Activity-Based Management

A number of crucial features were acknowledged for the development of ABM, which include:

• Supporting process model
• The integration of process measurement information with economical data
• Senior management obligation
• Participation of line staff to plan their processes
• Facilitation by a focal team to generate the ‘big picture’ of the end-to-end processes
• Multi-dimensional software and philosophy
• Approval that an 80/20 approach in stipulations of precision and average was good enough at the beginning.

The vision o ABM was to colonize activities with data from bottom up, in turn providing costs at activity level.

Alternatively, Mercury believed ABM was a powerful tool, Mercury had enjoyed rapid growth since 1980’s, and it is a £1 billion turnover organisation and a major part of Cable and Wireless Group. However, numerous business dynamics in the market place have been rapidly changing and have increased pressure on product margins and major challenges. There is consequently a progressively powerful desire to comprehend and administer to improve the behaviour of costs within the organisation, not merely by process and performance, but also by the means in which they vary and support the different products and services provided to consumers in market sectors.

Kevin Hopps, controller of Mercury Group Finance, said

‘When we first started looking in some detail at the profitability of our services in response to increasing market pressures, we tried to apportion all our costs to them much more scientifically than ever before. However, we kept coming back to the same question: What activities are being performed in that area for that cot level? We therefore saw a natural link with Activity-Based Costing and started to explore how it might help us.’

(R Gwynne and G Ashworth (Dec1993) Management Accounting)

In Autumn 1992 the company conducted some piloting work in two key service support roles within the company. KPMG was appointed at project consultant and had aided to begin the project in the two service areas chosen. Mercury had been seeking how activity-based approaches could help address numerous business issues, as it faced up to rapidly changing external market dynamics. This includes not only the increased pressure on margins but also an increasing range of:

• Communication channels,
• Narrow framework within UK
• Treat of new market applicants
• Global obligation of corporate consumers and trend towards a more open contest in telecom sectors throughout the world.

The pilot provided Mercury with real evidence that ABM was a powerful tool for:

• Gaining a better understanding of the cost/volume dynamics or cost behaviour within the company and across Cable and Wireless Group
• Identifying the contribution of its product/services, customers and market segments
• Acting as a catalyst to improve performance.

For the pilot project to be successful and for ABM to be authenticated as a resolution to Mercury’s cost management challenge, each of the below requirements had to be achievable from the pilots output. Although Mercury were presented with negatives and positives which had to be considered, the team adopted a method of approach which would manage against the negatives and aim to optimise the positives. ABM at the beginning was consequently positioned as a means of constant performance improvement and efficient resource management.

ABM Roll-out (5 phases to ongoing usage, includes steps involved in each phase)

The above chat outlines that the activity frameworks were developed through five-phase structure. These aided to accelerate, gain consent and fully confirm the context as it was developed.

The purpose of the pilots was to experiment with the view that ABM might be a substantive significance to Mercury. Essential reviews of the outcome from the piloting work suggested decisively that ABM would provide a proposal for Mercury’s Cost management challenge. This is witnessed by:

• The fact that Mercury is rolling out ABM across the organisation
• A Cable and Wireless Group scheme publicizes the embracing of ABM throughout all operating companies in the group.

Mercury has developed a rollout strategy, and was keen that the programme would be manageable, progressive and effective. To ensure this they had set an ambitious but achievable ABM mission, which is phased over a three-year period.

Mercury has taken some vital steps on the way to implementing a wide variety of activity-based approaches both for managing resources more efficiently and for detecting and optimising its sources of profitable business. It still has some way to go, but development so far has been very encouraging. Management at all ranks are now buying into the notion and benefits to be acquired from ABM.

Activity-Based Costing (ABC) is a new component of cost analysis; Professor Robert Kaplan, Robin Cooper and H. Thomas Johnson presented it in Harvard in 1987. It has since been developed in many companies. The theory behind ABC is that costing should be much more that a financial scheme used by accountants, it should be part of the profit-making process of the business. Rather than simply monitoring and controlling costs after the event, costs should be planned for and managed before they have incurred.

