When Activity Based Costing (ABC) transcends its accounting aspects to expand into Activity Based Management (ABM), it sheds the tongue of book-keeping and starts talking the language of business management. Bala V Balachandran, the J L Kellogg Distinguished Professor of Accounting and Information Systems at Northwestern University, a well-known champion of ABM, explains why the transition is critical to change management.

The benefits that the principles of Activity Based Management (ABM) offer depend upon the end-user and what he's trying to do with it. If you think you don't know what your overheads really are, and, therefore, want a better solution, that's a very myopic view. That is to limit yourself only to Activity Based Costing (ABC). True, that's how it all began. But ABC is really the tip of the iceberg. The real power comes from being able to identify the root causes that force up costs. It's not about how you do your accounting, but about relentlessly pursuing reduction of costs. How do you eliminate waste? How do you get rid of non-value-added activities? That's the power of the concept. What started as a better allocation mechanism for costs has moved in a big way towards ABM, allowing you to look at the total picture. Sometimes, even though the product is the same, and the manufacturing cost is the same, it is the marketing and administrative costs that make the difference. Some customer orders 10 units of cost while others may take 100,000 units. Are they equal? Using ABM, even customer profitability becomes clear.

Business & ABM

When ABC started life, it was as another accounting system. But asking for a different accounting system on the logic that you don't trust your accountants is not going to help. However, if, suddenly, the CEO and top managers--such as the heads of marketing or purchase--realise that they're getting information that enables them to make better purchasing decisions, identify cheaper distribution channels, or create better marketing and product mixes, the problem changes. It's no longer an accounting solution that's being generated, but a complete management system.

ABC has two major numbers. The first is the numerator: the rupee, general ledger, money. The denominator is the measure of non-financial performance: the number of units sold, the number of customers who've defected, the number of defective pieces. These create the rupee per unit cost of an activity. Importantly, this denominator can be used, alongside the numerator and the fraction, for management decisions. A company can use the denominator information to increase productivity, for instance.

Clearly, ABM is not just about finance. It also talks about a number of non-financial performance measures--such as the number of defects. The rupee figures are only the consequence of the activity-based problems. The root problem could be in having too many vendors, or in too many customers demanding quick turnaround times and higher discounts, and placing big orders, thus driving up the transaction costs. Thereafter, as the focus falls on minimising or driving out costs, performance measures like the number of customers waiting, or the number of customers that have switched to the competition, become important. These are not accounting problems, but ABM makes the accountant understand them, and, in the process, the entire business. Thus, customer loyalty, retention, and intimacy, which were never talked about in accounting, are now being discussed by accountants. That's why it's important to make ABM the real goal.

As a result, ABM is no longer intimidating or insecure. To the typical employee, accounting information is all jargon. But ABM allows him, or her, to use their own language, and brings forth issues suggested by the CEO, not by the accountant or the CFO, which carries more weight. In most companies, the accountant is a policeman. That's why ABM shouldn't be viewed as an accounting system. Indeed, if ABM fails, it's because an accounting person heads the project, and tries to generate the kind of information he wants. By contrast, if the major benefits from ABM are likely to be in manufacturing, a person from that function should be in charge. Of course, it is equally important to create a cross-functional team, which understands the total process movement. In this situation, ABM no longer remains an accounting system, but becomes a manufacturing information system. Likewise, if the major benefits are in marketing, it becomes a marketing information system.

Under this framework, the role of finance changes from that of a controller to that of a consultant. Instead of policing, the accountant will turn into a helper and advisor, helping the manufacturing person to be better at his job, guiding the marketing person on where to focus--truly adding value. As a result, psychologically, the confrontation mode is substituted by the co-operation mode. The CFO becomes a decision-support system, even if operations is the decision-maker. Once that shift in roles takes place, the accountant is suddenly a welcome and extremely useful figure in the organisation, and friction within the company diminishes while the entire company sinks or swims together.

ABM provides a bedrock of opportunities to be seized. I call it leveraging the ABM information. At the first level, you're already aware of wastage--so get rid of it. Then comes the main part: identifying the non-value-added activities. If a particular activity costs me Rs 10 while the best-in-class competitor does it for Rs 8 in the same environment, that extra Rs 2 is arising from non-value-added activities. With ABM, these non-value-added activities can be identified. So why not eliminate them? Better still, why not team up with a customer, a distributor, and a vendor to form a partnership for inter-company business process reengineering? That's the kind of power that ABM can, ultimately, arm CEOs with.

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