 weeks to maintain the previous model. Employees
now spend time generating increased profits from the information rather than just updating and
maintaining the information.
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