Summary by Lorena A. Webb
Master of Accountancy Program
University of South Florida, Summer 2001
The purpose of this paper is to summarize the results of a study conducted by a research team on the best practices of implementing and using activity based management (ABM). The research team was sponsored by the American Productivity and Quality Center (APQC), the Consortium for Advanced Manufacturing International (CAM-I), and other participating companies. The research team examined the ABM methods used in a mixture of industries, in addition to the degree of success attained, the measurable improvements accomplished, and the factors that influenced the overall success of ABM.
A total of 750 service and manufacturing organizations were invited to participate in this research survey on ABM. Of these companies, only 166 answered the twenty-page survey. From the questionnaires that were returned, the top five most common applications of ABM were product costing, cost reduction, profitability analysis, process improvement, and cost estimation. The research team then chose 15 of the companies to be "best practice companies" for site visits. The companies were chosen in groups of five from the following industries: manufacturing, process manufacturing, and service. The companies were selected on the basis of their success in relation to the following four criteria:
The age of their ABM system,
Extensiveness of ABM applications,
Extent of ABM systems integration, and
Level of success with their ABM systems.
For their site visits, the research team decided to analyze the best practice companies on the following three broad areas of the ABM system:
Results achieved with ABM,
Linkage to the business environment, and
Integration with the existing information systems.
After visiting these companies, the researchers concluded that both internal and external factors were significant for the overall success of ABM.
The best practice companies designed their cost management system to react to divergent challenges in the external environment; for example, Delco Electronics and IBM manufacture printed circuit boards (PCBs). This technological industry has been extremely volatile. In response, both companies have developed a confrontation strategy. Their upstream component plants do not serve as ensnared suppliers to the downstream assembly plants. Since the component plants are no longer isolated, they can now compete with external suppliers directly for production orders. ABM falls into place here by asking the question of "what if" by permitting plants to collaborate with other customers on alternative product designs.
While companies have been coupling together to reduce costs from their own supply chains, some companies have employed ABM to remove costs from their supply system. Companies have started to outsource some of their activities in an attempt to re-focus their attention on their core competency. For example, an IBM plant has joined with a supplier to reduce the overall cost of drilling the hundreds of holes for each PCB they produce. The supplier delivers inventory to the shop floor, re-sharpens drill bits, offers technical support, and encourages new product development. At this plant, it has reduced drilling costs by 40 percent.
The best practice companies recognize that suppliers and consumers have some bearing on the price, quality, and delivery of their products to their final customer. Thus, companies have begun building stronger relations with their suppliers and customers. An example of this is clearly demonstrated in a grocery industry’s efficient consumer response (ECR) program. All of the trading partners in this value system must be in correlation with one another in an attempt to reduce costs, inventory levels, and cycle times during the manufacturing, distributing, and sale of the grocery products. For this to be successful, everyone in the value chain must work as a team in order to profit. For example, McNeil Pharmaceuticals has supported using ECR and ABM to measure and improve the cost effectiveness of activities inside the value chain. The ABM model has produced both financial and non-financial advantages. Trading partners have achieved savings through system integration, shared information, reduced cycle times, and the ability to diminish inventory constraints.
For ABM to be successful, effective change management is essential. The internal environments of the best practice companies foster towards supporting changing environments. By extending beyond traditional product costing and cost control, Deere & Co. has implemented a new application of ABM. They have extended their traditional product costing to include post-manufacturing costs for after-market service parts that are used to repair worn-out engine parts or replace damaged ones. This innovative product costing is important due to the large amount of costs associated with storing and distributing additional inventory for the after-market service parts business. ABM provides important information for managers to make decisions on the best cost efficient distribution route for the service parts.
ABM must be able to align its efforts with the needs and directions of management. In rare situations, an ABM accounting system can change the overall organizational structure of a company. For example, PCS Health systems, a company that processes large drug claims for insurance companies, felt the effects of this occurrence. Their organizational structure had traditionally been vertically and functionally oriented. Conventionally, managers had only been responsible for a section of the entire process. Thus, ABM was implemented in an attempt to account whole processes and provide a horizontal view of the entire company. The difference in the traditional vertical strategy and the newly implemented horizontal strategy proved to be incompatible. As a result, the company had to reorganize according to processes. Managers were granted more authority and were now responsible for the entire process. Due to these changes, process owners have taken the place of functional managers. Within this framework, process cost information in the ABM system supplies financial benchmarks to gauge improvements.
By training employees to think of activities in financial terms, ABM has created a common language that all levels of an organization can understand. Training programs have been used to assist management’s needs and directions. At Deere & Co., ABM teams view their roles as teachers. In an effort to support decision-making, Deere & Co.’s ABM has helped users including suppliers understand overhead costs and cost behavior.
Through the team’s research, they discovered that the best practice companies have developed ABM models that are user friendly, easy to maintain, and share the same basic design. Many companies are progressing ahead of their off-line, PC-based systems to ABM systems that are completely integrated with their operating and financial accounting systems. This has reduced maintenance requirements for their ABM models and improved the timeliness of the ABM information. Due to on-line capabilities of accessing activity cost information, engineers can better understand costs associated with certain choices and actions. Traditionally, ABM information was used for management decision-making, but now, it is also used for external financial reporting. ABM has been applied in a multitude of different ways. The research team developed the following three categories for the application of ABM.
Typically, the best practice companies enter the ABM value chain cycle at one particular area and then revolve to other sections of the cycle. One of the most important improvement initiatives for companies is the practice of benchmarking.
Through their studies, the research team presented their findings of the most efficient way to implement and use the best practices in activity-based management (ABM). Within the ABM model, an organization must be willing to embrace and accept the validity of the activity measures provided and utilize them for benchmarking and performance measurements. The research team discovered several companies that exhibited pieces of the ABM system, but learned that very few actually had a fully developed system. After viewing the fifteen companies, the researches decided that the best practice companies take a process view of their organization, employ solid ABM practices, and tie ABM to other corporate plans. Although companies seem to be satisfied with the use of the information provided by ABM to support decision-making, they should be aware that relatively few changes or dollar savings have been reported. Many companies have not yet reflected in the terms of "total cost" of the ABM, but are inclined to focus on internal cost of designing and making a product. They must not disregard the upstream supplier or the downstream distribution and support costs. Due to the continual developments of ABM implementation techniques, companies are beginning to recognize the enormous value that an ABM system can provide.
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