Activity-based management (ABM) can be described as an organizational philosophy which helps companies adapt to changes, introduce new methods of manufacturing and quality control. In their attempts to increase productivity in the 1980s, managers tried to determine what was causing their costs, in other words, they tried to determine their cost drivers. The simplistic cost systems of the day usually assumed only one cost driver, which was volume of production.
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The examination of costs in most firms revealed a host of cost drivers, including such factors as number of setups, number of different products, material movements, and engineering change orders. Forrest (1996) states that: “an activity-based management is more a management system than a financial system” (1). Today, many firms attempt to eliminate non-value-adding activities. Researchers (Cokins 2001) explain that in the typical factory most products spend far more time sitting somewhere waiting to be worked on than they do in actual production. Furthermore, many activities do not add value per se. Among the activities that do not add value are moving, inspecting, training, and supervising. Manufacturers begin to increase productivity as they eliminated these non-value-adding activities.
Activity-based management influences all aspects of management including planning, organizing, coordination and control. Forrest (1996) underlines that “the quality of planning process in the early phases of development is essential to the success of ABM program. The extent to which varying viewpoints and perspectives are considered in constructing the program’s architecture could determine the long-term commitment of rank-and-file participants as well as senior management” (4). Some of the ideas and challenges applied for activity-based management are inventory systems, emphasis on quality, increased automation, changing factory layouts, continuous innovations, the concept of removal of constraints, and shortened product life cycles.
Activity-based costing is a part of activity-based management used as a financial tool in management planning and control. “Research has shown that automation, computer-integrated manufacturing, and robotics have increased overhead support costs that often are unrelated to allocation bases such as direct labor hours and dollars” (Albright, Sparr 213). Producers begin to recognize that carrying inventory tied up fundsthat cab not be used elsewhere in the business. They begin to realize that there are more profitable uses for money than having it tied up in inventory.
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In the narrow sense, JIT means elimination of all unnecessary inventories. The traditional view of inventories by manufacturers wasthat a business had to balance the cost of carrying inventory against the cost of stockouts. Because the fear of stockouts was high, most producers carried large amounts of inventory. In the raw materials area, manufacturers worried about running out of some essential item that would mean the production line would have to be shut down.
Dollar figures of how much per minute or hour it cost for a shutdown were somehow computed, and the threat loomed large in the minds of all production managers. Using activity-based management, manufacturers produce only when a customer place an order, to view production as being pulled through from the sales end rather than pushed through from the production end.
“Strategy today has to align itself to the fluid nature of this external environment. It must be flexible enough to change constantly and to adapt to outside and internal conditions even as the aspiration to deliver favorable outcomes for shareholders remains constant” (Bryan 18). With this kind of outlook, there is no need for workers to produce just to keep them busy. Indeed there is no need to produce at all unless there is an order. The result is a lean and mean approach that severely curtailed inventories of semi-finished products. “Improvement in both technology and management techniques continued in the manufacturing industries, with automation and the use of computers playing a major role” (Ndahi 14).
Total Quality Management
In terms of ABM, TQM can be explained as production of acceptable quality at minimum cost. When producers gain a marketing advantage by producing a high quality product, the old ideas are shaken. Curiously, many producers are also cost competitive. Globalization affects economic situation on the market and opens new opportunities for foreign competitors. In this case, foreign competitors can provide a product that is both higher in quality and lower in cost. Companies that have successfully upgraded the quality of their products have pushed back the emphasis on quality to the earliest possible point in the production process (Cokins 72).
The traditional approach was to inspect the product, usually in the final stages of production. In the meantime the defective products sat with all costs invested, using capital in much the same fashion as other excess inventories. Manufacturers trying to improve quality began to emphasize employee participation. Today, companies like Toyota, Apple, GM, and others have maintained their market shares by emphasizing high quality. Today, workers are encouraged to inspect the product themselves rather than rely on a separate team of inspectors.
Quality is a critical aspect of the management function, no longer left entirely to the operators. But a top-management commitment is necessary to realize improvements in quality (Cokins 79). The continuing competitiveness of U.S. corporations depends on how well quality is managed. In this case, setup cost reduction on lot size has a crucial impact on product cost and profitability. The impact is shown to be significant with order quantity reduction. The resulting reduction in setup times facilitates production changeovers, thereby making it possible to respond rapidly to changes in demand and substantially increase manufacturing flexibility.
E. Deming’s Approach
Creating new products is important, but not without the ability to produce them efficiently as well. Deming underline that the ability to scrutinize, streamline, and refine processes of manufacturing and service — while adding to and enhancing quality — are the main factors of success.
Central to his methods and management philosophy is an insistence that anything made or done can be made or done better, that unheard of levels of quality and improvement are achievable if we begin to recognize and appreciate the strengths of each individual worker. Deming singles out 14 main points of effective quality control and management. The main points include (1) create constancy of purpose toward improvement of product and service; (2) adopt the new philosophy; (3) cease dependence on mass inspection; (4) improve constantly and forever the system of production and service, etc. (Walton 1990).