The process of developing an ABC system comprises of six phases with a total of sixteen steps, which is demonstrated below. These are the basic steps that are abided to in the approach, which is used, whether is it be a one-off review of activities and overheads or a frequent reporting system for analysis.

The Activity-Based Costing Process

There are in fact many uses of ABC, and can be analysed in various ways. The chart below gives a summary of the different uses and how they are broken down:

Uses of ABC summarised

ABC can have a big impact on companies, as it has done with Wavin, it has managed to become part of Wavin’s day-to-day management customs. In 1990 Wavin commenced its Total Quality Management (TQM) initiative throughout all of its European business’. It provided a structure for the company to organise and implement other schemes, which were more particularly aimed within the company.

The concept of ABC was manufacturing delivered, which was important as manufacturing embraces aspects of the supply chain and characterises products on supply and demand. Grasping the association between product costs and manufacturing resources produced new opportunities produced for managing the supply of resources, which in the past had been perceived as overhead, to the manufacturing process.

Prior to taking an activity-based approach to the entire outstanding overhead, there was a change in product profitability, which needed to be considered within the overall structure of Wavin’s business strategy.

Wavin, later introduced ABC by linking it to a practical business application, which was profitability management. It was considered to provide an ultimate pilot area for gaining knowledge of ABC, whilst simultaneously broadening company’s understanding about the relationship between product and customer profitability.

At the time it was essential to move beyond the conventional allocation of direct manufacturing costs to merchandise due to the fact that the management team suspected that not only was the one of the market sectors unprofitable but also a disturbance to the focal point of the business’ activities. All the functional business managers fully supported the project and were dedicated to understanding and distinguishing the most likely and applicable cost drivers. This decision not only increased profitability but also proved that ABC was worth pursuing.

However, they experienced some fundamental difficulties which must be dealt with before pursuing the project further, these were:

• Although progress was made in recognising relationships between cost types and product groups it was exceptionally complicated to allocate certain costs to individual products without being subjective in the approach
• Two discrete classifications could be made about customers, whether they were large or small, the size was determined by the turnover of the company
• There were certain costs for which there were no drivers to link them to products/services. However, these costs symbolized a minor percentage of total costs but were not considerable enough to distort the overall result

To over come this the following solutions were produced:

• Instead the emphasis should be positioned on ensuring the precision of activity-based costs attributed to product families at which stage the decision-making process was most vital.
• Customers should in fact receive individual treatment if:

1. The economics of the business are at a enjoyable level
2. Some costs are immediately attributable.
3. Customers are viewed as important aspects of the business despite whatever the turnover.

• From the problems encountered in the first profitability management study Wavin learnt a significant amount not solely on ABC but also ABM. Therefore this approach was also taken upon by Wavin.

Wavin did not use a specific ABC software package because it wanted to preserve an adaptable approach to solving problems using both established and original ABM procedures.

The first time Wavin used ABC to calculate product costs there it was found that some of the cost drivers chosen needed to be developed or restored. A number of the efforts to use ABC resulted in additional overhead costs being allocated to products. The real break through came when Wavin began to think about the reasons why the costs incurred instead of calculating product costs.

ABC has participated and will continue to play a significant role in the Wavin management process; this may be purely ABC solely or with ABM combined. Wavin had used ABC/ABM in:

• Manufacturing excellence
• Profitability management
• Customer profitability
• Product profitability and costing
• Performance measurement

I shall now discuss the use of ABC in a totally different environment, this company, Torres S.A is a medium sized company that produces thirty varieties of wine and seven varieties of brandies. The company had 350 employees and is located in Spain.

Torres’ objective was to be able to maintain a price-quality relationship across its product range whilst producing a reasonable profit margin. For many years the organisation had utilised a direct cost system representing the sales volume required to break equal for each group.

The current accounting system, which was in progress by the company, took no account of inflation, which lead to misleading results especially if 1982 costs were compared to 2004. Other problems, which the company was experiencing, were:

• The reporting system did not relict the new business framework.
• There were three different costing systems in process
• Fixed overheads of business activities we not allocated

To solve the above problems the organisation created an Administrative-Financial Department in 1993. It allowed the organisation to take responsibility for management control function, calculations of costs and production and control of budgets.

