Chapter 8: Activity-Based Management

THE DUPONT MODEL assesses the impact of Strategic Alternatives (SAs) by analyzing drivers of financial performance. It provides a high-level view of drivers that affect financial performance. The next step in the operational filter of the Step-Wise Approach to Value (SWAV) is to evaluate SAs in terms of business processes. Activity-based management (ABM) helps you understand the process impacts of Strategic Alternatives.

This financial technique was developed in the 1980s by Robert Kaplan and Robin Cooper, Harvard Business School professors. The tool was initially developed as a way to understand resource consumption and was used as a costing tool called activity-based costing (ABC). It is prevalent in many Fortune 1000 companies (such as Mobil and Chrysler) and is different from traditional accounting methods because it is based on connecting costs to activities (how expenses are incurred)—not broad categories (what expenses are incurred on). Activity-based costing will partition these costs by specific processes (activities) and drive them into sales channels, customers, and units of production. Another variant to ABC is activity-based management or ABM. ABM is a management system that produces the profitability and costing data on a regular basis to drive decision making.

Attaching Costs to Your Business Process

ABM gives you the ability to attach costs to your business process. These costs can give you ideas about your process changes, core competencies, and strategic alternatives. Exhibit 8-1 illustrates an ABM analysis of an IT project.

Exhibit 8-1: An ABM analysis of an IT project.

Conventional vs. ABMBudgets
Conventional Method		ABM Method
Salaries and Bonuses	$1,800,000	Develop Initiative Strategy & Planning	$150,000
Consulting Fees	$300,000	Design and Implement	$600,000
Software License Fees	$300,000	Test & Deploy	$150,000
Communications Fees	$450,000	Operate Existing Systems	$900,000
Hardware Vendor Maintenance Agreement	$150,000	Maint & Upgrade Systems	$1,200,000
Total	$3,000,000	Total	$3,000,000

The conventional method of understanding costs is depicted the left, and the ABM view of the project is depicted on the right. Conventional financial reporting aggregates shared costs into categories based on what resources are, such as consulting fees and software fees. The ABM method takes a process view focusing on how money is being spent in processes like design and implementation. This enables you to weigh the cost versus the value of specific activities, processes, and tasks. A process question arising from the task view is, "Why are maintenance expenses consuming the majority of the initiative costs, and how can they be reduced?"

How does this help assess Strategic Alternatives? It gives management a financial measure that serves two purposes in assessing processes. First, you can attach a monetary value of a certain activity or task as a way to initiate process changes. If you are looking to reengineering to improve efficiency, ABM will identify areas of improvement. A certain activity can look overly expensive and may warrant further investigation. The activity view in Exhibit 8-2 shows us an example where $160,000 was spent on recruiting.

Exhibit 8-2: Human resources process.

Activity View				Functional View
Recruiting	$160,000	40%	Finance & Accounting	$40,000	10%
Benefits Administration	$40,000	10%	HR	$20,000	5%
Training	$80,000	20%	Manufacturing	$80,000	20%
Employee Remediation	$40,000	10%	Plant	$20,000	5%
Employee Relations	$80,000	20%	Information Technology	$240,000	60%
Total	$400,000	100%	Total	$400,000	100%

There may be two ways to lower this high cost: First, change the activity (redesign or reengineer the process) or change contiguous activities that may be driving these costs. Streamlining the number of candidate interviews with HR personnel is an example of an activity change. Developing a focused approach to staffing departments (to eliminate unneeded interviews and employee searches) illustrates a change to a contiguous process. A second redesign alternative is to lower the cost of interview scheduling by hiring an administrator for $50,000 per year to handle scheduling, as opposed to having HR directors earning $120,000 per year handling this process. ABM lets you get to the heart of the process issues before spending a tremendous amount of time and effort to change processes that may already be financially efficient.

Second, you can assess the strategic value of an activity. The strategic view provides the information to assess the value of an activity against the core competencies of the company. The central question in this analysis becomes, "Is this activity worth the money we are currently paying to perform it?" If the answer to the question is no, then Strategic Alternatives can be considered to reduce cost.