R Joswa Caxton (13MM08)

Activity Based Management1ABM : ConceptValue Added Analysis TreeValue added activityStrategic activitySupport activityValue added analysis in manufacturingSyllabusABM: CONCEPTA procedure that originated in the 1980s for analyzing the processes of a business to identify strengths and weaknesses. Specifically, activity-based management seeks out areas where a business is losing money so that those activities can be eliminated or improved to increase profitability. ABM analyzes the costs of employees, equipment, facilities, distribution, overhead and other factors in a business to determine and allocate activity costs.Investopedia: Activity-based management can be applied to different types of companies, including manufacturers, service providers, non-profits, schools and government agencies, and ABM can provide cost information about any area of operations in a business. In addition to improving profitability, the results of an ABM analysis can help a company produce more accurate budgets and financial forecasts.

Definition of ABMActivity-Based Management (ABM) manages activities to improve the value of products or services to customers and increase the firms competitiveness and profitability.ABM draws on ABC as its major source of information and focuses on the efficiency and effectiveness of key business processes and activities.Using ABM, management can pinpoint avenues for improving operations, reducing costs, or increasing values to customers.By identifying resources spent on customers, products, and activities, ABM improves managements focus on the firms critical success factors and enhances its competitive advantage.BRIEFING ABMABM supports business excellence by providing information to facilitate long-term strategic decisions about such things as product mix. ABM allows product designers to understand the impact of different designs on cost and flexibility and then to modify their designs accordingly. ABM is more than an accounting tool; it's a system for continuous improvements.The real value and power of ABM comes from the knowledge and information that leads to better decisions and the leverage it provides to measure improvement.

BRIEFING ABMABM classificationABMOperational ABMStrategicABMIt enhances operation efficiency and asset utilization and lowers costs; Operational ABM applications use management techniques such as activity management, business process reengineering, total quality management, and performance measurement.

ABM classification :Operational ABMStrategic ABM attempts to alter the demand for activities and increase profitability through improved activity efficiency. Strategic ABM focuses on choosing appropriate activities for the operation, eliminating nonessential activities and selecting the most profitable customers.

Strategic ABM applications use management techniques such as process design, customer profitability analysis, and value chain analysis.ABM classification : Strategic ABM

ABCs Horizontal view of Org.The cost of activities and business processes;The cost of non-value-added activities;Activity-based performance measures;Accurate product/service cost (cost objects);Cost drivers.Outputs of ABMThe cost of activities and business processesThe basic output of the ABM system must be to provide relevant cost information about activities.The cost of non-value-added activitiesA non-value added activity is an activity that is considered not to contribute to customer value or to the organization's need.This is defined as waste. Identification of waste is valuable to management.This crucial information output provides a focal point for improvement efforts.Outputs of ABMActivity-based performance measuresIn addition to cost information for business processes and activities, the ABM system must report information and data on activity performance.Knowing the total cost of activity is insufficient to measure activity performance.Activity measures of quality, cycle time, productivity and customer service may also be required to judge activity performance.

Outputs of ABMAccurate product/service cost (cost objects)Because products and services consume resources at different rates and require different levels of support, costs must be accurately determined. Cost driversA cost driver is any factor that causes a change in the cost of an activity. An activity may have multiple cost drivers associated with it.

Outputs of ABMABM MODELABM MODEL - Cost Accounting Management-International (CAM-I)

Steps in ABM ImplementationAnalysis of activitiesIdentify value-added and non-value-added activitiesAnalysis of critical activitiesCompare activities with benchmarkingImprovement of activitiesReduce the time or effort required to perform an activityEliminate unnecessary activitiesSelect low-cost activitiesSharing of activitiesSteps in ABM ImplementationPerformance measurementsIdentify the root cause of the problemThe 5 whys - Fix the problem, not treat the symptomEstimate cost and cost savingsEvaluate results

Steps in ABM Implementation

Activity AnalysisTo be competitive a firm must assess each of its activities based on its need by the product or customer, its efficiency, and its value content.

