Activity Based Management has evolved from an improved product costing methodology in the late 1980’s (ABC) to a management style that focuses on waste and non-value added time reduction in the organization. Understanding the activities that management pays people to do and what they get in return for the resource commitment is what makes ABM a useful tool. No longer does management need to manage the business through oblique terms such as salaries, wages, overtime, depreciation, etc. Managers can look at the business in a horizontal, or process mode that yields information that is actionable. Management can see the activities that they are paying people to complete, not just cost categories made up in the accounting department. This is information management truly needs.
Data from an ABM system provides management with solid insights as to
where improvements will have the most benefit. Using the data for this
purpose should easily result in the payback for the entire ABM system and
implementation process. Process improvements allow for non-competitive
products to become competitive and even highly profitable if the right
actions are taken to reduce process cost components charged to product.
Where TQM often just provides a nice warm feeling, ABM provides insights
and allows for determining cost reductions, cycle time reductions, etc.
that can be measured financially as far as impact on resource allocations
and profitability for the company
From a process improvement standpoint, the economic value chain should be considered. This value chain extends beyond the company’s doors, into the suppliers’ and customers’ businesses. Identification of what steps can be eliminated or improved throughout the value chain will minimize costs and maximize profits to everyone involved. Activity cost information and cost driver analysis from the ABM system will provide much of this information.
Activity based data is used to determine where to focus improvement efforts based upon the greatest financial return. Activity cost data sorted by cost driver may indicate that product changes result in unacceptable levels of non-value added costs for manufacturing, service and customers. Or, ABM data sorted by process and then by non-value added activity provides solid indicators to management which processes need to be improved or redesigned (re-engineering lends itself best to processes with non-value added costs in excess of 30% of the total process cost). Also, process improvement teams should focus on activities nearer the beginning of a business process as they have the biggest opportunity for downstream impact and, therefore, the biggest savings.
Different tools and methods are available, including fishbone charts, StoryBoarding, Brainstorming, Gantt Charts, O2 Method and others are available to focus efforts on identifying root causes of activities and solutions for improvement. Identification of root causes is critical for real improvement to take place so the most time usually is spent on this phase. Cost driver information from the ABM system helps to focus on root causes .
Combining the teams with proven techniques and solid training yields sound solutions. Once the solutions have been developed, the hardest part of the improvement process starts; implementing the changes and selling the changes to the affected people. Be prepared to get resistance to change no matter how obvious the improvement seems. People need to know and believe that it is better to tie their hopes to their potential than to their past. Until they reach this conclusion, they will resist change with all their might.
Cultural barriers to change frequently impede progress on improvements. Management must commit to change. Change needs to be viewed as for the good of the organization. Top management, in order to support the recommended changes, needs to be actively involved in the change process. How many successful businesses are there today that operate the same way they did in 1985? 1990? None. Change is critical to success.
In order for process improvements to work long term, employee behavior needs to be changed. Employee and management outlook on change and company goals needs to become less and less departmental and more and more process oriented. Everyone needs to understand who their customer is, internal and external. High quality, low cost and timely service needs to be provided to all customers. Until this is clear to everyone, only the surface will be scratched with process improvements.
Work on the change process and on the cultural roadblocks needs to begin very early in the ABM/Process Improvement effort. Using videos and tapes like Barker’s Power of Paradigms, Covey’s Seven Habits, and other change motivation programs help to start the change process. Posting positive results and progress on change programs on bulletin boards and in company newsletters is also important. Posters, pamphlets, charts and graphs and other forms of communication that show the benefits of change and the positive impact of process improvements are mandatory to help build the culture. This part of the change process cannot be emphasized enough. If the culture does not grab hold of the importance of change and how it is accomplished, the effort to improve will be suffocated.
Communicating the information in the ABM system is another roadblock. If the ABM system needs to compete against the GAAP based system or the standard costing system, you will spend more time reconciling the systems than making improvements. GAAP generated financial statements have an external focus with bankers and investors in mind; outside governing bodies tell you how to track and report data. ABM systems are intended for internal use. You decide how to track data and report information. This ABM information is valuable in pricing, marketing, managing processes and departments and improving day to day operations. Once the ABM data base is accurate and reliable, the GAAP based reports should be eliminated except for external purposes.
A case in point. Management frequently evaluates a purchasing department on its ability to hold down raw material costs. This focus, if not balanced with other relevant supplier relationship criteria, can result in working with the worst suppliers in town; those that do not deliver on time, deliver whatever quantity they feel like and have poor product quality. When discussing the adverse affects of his buying habits, one purchasing department employee said, “Until management changes the way they measure my performance and pay me my bonus, I will not change my emphasis on raw material cost reductions.” This person made all of his purchasing decisions based on raw material costs. In one case, this buyer dealt with a low cost supplier that missed a delivery date by two weeks, forcing the shutdown of two work cells in the company. How much did this cost compared to the raw materials savings? ABM will take the focus off of raw material cost reductions and place them on total procurement and manufacturing costs - typically the best supplier doesn’t also have the lowest cost, but the supplier’s quality and delivery performance result in huge cost avoidance in the purchasers organization
What every business needs is a complete set of performance measures,
one that encourages well thought out decisions by employees. As a result,
performance measurement systems need to be changed in many organizations.
Measures need to tie in with and support the company’s vision, goals,
strategic plan and core competencies. The measures need to be balanced
between internal and external and financial and non-financial. Once this
has been done, behavioral changes, initiated and identified through the
ABM process, will have a much better chance of taking place.
If you are considering implementing an ABM system to only to have more accurate product costs, I suggest you hold off. Knowing your true product costs does nothing if you cannot change market price and are not planning on changing your support costs. Only through using process improvements can product costs be reduced, making products more profitable in a fixed market. Using value added and non-value added analysis, a better performance measurement system and discarding the GAAP based system for internal decision making are big steps down the right path.
Many companies, including some of your competitors are implementing
ABM systems to give themselves an advantage in the market by clearly understanding
their resource commitments. With effective use of the information provided
by ABM, they will be able to identify cost reductions, eliminate waste,
reduce non-value added time and reduce cycle time and lead time. What will
your answer be? Will you have enough time to come up with an answer?
Bob has spoken publicly on ABM to over 500 business leaders at seminars and training workshops sponsored by groups such as Minnesota Society of CPA's, Minnesota Technology, APICS and at many Firm sponsored events. Bob is a member of the American Institute of Certified Public Accountants, Minnesota Society of Certified Public Accountants, and he is an Affiliate with the ABC Technologies.
Bob has implemented activity based management/costing systems in
various manufacturing, service and retail businesses. The focus of the
ABM systems has been on customer profitability, process costing, cycle
time reductions, process improvements, and performance measurements. Companies
have ranged in revenues from $4 million to Fortune 100 companies.