Activities Based Management is used to describe the cost management applications of Activities Based Costing.
Activities Based Management views the business as a set of linked activities that ultimately add value to the customers.
It focuses on managing the business on the basis of managing the activities that make up the organization and assumes that such activities consume costs. Therefore by managing activities, costs will be managed in the long term.
Simple, Activities Based Management build the principle of activities based costing and activities based budgeting to improve the profitability of an organization.
It does this by identifying which activities can be performed more efficiently, which activities can be eliminated entirely, how changing the design of a product can lower costs and improve relationships with customers and suppliers.
Traditional budget and control report analyses cost by type of expense at each cost center. In contrast, Activities Based Management analyses cost by activities and providing management with information on why the cost is incurred and the cost drivers.
Activities Based Management focuses on managing the business on the activities that make up the organization.
It is based on the premise that activities consume cost. Therefore, by managing the activities, the cost will be managed in the long term.
The goal of Activities Based Managements is to enable customers to need to be satisfied while making less demand for organization resources.
Prior to the introduction of ABM, most of the organizations have been unaware of the cost of undertaking the activities with the highest cost to be highlighted so that they can be prioritized to detail study whether they can be eliminated or perform more efficiently.
Value-added and Non-value added:
To identify and prioritize the potential for cost reduction using ABM, many organizations found it is useful to classify activities as either value-added or non-value added. By doing so, the organization knows clearly what activities should improve should to eliminate.
Value-added activity is an activity that customers perceive as adding users to the product or service they purchase whereas a non-value added activity where there is an opportunity for cost reduction without reducing the product’s service potential to the customer.
Taking action to reduce or eliminate non-value added activities is given top priority because by doing so the organization permanently reduces the cost it incurs without reducing the value of the product to customers.
However, management should be making sure that the eliminations are not affecting other value-added activities.
To implement an Activities Based Management system, the following stages.
Here are three steps to implement Activities Based Management:
Step 1: Identify the major activities in an organization
In this step, we simply study the activities that happen in the organization or in the specific production process.
First, you probably pick up all the activities and then categorize them into different categories. Remember, this stage we select only the important activities in the organization.
Therefore, once we categories the activities, we then select only the important activities for study. For example, the major activities in the organization include:
- Purchase order
- Material handling
- Quality Inspection
- Assembly, and
Maybe there are many other important activities in the organization that is not included here. But, here are all the activities.
So, once we identify the major activities, we then need to assign the costs to those activities. Late see next step,
Step 2: Assigning cost to cost pools/ cost centers for each activity
Now it is time to assign the cost to those activities that we identified above. This is a very important stage of Activities Based Management, and probably the most difficult in the real situation.
The reason is the cost of those activities is not realistic or we cannot obtain enough data to assign the cost for those activities as most of the system or accounting records are not classified for.
n general, the accounting records are based on the types of staff or material rather than activities. To implement this we do need system that could accomplish such kind of reports. For example, how much is the cost for assembly and how much is the cost of installment.
Now assume you have all of those reports and data.
Let move to the next step,
Step 3: Determining the cost driver for each activity
In this step, you simply need to find out what is the cost drivers of each of the activities that you find in step 2. For example, Quality Inspect, probably the number of inspections or hour spend for inspection.
This is very important and you need to figure out this. So once you figure out the cost drivers, you then need to accomplish the number of those drivers spend in each product.
Then you will know, which product you spend a high cost and which product you spend a low cost. By knowing this, you then could manage the activities by making sure that those activities run more efficiently.
I hope this Activities Based Management help.
Boston Consulting Group develops a matrix that could help the management of the company to assess the position of the strategic business unit and develop the right strategy in order to maintain and improve business units or products.
In a large business corporation, there are many types of products, division and business units that diversify differently.
Such product, division, and business units are position differently base on their market share and market growth. Basically, the products that have a high market share and have high demand in the market would stand on top of business portfolio management.
It is very important for management to assess how the position of their products or business unit in the market is.
Knowing the strategic position of products is not only helps managers to develop the right strategy for those products but also helping them to design the right measurement systems in order to keep that product move in the right direction.
Boston Consulting Group model classifies the business unit into four different categories based mainly on their market share and market growth.
Star Product in Boston Consulting Group:
Star refers to a product or group of products that gain better market shares than other similar products in the market.
These minds of products are currently satisfied with the customer’s requirements. The market growth or demand for these products in the market keeps increasing, while the prices are less competitive.
Such products normally earn a high-profit margin as customers are willing to pay. The competition in the market seems low for these kinds of products because not many competitors come.
Management should be setting up the right strategy and put the right performance measurement for this kind of product. For example, growing in sales compared to the total market share.
