Unit – 5

Modern Management Concepts

Management by Objectives

The concept of management by objectives is a logical extension of Goal Setting theory.

The Goal Setting theory studies the processes by which people set goals for themselves
and then put in efforts to achieve them. Evidence proves that 90 percent of the time,
performance improves with goal setting. Comparatively high achievers set
comparatively more difficult goals and they are more satisfied with intrinsic rewards
than extrinsic rewards. Management by objectives is an extension of Goal theory as it
involves systematic and programmatic goal getting throughout an organization.

The concept of MBO was introduced by Peter Drucker in 1954 as a means of using goals
to improve people rather than to control them. Thus this concept of MBO is also known
as Goal management. It is based upon the assumption that involvement leads to
commitment and when an employee participates in goal setting as well as setting
standards for measurement of performance towards that goal then the employees will
be motivated to perform better and in a manner that directly contributes to the
achievement of organizational objectives. Simply stated, “MBO is a process whereby
both managers and subordinates work together in identifying goals and setting up
objectives and makes plans together in order to achieve these objectives. Their
objectives and goals should be consistent with the organizational goals”.

Principles and Steps of Management by Objectives

The basic steps that are common in all the processes of management by objective (MBO)
are:-
1. Central goal setting: defining and verifying organizational objectives is the first step
in MBO process. Generally these objectives are set by central management of the
organization but it does so after consulting other managers. Before setting of these
objectives, an extensive assessment of the available resources is made by the central
management. It also conducts market service and research along with making a
forecast. Through this elaborate analysis, the desired long run and short run objectives
of the organization are highlighted. The central management tries to make these
objectives realistic and specific. After setting these goals it is the responsibility of the
management that these are known to all members and are also under stood by them.
2. Development and individual goal setting: After organization objectives are
established by the central management, the next step is to establish the department
goals. The top management needs to discuss these objectives with the heads of the
departments so that mutually agreed upon objectives are established. Long range and
short range goals are set by each department in consultation with the top management.
After the department goals are established, the employees work with their managers to
establish their own individual goals which relate with the organization goals. These
participative goals are very important because It has been seen that employees become
highly motivated to achieve the objectives established by them. These objectives for
individuals should be specific and short range. These should indicate the capability of
the unit of the individual. Through this process all the members of the organization
become involved in the process of goal setting.
3. Revision of job description: In the process of MBO resetting individual goals
involves a revision of job description of different positions in the organization which in
turn requires the revision of the entire structure of the organization. The organization
manuals and charts may also have to be modified to portray the changes that have been
introduced by the process of MBO. The job description has to define the objectives,
authority and responsibility of different jobs. The connection of one job with all other
jobs of the organization also needs to be established clearly.
4. Matching goals: The establishment of objectives cannot be fruitful unless the
resources and means required to achieve these objectives are provided. Therefore the
subordinates should be provided required tools and materials which enables them to
achieve the objectives efficiently and effectively. Resource requirements can be
measured precisely if the goals are set precisely. This makes the process of resource
allocation relatively easy. Resource allocation should be made after consulting the
subordinates.
5. Freedom implementation: The task team of manager and his subordinates should
be given freedom in deciding the way to utilize their resources and the way to achieve
their objectives. There should be very little or no interference by the seniors as long as
the team is working within the framework of organization policies.
6. Establishing check points: The process of MBO requires regularly meetings
between the managers and their subordinates to discuss the progress achieve in the
accomplishment of the objective established for the subordinates. For this purpose the
mangers need to establish the standards of performance or check points to evaluate the
progress of their subordinates. These standards need to be specified as for as possible
quantitatively and it should also be ensured that these are completely understood by
the subordinates. This practices needs to be followed by all managers and these should
lead to an analysis of key results has the targets are represented in terms of the results.
The analysis of key results should be recorded in writing and it generally contains
information regarding :
(i) The overall objectives related with the job of subordinates.
(ii) The key results which must be achieved by the subordinate to fulfill his objectives.
(iii) The long term and short term priorities, a subordinate needs to adhere to.
(iv.) The extent and scope of assistance expected by a subordinate from his superior and
other departmental managers and also the assistance, the subordinates is required to
extend to other departments of his organizations.
(v.) Nature of information and the reports receive by the subordinate to carry out self
evaluation.
(vi.) The standards use to evaluate the performance of the subordinate.
7. Performance appraisal : An informal performance appraisal is generally conducted
in routine by the manager, a periodic review of performance of the subordinates should
also be conducted. Periodic reviews are required as the priorities and conditions change
constantly and need to be monitored constantly. These reviews help the mangers as
well as the subordinates to modify the objectives or the methods whenever require.
This significantly increases the chances of achieving the goals and also ensures that no
surprises are found at the time of final appraisal. Periodic performance appraisal needs
to be based on measurable and fair standards so that these are completely understood
by the subordinates and there are also aware of the degree of performance required at
each step.
8. Counselling: Periodic performance review helps the subordinates in improving his
future performance.

Limitations of Management by objectives Process

 It sometimes ignores the prevailing culture and working conditions of the

organization.
 More emphasis is being laid on targets and objectives. It just expects the
employees to achieve their targets and meet the objectives of the organization
without bothering much about the existing circumstances at the workplace.
Employees are just expected to perform and meet the deadlines. The MBO
Process sometimes do treat individuals as mere machines.
 The MBO process increases comparisons between individuals at the workplace.
Employees tend to depend on nasty politics and other unproductive tasks to
outshine their fellow workers. Employees do only what their superiors ask them
to do. Their work lacks innovation, creativity and sometimes also becomes
monotonous.
Advantages of Management by Objectives

1 . Since Management by objectives (MBO) is a result-oriented process and focuses on

sett1ing and controlling goals, if encourages managers to do detailed planning.

