We will start with definition of Activity Based Costing (ABC). According to the CAM-I (www.cam-i.org) the definition of ABC is ‘method of costing products through costing the activities’. In ABC we calculate the cost of activities firs and then the cost of products. This does not mean we can calculate cost of products only. It is based on the concept ‘cause-and-effect’. The cost objects (products, customers etc.) consume activities. This means we perform activities for products, customers etc. The activities consume resources i.e. the resources (people, facilities, expenses etc) are utilized to perform the activities. Based on this logic the cost are flown to the products, customer etc. Generally the costs are can be grouped into product related, customer related, unused capacity and the rest are ‘business sustaining costs’.
Activity Based Management (ABM) is a methodology to manage your business. It is like various management techniques that have emerged over a period of time like Management by Objectives (MBO), Management by Exceptions (MBE) etc. Let us see the definition of ABM: it is the method to manage your business with managing your activities to improve operational excellence (internal) or value provided to the customer (external). ABM is calculation of costs with the ABC method then analyze the data and take action on it to improve your business performance.
ABM can be used to understand and improve the performance at all the levels in the organization. It can be used to take decisions about the products, customers etc (Strategic use). It can also be used by a head of the department to manage her portfolio of products or customers (tactical use) or to improve certain processes (operation use). Based on these uses few people have segregated it as ‘Strategic ABM’ and ‘Operational ABM’.
Strategic ABM – ABM can be used for the purpose of taking strategic decisions like adding or retiring products, acquisition or retentions of customers etc. These decisions are based on the profitability information calculated using ABC method. This information is historical information of profitability. This historical information coupled with the future trends, competition etc can help the organization to take the decisions. In other words it is ‘doing the right things’.
The ideal way of performing for an organization is to sell best of their products to best customers. For this the organization has to understand which their best products are and who their best customers are. ABC helps the organization to find their best products and customers as per the profitability. Once the organization has to find out the profitability, it can then group them into deciles (make 10 groups according to their profitability numbers). Each of deciles can be analyzed for products and customers as to what are the reasons for those to fall into that category. Then various action plans can be taken to move them from lowest of the deciles to the highest. As I said this is a historical data of profitability, one has to look for the potential future trends and couple them with current (and historic) data to take the strategic decisions.
ABM models for Strategic ABM are at a comparatively gross level. The activities are defined at almost a process level. Now a day we can calculate the profitability of the products even at SKU (stock keeping unit) level, in the hierarchy LOB-Product Group-Product-SKU. We can also calculate the profitability at account level in banks, subscription level in telecom. This can be grouped at the customer level, household level or other customer segments.
Operational ABM – In this case the use of ABC information is for improving the performance of various operations (processes) in the organization. The process is nothing bust various activities performed in a sequence by one or more functions in the organization. In this case various activities are tagged as ‘value add- non value add’ or ‘core, discretionary or sustaining’ and based on the analysis the activities are eliminated. Here I remember a methodology explained by Gary Cokins as:
a) See if the activity is required by the customer (internal or external). If the activity is not required then eliminate the activity
b) For the rest of the activities see if you reduce the recurrence of the activity. That means see if you can reduce how many times you have to perform the activity
c) Once this is done go one level down i.e. at the task level and repeat the steps mentioned above.
The activity costs can be analyzed by finding their ‘cost drivers’. Cost drivers are the causes of costs for the activity and typically ‘unit cost’ of the activity. For example;
When one wants to improve the cost of an activity, one has to work on those cost drivers. Once we analyze and take action plan to improve on those cost drivers we can measure the performance of the activity. Performance can be measured by at least three ways 1) productivity 2) cycle time 3) quality. This actually forms the horizontal view of the CAM- cross which is also called as ‘Process View’.
Sometimes the cost driver is used interchangeably with the resource driver and activity driver. The resource and activity drivers are nothing but the logic with which the costs are taken from resources to activities and from activities to cost objects.
ABM models for operational purpose are more detailed in the ‘Activity’ section. Here the level is taken to tasks. Most of the times these models can be created for each process separately. If you try to model everything in one then it may create implementation and maintenance issues for the model.
I have seen some of the consultants that do not use any software solution for modeling; it is very difficult for them to calculate the product, customer profitability in detail. They use the information of activity costs to improve the performance of the processes. So the ‘Strategic ABM’ and ‘Operational ABM’ are not altogether new concepts of ABM, but it is just what the concept is used for.
