Category list

Strengths of ABM

Here are some of the advantages of ABM:

It identifies activities that do not add value. By attaching a monetary value to a process, you are able to assess activities from a monetary perspective. This can tell you if Strategic Alternatives are directed at the right activities.
It provides insight into cost by unit of measurement (customer, channel, unit of production). Customers and channels do not have the same resource consumption profile. ABM will tell you if the Strategic Alternative is being directed at the right aspects of your business.
By using ABM, you can get a better understanding of resource consumption and allocation. This technique will show you the true cost of a Strategic Alternative by creating a more comprehensive picture of its cost.

Weaknesses of ABM

Here are some of the weaknesses of ABM:

It may create confusion over unit costs in the short run. Once costs are fully loaded into products, activities, and channels, executives may make knee-jerk decisions about abandoning initiatives because of their high cost. It is important to understand the trends in cost and profit before taking action.
This method does not take into account nonfinancial measurements. It is important to be cost-and profit-conscious, but not at the expense of quality and service. Driving your costs to zero is a going-out-of-business strategy.

Using ABM to Make Strategic Decisions

Costs by product, channel, division, and unit provide a clear picture of the monetary value of these dimensions to your business. These costs are valuable metrics for evaluating Strategic Alternatives and developing scorecards for performance. They can be used to compare the baseline to projected costs of an SA. More focused data on the cost structure and the potential changes that may occur with new initiatives makes you a better decision maker. A more realistic view of the costs associated with product launches may be the deciding data point between a joint venture and de novo entry. The de novo cost may be significantly higher after general and administrative costs are driven into the launch assessment. You also have the ability to measure the results of the implemented decision against your initial baseline for a clearer picture of the performance of the Strategic Alternatives. You can evaluate the performance of the SA against the alternative selected.

Conclusion

To summarize, ABM is a method of looking at your cost structure based on how you do things and not what you spend money on. It differs from traditional accounting because it expresses the cost structure based on your processes and provides a look at the "true" costs of doing business. This method is especially useful when considering reengineering and technology initiatives that involve efficiency-driven value propositions such as cost reduction.

Note

Robin Copper and Regine Slagmulder, "Activity-Based Costing Management System Architecture", Strategic Finance , October 1999, vol. 81, p. 4.

Part 4: The Valuation Filter

Chapter 9: Regression Analysis
Chapter 10: Components of Value
Chapter 11: Valuation

Chapter 9: Regression Analysis

An Overview of Regression Analysis

AT ITS MOST BASIC LEVEL , regression analysis is a statistical technique for developing an equation that describes the relationship between two or more variables . ^[1] This equation generally takes the form of:

The following variables are represented in the equation:

Y equals the dependent variable.
x _n equals the independent variables; the parameters used to predict y.
a equals the value of y when all independent variables are zero.
b ₁ equals the regression coefficient that indicates the impact that the independent variables have on the dependent variable.

One variable, the dependent variable, is the variable that you are trying to understand. The dependent variable is the answer. The other variable(s), the independent or explanatory variables, are the factors you feel affect the (dependent) variable or the answer. Let's say a national general merchandise retailer may think that there is a direct relationship between sales and advertising expenditure; more specifically , that an increase in advertising expenditure will result in an increase in total sales. This is based on the rationale that increased advertising will produce greater brand awareness, leading to larger demand for the company's product. In this example, sales are dependent (what you are solving for)—at least to some degree—upon advertising expenditures.

^[1] Terry E. Dielman, Applied Regression Analysis for Business and Economics (PWS-Kent, 1991).