In terms of ABM, improvement is not a one-time effort. Everyone in the organization must constantly be looking for ways to reduce waste and improve quality, to save time, and to promote achievement. The main point for modern organizations is that as times and conditions change, there is always a need to refine processes and procedures in order to become even more effective. Giving people time to think and talk about their work and methods is essential to constant improvement (Forrest 1996).
Moreover, his method promotes complacency by establishing management-determined standards for employees rather than allowing them to establish and work toward their own standards in areas in which they have expertise. Mass inspection is antithetical to the belief that people will strive to do high-quality work where trust exists. This does not mean that there is no place for quality control, nor does it rule out peer assessment for the purpose of improvement (Forrest 24)
For modern organizations, six sigma quality programs can be the main tool which helps to adapt to new economic environment and implement technological innovations. For instance, Six Sigma allows companies to integrate the Internet into every aspect of the company, both to reduce costs and to expand markets. With Six Sigma, there is heavy emphasis on analysis and results. Like other management concepts that get elevated to fad status, companies can now buy Six Sigma off the shelf and put it into operation at their own companies (Forrest 1996). Six Sigma approach cannot control events outside the company such as an economic crisis or collapsing demand.
ABM plays a crucial role in lean manufacturing allowing companies to reduce cost and improve productivity. The most visible difference in today’s factories is the increased use of quality control. Although development of new technology has always been a U.S. strength, adoption of that technology in factories has not been as rapid as might be expected. Lean manufacturing focuses on the following activities: transportation, motion, inventory, waiting time, over-production and defective product. “The lean concept encourages the use of versatile machines that can be used for continuous and small-batch production. These machines may not necessarily be huge, but they must be flexible.
The objective is to reduce cycle time” (Ndahi 16). For example, if a manufacturing process required a mixing, molding, and finishing operation, the old layout would place all the mixing machines together in one place or department, and all the molding and finishing machines would be similarly grouped. Workers usually did not move out of their department and learned how to operate only one type of equipment. “The use of versatile machines and the infusion of computer-integrated manufacturing (CIM) has allowed for flexibility in manufacturing design, process planning, machining, quality control, inspection, and inventory” (Ndahi 16).
In modern economic conditions, ABM will be an effective solution to many organizations which try to improve service and product quality, reduce cost and remain competitive in dynamic markets. Companies can use different methods and elements of ABM which meet their organizational structure and needs. One feature of most of the changes in the manufacturing environment is that they came more from concepts or philosophies than from specific techniques.
Of those concepts, one of the most pervasive is the idea of continuous improvement. “Competition in manufacturing exists because quality and cost are the most important factors to customers. Therefore, to maintain a competitive edge in the global market, lean manufacturers are continuing to pursue quality management practices and approaches for continuous improvement” (Ndahi 16).
ABM is seen as the key to global competitiveness and the long-term survivability of the firm (Cokins 37). Within ABM, quality is seen as customer and environment driven. Modern production organizations should understand the impact of their actions on other organizations and see that their inability to improve quality and productivity affects the productivity of organizations dealing directly or indirectly with them.
As a result, society suffers as productivity declines and companies are not able to provide more jobs. Thus a company should try to be responsive to its environment and show concern for societal needs and demands. Today, ABM can be a strategic tool that goes beyond the present focus on direct products or services rendered. Activity-based costing seeks to identify activities that cause or drive costs (Cokins 39). Once these activities are identified, product costs are assigned according to the activities consumed (Caplan et al 51).
Modern manufacturing environment is an era of change in many ways. Whether the changes will be sufficient to meet the demands and beyond remains to be seen. Whatever the challenges in manufacturing, it is clear that managers need relevant, accurate, and complete cost information. Without such information, they will be unable to make the important decisions they face. The advantage of ABM is that it is customer and environment driven, with both factors considered in developing an effective quality program. Cost oriented focus and market-driven quality are often narrow, focusing primarily on the ability of a product or service to satisfy a customer’s direct need and improve companies profitability and market share.
Albright, Th., Sparr, R. Activity-Based Management for the Labor Intensive Manufacturer: A Field Study. Journal of Managerial Issues, 6 (2), 1994, p. 213.
Bryan, L.L. Just-in-Time Strategy for a Turbulent World. The McKinsey Quarterly, 2002, pp. 17-20.
Caplan, C., Melumad, N.D. Ziv, A. Activity-Based Costing and Cost Interdependencies among Products: The Denim Finishing Company. Issues in Accounting Education, 20 (1), 2005, p. 51.
Cokins, G. Activity-based Cost Management: An Executive’s Guide, Wiley, 2001.
Forrest, E. Activity-Based Management: A Comprehensive Implementation Guide. McGraw-Hill; 1996.
Ndahi, H.B. Lean Manufacturing in a Global and Competitive Market. The Technology Teacher, 66 (3) 2006, pp. 14-19.
Walton, Mary. Deming Management at Work. New York: Perigee, 1990.