Activity-Based Management for Cost Control

¶ … activity-based management for cost control" from the Journal of Performance Management, offers an overview of the process and value of deploying activity-based management (ABM) as opposed to conventional cost accounting techniques. The article does not spend more than a few sentences defining such conventional accounting reporting methods; rather it assumes a familiarity with conventional accounting on the part of the reader. Author L. Kren does note that conventional accounting reports tend to be more descriptive rather than prescriptive. This is why Kren believes they offer few real, practical suggestions for operations managers about how to make strategic budgetary cuts. Kren believes that the frequent, unfortunate result of traditional cost accounting is that arbitrary cuts are made for the mere sake of making cuts, which may result in "unintentionally eliminating value-added services and reducing organization value"(Kren 2008). The best as well as the worst parts of the organization may be downsized.

The solution to the problem of arbitrary across-the-board cuts is activity-based management. ABM is deemed superior because it is designed to highlight non-value added activities, to ensure that they are cut, rather than value-conveying activities. It is strategic in its nature, rather than general and sweeping. In a conventional cost management equation, 'across-the-board' spending cuts are usually deemed the most 'fair' when in fact they are not: across-the-board "disproportionately discipline already-efficient managers" while "on contrast, ABM-based targets which require reductions in nonvalue-added activity do not unfairly penalize managers with low levels of nonvalue-added activity" (Kren 2008).

The article also suggests that ABM provides a more realistic view of managerial activities. While the traditional accounting approach suggests that managers have direct control over all aspects of spending in their area of responsibility, many of these items are contingent upon the behavior of other organizational actors and external forces. ABM, by using activity rather than traditional ledger-based analysis reflects the reality that managers have control over their activities, not the cost of items. "Thus, managers can control spending only by managing the activities performed in their area of responsibility" (Kren 2008). ABM can thus be used during planning to identify nonvalue-added activities, such as by cutting excess capacity in activity inputs. It also provides guidance about implementing performance improvement targets if different activities are implemented, thus also reducing costs in a productive manner. "These targets provide reasonable, explicit, and easy to understand objectives for operations managers" (Kren 2008). Finally, "end-of-period cost variances based on an ABM framework overcome many of the problems associated with conventional variances by providing clear signals about the actions needed for cost control and capacity management" (Kren 2008).

The article attempts to demonstrate the implementation of ANM with a fictional case study of a loan processing division at LakeSide Bank, showing how costs can be contained in two cost pools, Underwriting and Technology. The cost driver for Underwriting costs are "review hours' in the form of labor costs and the cost driver for Technology cost is 'IT hours'" (Kren 2008). In the scenario, some costs involve committed resources that cannot be easily adjusted while others do not. ABM provides guidance as to how to adjust the flexible aspects of the enterprise. For example, the average cost per hour for the Underwriting input at the plan level of activity is $44.13 but when the organization is operating at full capacity, the average cost per hour falls to $38.00, "because the cost of resource that is not needed is being spread over the service that is needed. Thus, one could argue that $38.00 per hour represents the 'true' cost because there is no excess capacity cost to burden the resource that is needed" (Kren 2008). Reducing non-full capacity operations is deemed critical to reducing costs.

The format of the article is somewhat problematic. On one hand, the inclusion of helpful, clear definitions of ABM vs. conventional styles of accounting and cost control are illuminating. But there are no examples drawn from real life to show how ABM is better than conventional methods, although the rhetorical case the article makes is indeed persuasive. The inclusion of a single, extended, fictional example, even though it has extensive figures and close, line-by-line analysis is questionable because it is created to prove the author's point. Nor are there any examples of conventional accounting methods to illustrate how they are inferior, and would result in less efficient cuts than ABM.