The introduction of ABC on production cost basis showed that product lines required major amendments. However, this was objectionable on marketing terms, as it may have left an unbalanced portfolio of products. Hence, the ABC product costs signifying a substantial shift in the profitability in product lines was unsuccessful to account for the company’s marketing strategy.

Below is a diagram, which demonstrates the significant amount of analysis provided by the use of ABC within Torres.

Difference between Direct Costing and ABC

In addition were was inadequate confidence in either the identification of the cost drivers or the analysis of outflows into cost pools to rationalize such radical actions on the basis of the statistics produced from this attempt. The recognition of cost rivers was relatively simple, the analysis of expenditure into cost pools, however, was somewhat time consuming as the original documentation has not been cost coded to suit the customer-based analysis.

There are numerous aspects of interest in this case study, not only does it demonstrate the application of ABC and current-cost stock adjustment but as it was conducted in Spain it contrasts with those in the UK and America.

Overly, from the theory above, case studies and extensive research I can confirm that ABC along with ABM is a powerful tool; it has helped numerous organisations globally to become more efficient and effective. ABC highlights information, which was not identifiable with traditional accounting systems.

Although ABC has many of its advantages as displayed by the case studies above, there are in fact disadvantages. Firstly, the implementation of ABC not only requires many resources but it is also very time consuming. The above case studies reveal how ABC/ABM has made improvements in many sectors, however, it is not made aware to the public, the difficulties and complications of implementing ABC within the business. Barclays experienced a great outcome when ABC tackled extreme problems in a short period of time, however, they do in fact confess the complications they experienced whilst applying the system. It is made aware from John Porteous article that Barclays Service Provision chose to put ABC into effect, but they had discovered that internal clients had difficulties understanding the basis of cost allocations.

The same can be confirmed about ABM, Stephanie Gourdie’s article points out that ABM is a successful application but it requires careful planning and radical thinking of the company’s culture.

Secondly, the Wavin case does in fact show a weakness of ABC; although the general outcome was pleasing it did in fact experience some fluctuations. At the beginning of applying ABC extra overhead costs were incurred, this may demonstrate either

• That ABC is a system that takes time to take effect and in fact some organisations may experience many down falls, or
•  That ABC cannot be recommended purely as a replacing product costing system and in fact other broader systems could be taken into consideration, such as ABM/ABB

At first sight the launch of ABC in the company can be a daunting experience, however many PC based software tools have been produced to make the procedure much easier. One certainty is that the ABC system is rapidly growing in organisations all over the world

Bibliography

Textbooks

Datar, Foster & Horngren (1997) Cost Accounting, a managerial emphasis 9th Edition, International Edition, Prentice Hall International (UK)

Julie Mabberley (1992) Activity-Based Costing in Financial Institutions, Pitman Publishing

M.W.E Glautier & B Underwood (2001) Accounting Theory and Practice 7th Edition, Ashford Colour Press Ltd

Internet

 (2004)

 (2003)

 (2004)

 (2004)

Journals

J Gibbon, J Loughran, J Robinson & K Johnston (1995), Activity-based management The Lloyds TSB experience, Management Accounting, December (pg 48)

S.Gourdie (2001) Tool of the trade, Management Accounting, November (pg38-39)

R Gwynne & G Ashworth (1993) Implementing activity-based management at Mercury Communications, Management Accounting, December (pgs 34-36)

Brent Marshall (1995) Activity-based costing at Wavin, Management Accounting, May (pgs 28-30)

M May (1995) Activity-Based Management Accounting, Management Accounting, January (pg 40)

John McKenzie (1999) Activity-Based Costing for beginners, Management Accounting, March (pgs 56-57)

 J.Porteous (2001) As easy as ABC, Management Accounting, November (40-41)

O.A Salas, J Blake & P Wraith (1995) Learning ABC in Spain…with no sour grapes, management Accounting, October (pgs 36-37)

Referencing

R Gwynne & G Ashworth (1993) Implementing activity-based management at Mercury Communications, Management Accounting, December (pg 34)