Midwestern Region
Activity-Based Management:
An Approach to Managing Your Organization
Atool that can help management make competitive headway.
Thomas 1. Zeller and Lea A. P. Tonkin
Instead of wasting time on useless information, why not focus on information that can
lead the firm to world-class status? Why not
supply better information to the work force
and management, helping them to make better decisions? These considerations are among
the reasons why some manufacturing managers are turning to Activity-Based Management (ABM). ABM-related definitions and
applications were among the topics at a recent
AME seminar in Rosemont, IL, presented by
consultantJohn Antos.
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ABM is a process of simplification. The
traditional Activity-Based Costing (ABC) system
of cost allocation (see box below) ties the cost
of resources to activities and the cost of activities to the cost object (generally a product,
business process, or service).
formance measures (see box below). This view
of company activities means linking activity
inputs and outputs across functional boundaries. Examples of business processes are the
procurement process, the sales order process,
or the design process.
An ABM system focuses attention on the
process of business activities. Abusiness process view ties activities to cost drivers and per-
Cost drivers are factors that determine the
work load and effort required to perform an
activity and cause cost in subsequent activities.
Update on Excellence
They tell you why an activity is performed and
how much effort must be expended to carty out
the work l , 2 For example, the occurrence of a
large number of defects is a cost driver that can
increase the effort needed to conduct customer
service activity.
Performance measures describe the work
done and the results of the work achieved in,an
activity - how well an activity is performed. 3
Performance measures include, for example,
cost per unit of activity, time to perform the
activity, and the quality of activity performed.
Information to Improve Business
Processes
ABM equips employees and managers with
information to improve business processes.
Using ABM, they focus on the cost, time, and
quality of tasks performed by people or machine
within a business process.
For example, material receiving may be
viewed as a manufacturing activity, and the
tasks within it as a process. Material receiving
tasks might include: receive, move, inspect, and
expedite material. The left side of Figure 1shows
traditional accounting data classified by function in the receiving department. Information in
this format does not help management improve
the receiving department process.
Reclassifying the accounting data according to tasks within the receiving department
(Figure 1, right side) provides information that
is helpful in decision making about performance improvement. In this example, accounting data classified by activity allows managers
and employees to focus on reducing non-value
tasks such as moving, inspecting, and expediting material.
The process view of each activity provides
a versatile,tool for continuous improvement
efforts. For example, instead of focusing on
value versus non-value tasks, the user may need
information about primary time versus secondary time related to work (such as product
development or check processing time). In product development, primary time would be the
time spent on actual development and secondary time might be devoted to meeting
bureaucratic requirements.
Focus on Resource Allocation
An ABM system can also be used to focus
attention on resource allocation. Management
Receiving Department ABM Reorganization of Existing Data
Charts of Accounts View
Supplies
$1000
Depreciation
8000
Overtime
3000
Salaries
35,000
Other
500
Total
$47,500
ActiVity Accounting View
Value
Non-Value
Receive material
Moving
Inspection
Expedite
$29,000
1000
6000
$2500
3000
2000
4000
Total
$36,000
$11,500
Figure 1. On the left side of this figure, users find traditional accounting data classified by function in the
receiving department. Reclassifying according to tasks within the receiving department (right side),
accounting data is helpful in decision making about possible performance improvements; non-value activities
such as moving, inspecting, and expediting material are highlighted in this example.
may want to compare, for example, the
amount of resources consumed by an activity
and the resources supplied for an activity at the
task level. Asignificant difference between
"supplied" versus "consumed" indicates where
resources are needed and where they can be
recovered. 4
An ABM perspective complements Total
Quality Management (TQM) activities and
concepts. For example, a quality measure for
the receiving department might be the percentage of receipts without error per dollar of
resource committed to the task. An increasing
error-per-dollar rate would tell the workforce
and management that something is wrong
within the system, and approximately how
much the error is costing the company.
Creating a "Bill of Activities"
Acost-based ABM system helps users
plan and control the costs consumed by activities and business processes across the organization. In this case, the focus is on controlling
activities that create costs. The cost structure of
each activity should be viewed as a constraint
in meeting the customer's needs and wants.
For example, activity information can be
compiled at the product level to view the entire
cost-process relationship in a "bill of activities." Abill of activities can help the work force
and managers tie the company's reward structure to desired company-wide performance (in
meeting customers' needs and wants) rather
than to individual activity reports.
