Activity-based management (ABM)

January 30, 2010

Activity-based management (ABM); operational ABM, strategic ABM; customer profitability analysis, customer cost analysis, customer life-time value (CLV).

1. Activity-based management (ABM)

Activity-based management (ABM) is a discipline about the management of activities that improve values received by customers and the profit generated by providing such values. ABM uses a lot of information from an activity-based costing (ABC) system. There are two types of ABM: operational ABM and strategic ABM.

Operational ABM manages activities that increase operational efficiency and lower production costs. Operational AMB utilizes such techniques as total quality management (TQM), performance measurement, and activity management.

Strategic ABM aims to enhance activity efficiency: it eliminates nonessential activities and selects appropriate operational activities as well as profitable customers. Strategic ABM utilizes such techniques as value chain and customer profitability analyses.

Let’s look in greater detail at value-added and customer profitability analyses tools used in strategic ABM.

2. Value-added analysis

In value-added analysis activities are divided into high and low value-added activities. This allows companies to focus on activities that increase customer satisfaction and eliminate activities with little or no value to customers.

A high value-added activity is an activity that improves value of products or services to customers. Examples of high value-added activities are: designing products, delivering products, processing customer orders, improving product quality, etc.

High value-added activities:

  • Are necessary to meet customer expectations
  • Contribute to customer satisfaction
  • Are important steps in production
  • Resolve product quality issues
  • Are requested by satisfied customers

A low value-added activity is an activity that consumes resources but adds little value to customers. The elimination of a low value-added activity does not change or slightly diminishes customer satisfaction. Examples of low value-added activities are: setting up machines, moving product parts, waiting, reworking, inspecting, storing, etc.

Low value-added activities:

  • Add little value to customer satisfaction
  • Add unnecessary steps to production
  • Are performed due to errors in production
  • Produce waste and/or unwanted output
  • Are performed to monitor product quality
  • Are requested by unsatisfied customers
  • Start with “re-“ (e.g. repaint, resize, return)

Companies are interested in not only satisfying their clients, but also in identifying the most profitable customers. To accomplish that, firms utilize customer profitability and customer cost analyses.

3. Customer profitability analysis

Customer profitability analysis is used to determine profitability of each customer or group of customers. It allows management to introduce new profitable products or service, to improve customer service, to offer discounts to low cost-to-serve customers, to decrease services for high cost-to-serve clients, to determine surcharge fee for expensive cost-to-serve activities, etc. The activities considered in the customer profitability analysis are all activities necessary to sell a product and satisfy the customers.

Customer profitability analysis begins with customer cost analysis, which identifies the cost of activities necessary to service customers before and after sales (i.e. does not include product costs). Customer service activities, similar to the production process activities, have a hierarchy.

Customer cost levels:

A customer unit-level cost is the cost of resources consumed for each unit sold to a customer. Examples are: shipping costs (i.e. when freight-in fee is based on the number of units transported), restocking costs, sales commissions, etc.

A customer batch-level cost is the cost of resource consumed for each sales transaction. Examples are: order processing, invoicing, recording returns.

A customer-sustaining cost is the cost of resources consumed to service a customer regardless of the number of units sold to the customer. Examples are: monthly statement processing costs, salesperson travelling expenses to visit customers, etc.

A distribution-channel cost is the cost of resources consumed in each distribution channel utilized by the company. Examples are: operating expenses of a regional warehouse, cost of distribution centers, etc.

A sales-sustaining cost is the cost of resources consumed to sustain sales and customer service in general (i.e. cannot be traced to specific units, batches, customers, or distribution channels). Examples are: sales department general expenditures, sales department staff salaries, sales manager bonus, etc.

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