Summary by Dan Crick
Master of Accountancy Program
University of South Florida, Summer 2003
The implementation of activity-based management leads to process reengineering and increased profitability. The article focused on the activities, modifications and results of implementing an activity-based management (ABM) system in the banking industry. The authors provided limited information regarding First Tennessee National Corporation’s implementation of ABM as a real life example. Steps necessary for ABM implementation were described in the article. Furthermore, differences between banking and manufacturing, which was first to implement activity-based costing, were described, providing an understanding of the peculiarities in the banking industry. Finally, the article discussed the modifications necessary for banking applications of ABC and the future plans of First Tennessee National Corporation.
Steps to Increased Profitability and Implementation of ABM
According to Sweeney and Mays, the steps to increased profitability through ABM include:
1. Financial Accounting
2. Management Reporting
3. Activity-based Costing
4. Internal Benchmarking
5. External Benchmarking
6. Process Reengineering
Financial accounting provides an aggregated presentation of financial results. This information then is presented to management in a disaggregated format through management reporting to assist operational or managerial planning. Activity Based Costing (ABC) provides a method of tracing costs to products more effectively than traditional costs systems. Following implementation of the ABC system, internal benchmarking further promotes efficiency and effectiveness. Internal benchmarking occurs when a company compares results of one operation or process at one location to the same or similar operations or processes at another location. External benchmarking follows internal benchmarking by extending the results comparisons to the external environment of the company. Finally, process reengineering improves systems and increases profitability. Reengineering may involve such things as replacing paper with electronic systems and replacing people with automated processes.
Differences Between Manufacturing and Banking
Manufacturing firms incur costs prior to the sale of their products. Therefore, measurement of profits occurs at the point of sale. Banking firms incur costs over time, based on customers’ activities. Therefore, profit measurement becomes more difficult due to cost determination based on future services provided to the customer.
ABC Modifications for Banking
The banking industry generally derives revenue from service fees and the spread of interest rates (the percentage charged on loans less the percentage paid on deposits). The authors note that neither of these revenue-producing activities is directly tied to customer usage, which ultimately determines profitability. Consequently, classification of different banking activities is necessary. In the article, the activities were split into customer order-driven, i.e., sales, services, processing and administration, and ongoing-concern, i.e., overhead, accounting, finance, personnel, general counsel. These activities are then evaluated using the value-added, nonvalue-added activities analysis. Ultimately, nonvalue-added activities, which increase elapsed time of various processes, are eliminated or reduced to increase profitability.
Activity-based management, regardless of the industry, takes information from financial reporting, management reporting and, most importantly, activity-based costing. The information guides management to the areas of concern and facilitates resolution to identified problems. ABM provides a proactive approach to streamlining processes and improving profits. By using ABM, companies can experience lowered product/service costs and a better understanding of the processes within the company. Benchmarking then assists the company in applying successful improvements in one department or location to other departments or locations. Ultimately, the processes become less costly and provide more effective and efficient operations. The following example briefly summarizes the effects of activity-based management in the banking industry.
First Tennessee ABM Implementation Example
The prior management system implemented by First Tennessee did not provide useful information to management regarding cost control. Consequently, an ABC system was implemented to support process analysis, design and reengineering. First Tennessee realized that banking was a time-based industry that required a high level of efficiency and effectiveness. Efficiency was defined as “doing things right”. Effectiveness was defined as “doing the right things (Sweeney, 20)”. First Tennessee recognized that cross-subsidization and cross-functional internal processes inhibited efficiency and effectiveness. ABC resolved those problems.
First National utilized the value-added, nonvalue-added analysis. The company termed these activities mission-related and nonmission-related to emphasize that all processes had value but did not always achieve the company’s mission. The company first applied ABC to certificates of deposit, 30% of customers were served at a 7% loss. The issue was corrected through higher minimum balance requirements, new products, and process redesign. First National discovered deficiencies in profitability on loans. Loans of $20,000 and $3,000 over a three-year period proved unprofitable. The company addressed the problem through pricing changes, product redesign and processing changes.
Finally, the company reengineered proof operations and used internal benchmarking to apply the new methods to other locations. Internal benchmarking involved a "root cause analysis" comparing a less efficient bank location's proof operations against another location where ABM had been applied. This analysis revealed a number of problems that created a need for a larger number of operators per fields encoded per hour at the less efficient location, e.g., old check filming machines, inadequate work space and a higher labor turnover. Correcting these problems reduced the number of operators from 12 to 8 and saved the bank $75,110.
After implementing ABM, First Tennessee realized approximately $11 million in improved profits over an 11-year period. Consequently the company plans to perform external benchmarking and to extend the reengineering process.
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