Activity-based management (ABM) is used to determine the profitability of every aspect of a business, so that those areas can be upgraded or eliminated. The intent is to achieve a more fine-tuned organization with a higher level of profitability.
The information used in an ABM analysis is derived from activity-based costing, where general overhead costs are assigned to cost objects based on their use of activity drivers. A cost object is anything about which a business wants to collect cost information, such as processes, customers, products, product lines, and geographic sales regions. Several examples of how ABM can be used are:
- To determine the total profitability of a customer, based on its purchases, sales returns, and use of the time of the customer service department.
- To determine the total profitability of a new product, based on its sales, warranty claims, and repair time required for returned goods.
- To determine the total profitability of the R&D department, based on the funds invested and outcome of new products developed.
The information derived from an ABM analysis can also be carried forward into a company's forecasting models and budgets, which gives management a better idea of the future prospects of the business.
The trouble with ABM is its underlying assumption that all of the benefits and costs of a cost object can be translated into monetary terms. For example, the outcome of an ABM analysis might lead management to the conclusion that the workplace should be downgraded to a lower-grade property in order to save money; in reality, a fancier office space is useful for attracting recruits to the company.
For the same reason, it can be difficult to apply ABM to strategic thinking. The problem in this area is that a new strategic direction may be quite expensive in the short-term, but has prospects for a long-term payoff that are difficult to quantify under an ABM analysis.
For the two indicated reasons, the information generated by an ABM analysis cannot be used to drive all management decisions - it is simply information that can then be inserted into the general context of how an organization should be operated. Thus, it is one of several decision tools that management can use.