REASON FOR ANALYSISIt is required to meet the specification of the product or service or satisfy customer demand.It is required to sustain the organization.It is deemed beneficial to the firm.Activity AnalysisActivity Analysis: The Heart of Cost Reduction1.Activity elimination2.Activity selection3.Activity reduction4.Activity sharingActivity Analysis Can Reduce Costs Four Ways:Value Added Analysis TreeAnalysis andClassificationValue-addedActivitiesNonvalue-addedActivitiesActivitiesReduce orEliminateContinually Evaluate and ImproveValue Added Analysis Tree

Activities that augment accuracyThat are necessary or required to meet customer requirements or expectations.That enhance purchased materials or components of a product.That contribute to customer satisfaction.VA & NVAThat are critical steps in a business process.That are performed to resolve or eliminate quality problems.That are performed upon request of a satisfied customer.That you would do more of, if time permitted

A value-added activity is one that, if eliminated, would affect the accuracy and effectiveness of the newscast and decrease total viewers as well as ratings for that time slot.

Activities that augment delayCan be eliminated without affecting the form, fit, or function of the product or service.Begin with prefix re (such as rework or returned goods).Result in waste and add little or no value to the product or service.Are performed due to inefficiencies or errors in the process streamVA & NVAAre duplicated in another department or add unnecessary steps to the business process.Are performed to monitor quality problems.Are performed due to a request of an unhappy or dissatisfied customer.Produce an unnecessary or unwanted output.If given the option, you would prefer to do less of.

A low-value-added activity is one that, if eliminated, would not affect the accuracy and effectiveness of the newscast. The activity contributes nothing to the quest for viewer retentionVA & NVA

Activity Performance MeasurementActivity Performance Measurement1. Efficiency2. Quality3. TimeThree Dimensions of Activity PerformanceOperational Measures for Quality1.Defects per unit2.Number of defective units per total units produced3.Percent of external failures 4.Pounds of scrap per total pounds of materials issuedOperational Measures for EfficiencyOutput per materialsOutput per labor hoursOutput per persons employedOutput per kilowatt hoursOperational Measures for TimeThree Major cost elements:1. Development costs: planning, design, and testing2. Production costs: conversion activities3. Logistics support costs: advertising, distribution, warranty, etc.Planning Design Testing Production Logistics 100

90

75

25

Cost Commitment CurveLife CycleCost %90 percent of life-cyclecosts are committed at thispointActivity improvementIntegrating and linking ABM with existing performance measurement systems, improvement initiatives, reward systems, value-based and core competenciesEnsuring that system design specifications take into account techniques such as benchmarkingtransferring ownership of the system to line management;Implementing and emphasizing continuous improvement;Training managers on how to use the ABM informationActivity improvementThe Strategic ManagementABM and The Strategic Management Process

Customer Profitability AnalysisCustomer Profitability AnalysisCustomer profitability analysis usesactivity-based costing to determinethe activities, costs, and profit associated with serving particular customers.

Customer Profitability AnalysisOrderssmallquantities.Ordersfrequently.Oftenchangesorders.Requiredspecialpackaging.Demandfastservice.

A costly customerIdentify most profitable customers.Manage each customers costs-to-serve to a lower level.Establish a surcharge for or re-pricing expensive costs-to-serve activities.Reduce services for high cost-to-serve customers.Introduce new products and services.Improve the process of customer service.Offer discounts to gain more volume with low costs-to-serve customers.Select customer mixWhat types of customer should we market to? What types should we not market to?Choose types of after-sale services to provide.Customer Profitability AnalysisIdentifies activities and cost drivers to service customers before and after sales, not including product costs.customer-specific activities include:Order processing costs.Billing, collection, and payment processing costs.Accounts receivable and carrying costs.Customer service costs.Return or allowance processing costs.Restocking costs, Selling and marketing costs.Customer Cost AnalysisCustomer unit-level cost resources consumed for each unit sold to a customerCustomer batch-level cost resources consumed for each sales transactionCustomer-sustaining cost resources consumed to service a customer regardless of the number of units or batches soldDistribution-channel cost resources consumed in each distribution channel the firm uses to service customers.Sales-sustaining cost resources consumed to sustain sales and service activities that cannot be traced to an individual unit, batch, customer, or distribution channel.Customer cost analysis

Focus on critical needsGet top management supportThe main cost systemConsider a separate modelThe existing information systemThe implementation teamStart with product costingGuidance on implementing ABMCase study :

