Introduction of Activity-based management

Activity-based management (ABM) is a method of identifying and evaluating activities

that a business performs using activity-based costing to carry out a value chain analysis

or a re-engineering initiative to improve strategic and operational decisions in an

organization. Activity-based costing establishes relationships between overhead costs and

activities so that overhead costs can be more precisely allocated to products, services, or

customer segments. Activity-based management focuses on managing activities to reduce

costs and improve customer value.

Kaplan and Cooper (in Kaplan, R. S., & Cooper, R. (1998). Cost and effect: Using

integrated cost systems to drive profitability and performance. Boston: Harvard Business

School Press.) Divide ABM into operational and strategic:

Operational ABM is about “doing things right”, using ABC information to improve

efficiency. Those activities which add value to the product can be identified and

improved. Activities that don’t add value are the ones that need to be reduced to cut costs

without reducing product value.

Strategic ABM is about “doing the right things”, using ABC information to decide

which products to develop and which activities to use. This can also be used for customer

profitability analysis, identifying which customers are the most profitable and focusing

on them more.

A risk with ABM is that some activities have an implicit value, not necessarily reflected

in a financial value added to any product. For instance a particularly pleasant workplace

can help attract and retain the best staff, but may not be identified as adding value in

operational ABM. A customer that represents a loss based on committed activities, but

that opens up leads in a new market, may be identified as a low value customer by a

strategic ABM process.

Managers should interpret these values and use ABM as a “common, yet neutral, ground

… this provides the basis for negotiation” (Kennedy, T., & Bull, R. (2000). The great

debate. Management Accounting, 78). ABM can give middle managers an understanding

of costs to other teams to help them make decisions that benefit the whole organisation,

not just their activities' bottom line.

Introduction about review

Johnson & Kaplan (1987)’s publication of the book titled 'Relevance Lost' brought revolution in the history of the management accounting. The then management accounting systems failed to provide relevant information for product costing and performance evaluation in the time of ‘rapid technological change’, ‘fierce competition’, and ‘information processing revolution’. The pre-war cost accounting systems were designed to meet the financial reporting and tax planning needs. They failed to provide information for managerial decision-making and control purposes. Drucker (1992) argued that accounting systems should provide answers about their businesses, markets, customers, and environment to ‘information literate’ manager. Thus, the role of a management accountant expanded in multiple dimensions. They were not just to collect the cost information as accurately as possible but also analyze the utility of the cost information for taking vital managerial decisions. This new paradigm of management accounting called for certain additional skills of the management accountants. Anastas (1997) discussed the changes required in the skill set of the management accountants in view of the “Project Millennium: Customers & Future Markets…Looking Ahead to 2007”.The newfound utility of cost accounting led to a churning of the whole cost accounting system, its methodology and even it's philosophy in the mid 1980s. The most prominent that emerged out of the whole brain storming process was activity-based cost management system.This system was claimed to have the ability of providing accurate cost information while removing distortions in product/service pricing and customer profitability analysis in a complex manufacturing environment. Cooper (1988a, 1988b, 1989a, 1989b & 1995), Cooper & Kaplan (1988, 1991,1992, 1997 & 1998). For comprehensive review on the subject, see Borden (1990) and Cooper (1996).The present study plans to identify activity-based cost management practices in corporate India. Further, it investigates whether the corporate India uses contemporary cost management tools in the value chain analytic framework.

REVIEW OF LITERATURE

Evolution of Activity-Based CostingHighlighting the limitations of traditional costing systems in overheads cost allocation in a situation of product diversity in terms of volume and complexity Cooper (1988a) illustrated the need for activity-based costing system. Consistent with this research, Cooper (1988b) found that the firms facing high level of competition and having diverse product mix are more likely to benefit from precise cost information and the introduction of activity-based cost systems with an added caution that the activity-based costing system introduction initiative itself should be cost effective. 4 Meanwhile Kaplan (1988) observed that many companies used single cost system tomeet their three diverse needs, namely inventory valuation & financial reporting, product/service/customer costing and providing ‘operational feedback to frontline employees’ in the plant. However, he apprehended that, in a complex manufacturing environment with ‘product and process

diversities’, and ‘concern for excellence’, ‘single cost system’ for all the three needs might not suffice. With the help of case studies of Siemens Electric Motor Works, John Deere ComponentWorks, and Schrader Bellows Cooper (1989b) demonstrated that the ‘management objectives’ and ‘diversity of product mix’ determine the extent of the complexity in the design of activity-based cost management systems. The competitive environment in which the firm is operating drives the need for activity-based costing.Cooper & Kaplan (1997 & 1998) argued that operational control and activity-based cost systems are two separate systems as they have different purpose and different requirements for accuracy, timeliness, and aggregation. Any attempt to integrate the both be made with utmost care otherwise it would perform neither function well. The operational learning & control system provides economic feedback about process efficiencies by using actual & highly accurate data on continual basis in respect of each responsibility center. The emphasis is on short-term fixed and variable costs and the cost centers are expenses actually recorded in the financial system.Product, customer, and business-unit profitability are the objectives of the activity-based cost systems. It uses standard cost data based on standard cost driver rates and practical capacity of organizational resources and updates it periodically for the entire value chain. The well-designed integrated cost management system will help the management of company to identify opportunities for continuous improvement and point out unused capacity or capacity constraints, if any and will facilitate the introduction of activity-based budgeting in the organization. The activity based budgeting mindset makes all cost variables and attempts to match resource supply to resource demand.