In accounting, 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.
The analysis involves classifying business activities as either value-added or non-value-added. Value-added activities increase the customer’s perceived value of the company’s products. In comparison, non-value-added activities incur costs but do not increase the customer’s perceived value of the company’s products. Once activities have been identified as being either value-added or non-value-added, the company can focus on enhancing the value-added activities and reducing or eliminating the non-value-added activities.
Furthermore, company’s utilizing ABM may rank value-added activities on a scale of 1-5 or 1-10 in order to demonstrate different degrees of the customer’s perceived value added by each value-added activity.
Activity-based management has three primary objectives. First, identify and enhance value-added activities. Then, identify and eliminate or reduce non-value-added activities. Finally, redesign the company’s operational procedures so as to improve efficiency, maximize value-added activities, and cut wasteful spending on non-value activities.
Activity based management builds off of an activity-based costing system. Once a company has developed and implemented an activity-based costing system, implementing activity-based management involves the three following steps:
1. Classify activities as either value-added or non-value-added
2. Rank value-added activities in terms of added customer-perceived value
3. Enhance value-added activities and eliminate or reduce non-value activities
If the benefits of doing so exceed the costs, then a company should implement ABM. Implementing ABC and ABM can be costly in terms of time and resources. Many recommend implementing ABM when a company is facing intense price competition. It is also recommended more for companies with many complex products and processes as opposed to companies with simple products and processes.
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Source: Hilton, Ronald W., Michael W. Maher, Frank H. Selto. “Cost Management Strategies for Business Decision”, Mcgraw-Hill Irwin, New York, NY, 2008.