This is to ensure that these types of products still play in rank number one in the market. Management should also measure customers’ satisfaction.
In case, there are new competitors come into the market, the company still retains the old and keeps recruiting new customers since their services and product quality is good. Maybe a survey on customer satisfaction should be deployed.
Problem child in Boston Consulting Group:
Problem child refers to new products that just launched in the markets and the demand for those products is increased highly. However, these group of products doesn’t gain a better share in the market.
For example, your company is selling coffee, and currently, the demand in the market is quite high. Yet, your company does not get a high turnover on it. Base on Boston Consulting Group, Coffee here should be classified as Problem Child.
The product that class in Problem Child simply because of the internal problem rather than external effect. The product is quality, service, and awareness of your coffee in the market. Not the market itself.
The three important things to consider for the product in Problem Child are the quality, service, and branding. Maybe, the company should do more market research about these group of products, learn more about customers’ requirement and make sure the quality of products meet the requirements.
Cash cow in Boston Consulting Group:
Based on Boston Consulting Group, cash cow refer to the group of products that currently have high market share, but the demand seems to be mature. Maybe because there are a large group of competitors or substitute for products.
These groups of products generate a good amount of cash for the company but they will soon become Dog.
In most cases, management intends to keep cash cow products stay as long as they could be, as they generate a large amount of cash even low margin.
Management should be making sure that the products will meet the customer requirement and probably add on services to lock customers are required. More importantly, controlling the production process and costing management would be much better for gaining a better margin.
Dog in Boston Consulting Group:
Products that treat as Dog are the ones that gain low market share and poor market growth. In most cases, these groups of products are decided to be dismantled from the portfolio.
However, the assessment needs to be performed whether these types of products have a connection with others stare, cash cow or problem child or not.
These that is the case, management need to make whether dismantle these products could adversely affect those products.
Limitation of Boston Consulting Group Model
Besides helping management to assess the strategic position of Strategic Business Unit, Boston Consulting Group Model also have some limitation that could lead to miss allocation of products and subsequently lead to wrong decision making.
- Assessing the market share and market growth might be difficult and realistic. Such data might not available for certain markets or countries. If we can’t obtain those data accurately, the decision also seems unlikely correct.
- BCG focuses only on two main factors: Market Share and Market Growth, but to make a better assessment, other factors could also be important. For example, the attractiveness of products or services
The model considers each class of products are independent, yet in any case, the products of the company are linked together. The model seems unrealistic in this classification.
Activities Based Costing treats direct cost the same to absorption costing. However, Activities Based Costing treat the overhead cost based on activities that drive production.
For example, planning, scheduling, number of orders, labor hours, machine hours, etc. Absorption costing treats overhead based mainly on Direct Labor Hours or Direct material.
The following are simple steps to calculate Activities Based Costing:
Records Direct Cost ( Direct Material and Direct Labor) for each Product:
All you need to do in this step is to record all direct costs related to the product separately. This is the same as Absorption costing, prime costs (direct labor and direct material) are records separately.
After you deal with direct costs, now it is time to deal with overhead costs. As mention above, Activities Based Costing, the cost is absorbed into the product base on the main driver that drives those products.
Related: Absorption Costing (Ultimate Guide)
Therefore, what we need to do in the next step is to identify the activities in the organization.
Identify organization activities:
The step requires us to study about the activities in the organization that drives overhead cost. For example, there are ordering of products, handling material, product dispatch, and production schedule.
Collect the cost of each activity into what is called cost pool:
Then, collect cost data related to those so that we can find the real cost that each product should absorb. For example, how much the entity expenses on ordering activities, material handling, production scheduling, and dispatch.
Noted: Cost pool is an activity that consumes resources and for which overhead costs are identified and allocated. For each cost pool, there should be a cost driver.
Identify the factors which determine the size of the costs of activities:
In this step, we find the driver of each activity.
Activities: Cost Drivers:
Ordering Number of Orders
Material Handling Number of Production Run
Production Scheduling Number of Production Run
Dispatching Number of Dispatches
Then, calculate the Cost Driver Rate and apply them to each product.
Dispatching driver rate = Dispatching up cost / Number of Dispatches
Noted: Cost driver is any factor that causes a change in the cost of an activity.
Assign the cost of activities to products:
Now it is time to apply the cost of each product based on the driver that it consumes. For example, Product A required 600 number of dispatches and the dispatching driver rate is 5$.
Then, dispatching cost for Product A is 600 * 5 = 30,000$
Compare to Absorption Costing, Activities Based Costing is more accurate and it could help managers to manage the performance of the company as well as producing more effectively.
For example, management may study which cost that drives the overhead the most for product A.
Then, management might compare those costs to other products and companies. Subsequently, the benchmark against those costs for improvement will start.