ABM's versatility and its focus on the process rather than the product can help the user
improve a variety of business processes,
according to Antos. He cited ABM use to identify cost savings opportunities at an aerospace
manufacturing firm, to identify process
improvement options in a health care center, to
improve product costing by a candy manufacturer, and to enhance a software company's
productivity and product costing.
ABM Implementation
Implementing a successful ABM program
requires a systematic effort by management
and the work force. The first and foremost
requirement for ABM success is long-term top
management support. Management must
ABM is not a quickfix or a
''Project ofthe month. "
define the use and application of an ABM system and link performance evaluation to output
measures of the ABM system. They must also
specify a time frame for an ABM system. For
instance, it must be speCified as an ongOing
analysis of process improvement or a one-time
analysis of product cost, within management
capabilities. Without top management commitment, it is not advisable to proceed with an
ABM system, Antos said.
ABM is not a quick fix or a "project of the
month." Program maturity requires time and
experience. "An ABM system creates questions
first and solves problems second," Antos said.
Apilot project is the best place to start. It
quickly generates interest and results. Appointing top management responsible for the pilot
signals the company's commitment to ABM. The
users - work force and management - need
training in ABM, and they must be convinced
that it can provide information to help them
improve customer service and other measures.
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Mayljune 1993
Update on Excellence
Step-By-Step Approach
Figure 2 outlines specific steps to implementing an ABM pilot project. Top management starts by defining the scope of analysis.
They should identify specific objectives, such as
identifying cost savings opportunities, process
improvements, or productivity gains. Activity
analysis, step two, is driven by the need or scope
defined in step one. Akey factor is matching
organizational structure and company needs.
Activity definition, step three, involves
selecting primary activities for evaluation. The
rule of thumb is to select five to eight significant activities per department (each of the
activities should use more than five to ten percent of consumed time or cost). Selecting too
many activities is a common mistake; it distracts from the major process under study.
Identifying activities is not a simple job.
According to Antos, this step may require considerable time, training, and experience. Personnel training, activity sampling, and a study
of the production process, along with historical
data, etc., aid the identification of activities.
Activity cost calculations, step four, establishes the link between traditional accounting
information and reclassified information that is
helpful to users (as in Figure 1). This task is not
an exact science, and it requires sound judgment
and flexibility, Antos said. It is likely that acompany will modify the reclassification procedure
after gaining experience with an ABM system.
Step five, output measure definition, is an
evaluation of activity output. Each activity
should have one output. For example, the output for an "issue purchase order" activity
might be the purchase order itself or the number of lines on each purchase order.
Step six provides the user with information to control the time, cost, and quality of
activities performed by people or machines. To
calculate, rationalize, and verify activities
means taking the reclassified data and turning
it into information in a more usable form. For
example, management can look at:
1. Activity output volume
2. Dollar resource supplied per activity output
3. Dollar resource used per activity output
4. Cost per unit of activity
5. Apply the information to help make the
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Target
Activity Definition Methodology
select ActiviIy Analysis Approach
Step 1
Step 2
Step 3
Step 4
Step 5
Step 6
••
•
Step 7
Figure 2. Steps to implementation ofan ABM pilotproject, starting with defining the scope ofanalysis, are shown.
product mix decisions
6. Benchmark to company best practices, a
specified target, a competitor, or a world-class
company in that activity regardless of industry.
Putting ABM into action is step seven,
which has three parts. First, a company should
define cost drivers for each significant activity.
Cost drivers cause acompany to spend time and
money performing an activity. For example,
cost drivers for an "issue purchase order" activity might be poor training, automation, multiple
vendors, or incomplete requests from engineering. Once cost drivers are defined, the troops
should begin working on ways to reduce or
eliminate the cost drivers that do not contribute
to meeting the customer's needs or wants.
Second, activities must be linked to form
a business process. Examples of business processes are new product introduction or complaint resolution. Once existing processes are
defined and flow-charted, employees should
look for ways to streamline the cost of the process, reduce process time, and improve the
quality of the process.
Third, the work force and management
must be empowered to define time and quality
parameters for each activity. In tum, some activities may be eliminated or completely redefined.