G. E. Mustill (GEM) G. E. Mustill (GEM) is a small company with 0.5 million annual turnover.It employs about 20 people and is located in Essex, England. The main products of GEM are four types of machines ( viz. sander, splitter, shaper and foiler) for the picture framing industry.The foiler and sander machines are produced in different numbers of heads varying from 1 to 6. They produce machines in standard specifications and according to customers requirements. The company manufactures only 22% of parts of the machine in-house and purchases 78% of parts from subcontractors and suppliers.The assembly of all these parts is the main activity of the companyAbout GEMThe company works in a traditional way and all activities are performed manually. Information provided by an ABC system is used to find the opportunities of improvement in organization at the activity level. The analysis of activities involves classification of activities into value added and non-value added and then compare these with that of the world class company or the best practices. Benchmarking with the best practice offers avenues for improvement in value-added activities. This also explains how management can use the cost drivers as the performance measures and control the volume of cost drivers.The ideal cost object is `products that are sold to customers. The cost of all activities is calculated in a similar way to that of partsAbout GEMIn this case study the problem is approached in three steps

Analysis of activitiesCompare activities with benchmarkingPerformance measurementsApproachMarketing:The annual cost o f marketing is 23 330 which is divided equally between four types of machines. Then, this amount is divided by eight because the annual sale of a four-head foiler is eight machines. Therefore, the marketing cost for this product is 729.06.Inventory carrying cost:The cost driver for inventory carrying is the stock value.The total s tock value in GEM is 20 000. For a four-head foiler, the stock value is 1600. Hence, the inventory carrying cost for this machine is 491.20.General analysisEngineering support: The cost driver for this activity is the time spent by the engineering support staffs for a particular product. For this machine, a total of 80 h is spent by the engineering staffs and hence the cost of engineering support activity is 1480.. Assembly:The assembly of the machine is per-formed manually. The cost driver for assembly activity is the labour hours and the volume of the cost driver is 82 h. This leads to the total assembly cost as 886.42.

General analysisThe total cost of a four-head foiler

ABC provides detailed information about the company and its activitiesAnalysis of activities

Once the cost of each activity is calculated, the next step is to identify the value-added and non-value-added activitiesAnalysis of activities

It may not be possible to eliminate or reduce all nonvalue-adding activities at the same time. The key is then to focus on the critical activities which form a major portion of the total cost.Analysis of activities

Purchasing: World-class companies have a direct link with suppliers and subcontractors by the electronic data exchange (EDI) system, and it places orders automatically whenever materials are required.This leads to a reduction in ordering cost, lead time and overall purchasing cost as compared with that of manual order processing. Hence, there is room for improvement in the purchasing activity of GEM.Assembly:The assembly activity is performed manually in GEM. Compared to an automatic assembly activity, there are many chances of improvements. The cost of automation should be justified based on the labour cost and response time including tangible and intangible costs and benefits. .

Compare activities with benchmarking Material handling:The movement of materials between these stations is the cost driver. It is possible to reduce this movement by using multipurpose machines (AS/R S, robots, AGV s) to perform various operations.The movement of materials can also be reduced by changing the layout of machines. .Machining operations:GEM uses very old machines to perform basic activities like drilling, milling etc. and these are labour intensive. These machining operations can be compared with that of the CNC machine tools.

Compare activities with benchmarking Non-value-added activities are clearly identified. In GEM, the inventory carrying activity is the major nonvalue-added activity which should be eliminated.

However, it is difficult because the purchasing cost of the present system will increase as the company places more purchased orders with the objective to reduce inventories. Therefore, it indicates that the purchasing activity should also improve.

The comparison of this purchasing activity with the best practice (purchasing using EDI) indicates the scope for improvements.

Performance measurementsThe costing at part level or subassembly level helps the management in a make or buy decision. The analysis of activities to identify value-added and non-value-added activities and benchmarking at the activity level direct improvement efforts in the right direction.ConclusionImplementing Activity-Based Management: Avoiding the Pitfalls : Institute of Management Accountants (IMA)DEVELOPING AND PROMOTING STRATEGY : Activity-based Management An Overview : CIMA Technical briefingActivity-based management in a small company: a case study by A. GUNASEKARAN, R. MCNEIL and D. SINGH (PRODUCTION PLANNING & CONTROL, 2000, VOL. 11, NO. 4, 391 399)ACTIVITY-BASED COST MANAGEMENT - An Executives Guide by Gary Cokins, publication : John Wiley & Sons, Inc.ReferenceTHANK YOU