What is Activity-Based Management (ABM)?
– Definition: Activity-Based Management (ABM) is a managerial approach that uses the costs of business activities to evaluate the profitability and efficiency of products, services, customers, or processes. It identifies which activities consume resources and then links those activity costs to outputs so managers can decide where to improve, cut, or invest.
– Purpose: ABM’s goal is to improve decision-making and profitability by exposing where money is earned or lost across an organization’s activities (for example, production setups, inspections, distribution, R&D).
How ABM relates to Activity-Based Costing (ABC)
– ABC (activity-based costing) is an accounting method that measures the costs of specific activities and assigns those costs to products or services using cost drivers (for example, machine hours, number of setups).
– ABM uses the information produced by ABC as an input for management decisions. In short: ABC provides the cost data; ABM uses that data to manage processes, pricing, product mix, and resource allocation.
Typical uses and examples
– Product profitability: Break down marketing, warranty, production and return-processing costs to see whether a product’s revenue covers the activities it requires.
– Location decisions: Compare the full activity costs of operating a second office (staff, facilities, overhead) against the incremental revenues it generates.
– Service firms and public-sector use: Schools, non-profits, and government agencies can map program activities to costs to evaluate effectiveness and resource use.
– Process improvement: Identify high-cost activities that can be streamlined, automated, or eliminated.
Worked numeric example (small manufacturer)
Assumptions (overhead activities only; direct material/labor treated separately):
– Overhead pools and totals:
– Setup costs = $10,000 (100 total setups)
– Machine operation = $30,000 (6,000 total machine hours)
– Quality inspections = $5,000 (200 inspections)
– Activity usage by product:
– Product A: 80 setups, 4,000 machine hours, 150 inspections
– Product B: 20 setups, 2,000 machine hours, 50 inspections
Step 1 — compute cost per driver:
– Cost per setup = $10,000 / 100 = $100 per setup
– Cost per machine hour = $30,000 / 6,000 = $5 per hour
– Cost per inspection = $5,000 / 200 = $25 per inspection
Step 2 — allocate overhead to each product:
– Product A overhead = (80 × $100) + (4,000 × $5) + (150 × $25)
= $8,000 + $20,000 + $3,750 = $31,750
– Product B overhead = (20 × $100) + (2,000 × $5) + (50 × $25)
= $2,000 + $10,000 + $1,250 = $13,250
Step 3 — combine with revenues and direct costs (example numbers):
– Product A: Revenue $100,000; Direct costs $50,000; Overhead $31,750 → Profit = $18,250
– Product B: Revenue $40,000; Direct costs $20,000; Overhead $13,250 → Profit = $6,750
How ABM would use this
– Managers can see which activities drive costs (setups and machine hours for A) and target those activities for efficiency gains.
– ABM can highlight whether a product that appears profitable on direct costs actually consumes disproportionate overhead and should be re-priced, redesigned, or discontinued.
Checklist for implementing ABM
1. Define objectives: decide what you want ABM to inform (pricing, outsourcing, process redesign, product mix).
2. Map activities: list the major activities across the value chain (e.g., setups, inspections, sales calls).
3. Choose cost drivers: pick measurable drivers that cause the costs (e.g., number of setups, machine hours, invoice counts).
4. Collect data: gather activity counts and total costs for each activity pool.
5. Compute rates: divide each activity pool cost by its driver volume to get cost-per-driver.
6. Allocate costs: assign activity costs to products/customers/processes using driver quantities.
7. Analyze results: identify loss-making products/processes and high-cost activities.
8. Take action: redesign processes, change pricing, consolidate customers, or eliminate activities.
9. Monitor and update: periodically refresh driver data and re-evaluate decisions.
Special considerations and common pitfalls
– Data quality and granularity: Reliable activity counts are essential. Poor data produces misleading allocations.
– Implementation cost: ABM/ABC requires time, systems and staff resources; weigh benefits against setup/maintenance costs.
– Behavioral effects: Cost allocations can affect incentives; involve stakeholders to reduce resistance.
– Allocation assumptions: ABC/ABM still requires judgment when selecting drivers; results depend on those choices.
– Periodic review: Activity patterns change; revisit drivers and activity definitions regularly.
Key takeaways
– ABM is a management framework that turns activity-cost information into better operational and strategic decisions.
– ABC supplies the activity-cost data; ABM uses that data to manage and improve performance.
– ABM is useful across industries but requires investment in data collection and careful driver selection.
– The biggest practical value is linking costs to business activities so managers can prioritize changes that improve profitability.
Further reading (reputable sources)
– Investopedia — Activity-Based Management (ABM)
https://www.investopedia.com/terms/a/abm.asp
– Robert S. Kaplan (Harvard Business School) — research on cost systems and activity-based approaches
https://www.hbs.edu/faculty/Pages/profile.aspx?facId=6431
– Institute of Management Accountants (IMA) — resources on managerial accounting and cost management
https://www.imanet.org/
– Chartered Institute of Management Accountants (CIMA) — management accounting guidance and case studies
https://www.cimaglobal.com/
– APQC — benchmarking and resources on activity-based costing and process improvement
https://www.apqc.org/
Educational disclaimer
This explainer is for educational purposes only and does not constitute individualized financial or business advice. Apply ABM concepts with your organization’s data and consult accounting or management professionals before making major operational or financial decisions.