Where and How to Get Started
ABM systems are the exception rather
than the rule. In fact, most ABM systems are in
the preliminary application phase of implementation, Antos said. Managers considering
an ABM system can find additional igformation in a variety of sources.
Journals may be the best place to start.
For example, Target has assembled materials
on activity-based concepts. 5 Management
Accounting, Harvard Business Review, and
Journal of Cost Management are added journals that can prOVide background reading
material for a more complete understanding of
ABM and its advantages and disadvantages.
Limited text material on ABM is available. Cooper and Kaplan have a case and related reading text available on ABM, The Design
of Cost Management Systems published by
Prentice Hall in 1991. 6 Antos and James A.
Brimson wrote a book, Activity Accounting,
published byJohn Wiley & Sons in 1992.
An activity-based dictionary may be useful. Tom Pryor of Arlington, TX has published
one. This type of reference guide saves implementation time and reduces communication
problems when companies are studying and
adopting an activity-based system. Computer
Aided Manufacturing-International (CAM-I)
offers a glossary of ABM terms.7 Arecent book,
Common Cents: The ABC Performance
Breakthrough by Peter B.B. Turney,8 is available, as well as H. Thomas Johnson's book,
Relevance Regained. 9 (See review on p. 52.)
Evaluation of computer software is necessary in planning for an ABM system. Several
PC-based packages are available, offering a
wide range of costs, output options, and technical requirements. Most packages offer a
"demo" disk for review of the product. Accounting journals such as Management Accounting
feature advertisements of such software.
ABMWrap-Up
In summary, ABM offers the work force
and management useful information, and it
helps them to focus their attention on the pro-
Update on Excellence
cess of activities where significant improvements can be made. How and when the troops
respond to the information is what leads a
company to world-class status. The benefits of
improved decisions afforded by an ABM system
cannot be deferred; while you contemplate
change, the benefits are lost.
Implementing an ABM system requires
planning, training, management, qualitative and
quantitative skills. Critical ingredients include
accurate identification of the needs of the business and top management commitment. The
person in charge of the new system must be able
to see the "big picture" regarding the cost/benefit
of a long-term shift in measuring, controlling,
and planning the strategy of the enterprise.
1. Brimson, Jim, Activity Accounting, John Wiley & Sons, 1991,
p.69.
2. Turney, Peter B.B., "Activity-Based Management: ABM Puts
ABC Information to Work," Managemmt Accounting, January
1992, pp. 20-25.
3. Ibid.
4. See Cooper, Robin, and Robert S. Kaplan, "Activity-Based Systems: MeasUring the Cost of Resource Usage," Accounting Horizons, September 1992, pp. 1-13, for more details.
5. Target's reprint collection, The New Manufacturing
Accounting for Non-Accountants; How Companies Improve
by Using (Not Just Compiling) Cost Information, features
articles on Activity-Based Costing (ABC), cost accounting basics,
and accounting cycle time at companies such as Motorola,
Hewlett-Packard, and Stratus Computer; available through AME,
380 W. Palatine Road., Wheeling, IL 60090; 708/520-3282.
6. Abroad range of case studies about ABM implementation can
be found in the publication, Implemmting Activity-Based Cost
Managemmt: Moving From Analysis to Action, by Robin
Cooper, Robert S. Kaplan, Lawrence S. Maisel, Eileen Morrissey,
and Ronald M. Oehm, a joint study by the Institute of ManagementAccountants, Montvale, NJ, 1992.
7. See Norm Raffish and Peter B.B. Turney's The CAM-I Glossary
ofActivity-BasedManagmmt, Computer Aided ManufacturingInternational, Arlington, TX, 1991.
8. Turney, Peter B.B., Common Cmts: The ABC Performance
Breakthrough, published by Cost Technology, Portland, OR, 1991.
9. Additional insight regarding the fit of ABM and the global business environment is developed in a recent book by H. Thomas
Johnson, Relevance Regained (Free Press, 1992). Areview, by
Thomas 1. Zeller, of the book is featured in this issue of Target.
Thomas I. Zeller, Ph.D., C.PA, teaches cost/managerial
at Loyola University in Chicago, Department of
Accounting. Lea A.P. Tonkin, Target managing editor,
is a communication consultant based in Woodstock, II.
She is a member ofthe McHenry County (IL) fIPA Oob
Training Partnership AcO Private Industry Council and
AME's Midwest Region board
© 1993AME®
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