2.  Both the manager and the subordinates know what is expected of them and hence
there is no role ambiguity or confusion.

3. The managers are required to establish measurable targets and standards of

performance and priorities  for these targets. In addition, the responsibilities and
authority of the personnel is clearly established.

4. It makes individuals more aware of the company goals. Most often the subordinates
are concerned with their own objectives and the environment surrounding them. But
with MBO, the subordinates feel proud of being involved in the organizational goals.
This improves their morale and commitment.

5. Management by objectives (MBO) often highlights the area in which the employees

need further training, leading to career development.

6. The system of periodic evaluation lets the subordinates know how well they are
doing. Since MBO puts strong emphasis on quantifiable objectives,the measurement and
appraisal can be more objective, specific and equitable.

7. It improves communication between management and subordinates.

Disadvantages of Management by Objectives

1. MBO can only succeed if it has the complete support of the top management.
2.  Management by Objectives (MBO) may be resented by subordinates. They may be
under pressure to get along with the management when setting goals and objectives
and these goals may be set unrealistically high. This may lower their morale and they
may become suspicious about the philosophy behind MBO.

They may seriously believe that MBO is just another of the management’s ploys to make
the subordinates work harder and become more dedicated and involved. The emphasis
in the MBO system is on quantifying the goals and objectives. It does not leave any
ground for subjective goals. Some areas are difficult to quantify and even more difficult
to evaluate.

3.  There is considerable paperwork involved and it takes too much of the manager’s
time. Too many meetings and too many reports add to the manager’s responsibility and
burden. Some managers may resist the program because of this increased paperwork.

4. The emphasis is more on short-term goals. Since the goals are mostly quantitative in
nature, it is difficult to do long-range planning because all the variables affecting the
process of planning cannot be accurately forecast due to the constantly changing socio-
economic and technological environment which affect the stability of goals.

5. Most managers may not be sufficiently skilled in interpersonal interaction such as

coaching and counseling, which is extensively required.

6. The integration of MBO system with other systems such as forecasting and budgeting
etc., is very poor. This makes the overall functioning of all systems mare difficult.

7. Group goal achievement is more difficult. When the goals of one deportment depend
on the goals of another department, cohesion is more difficult to obtain. For example,
the production department cannot produce a set quota if it is not sufficiently supplied
with raw materials and personnel.
Management by exception
Management by exception is a style of business management that focuses on identifying
and handling cases that deviate from the norm, recommended as best practice by the
project management method PRINCE2.
Management by exception has both a general business application and a business
intelligence application. General business exceptions are cases that deviate from the
normal behaviour in a business process and need to be cared for in a unique manner,
typically by human intervention. Their cause might include: process deviation,
infrastructure or connectivity issues, external deviation, poor quality business rules,
malformed data, etc. Management by exception here is the practice of investigating,
resolving and handling such occurrences by using skilled staff and software tools. Good
management can contribute to efficiency of business processes. Often in these cases the
process will be called exception management, as exceptional cases are not the sole focus
of the managerial policy, and exception management (as opposed to management by
exception) denotes a more moderate application of the process.
Management by exception (MBE), when applied to business is a style of management
that gives employees the responsibility to take decisions and to fulfil their work or
projects by themselves. It consists of focus and analysis of statistically relevant
anomalies in the data. If an unusual situation or deviation in the recorded data appears,
which could cause difficulties for the business and can’t be managed by the employee at
his level, the employee should pass the decision on to the next higher level. For example,
if all products are selling at their expected volumes for the quarter, except one
particular product which is underperforming or over performing at a statistically
relevant margin, only the data for that product will be presented to the managers for
further investigation and discovery of the root cause. Management by exception can
bring forward business errors and oversights, ineffective strategies that need to be
improved, changes in competition and business opportunities. Management by
exception is intended to reduce the managerial load and enable managers to spend their
time more effectively in areas where it will have the most impact.
Exception management also has an IT application. When writing code, if the
programmer sees that there will be an exceptional case where a predefined assumption
of the application will be breached, the programmer will need to deal with that
exception programmatically from the outset.

Process of management by exception

Primarily, it is necessary to set objectives or norms with predictable or estimated
results. These performances are assessed and get equated to the actual performance.
[8] Next, the deviation gets analysed. With an insignificant or no deviation, no action is
required and senior managers can concentrate on other matters. If actual performances
deviate significantly, the concern needs to be passed to the senior managers, as an
“exception has occurred”. Finally, the aim is to solve this “exception” immediately.

Management by exception using variance analysis

The accounting department is responsible for the forecasting of budgets and cost
performance reports. The difference between the estimated and actual figures is
defined as variance. To understand the cause of the difference, managers need to
investigate the questions how the variance differs from last period and what are the
causes for not reaching the estimated figures. Analysers consider two types of
variances: adverse variance and favourable variance. Adverse variance “exists when the
difference between the budgeted and actual figure leads to a lower than expected
profit”. Favourable variance “exists when the difference between the budgeted and
actual figure leads to a higher than expected profit”. Rather than considering all
variances, managers establish criteria to determine which variances are significant to
focus on. Management by exception focuses mainly on large adverse variances, to find
the areas of business, which deviates from predetermined standards in a negative way.

Advantages of management by exception

The main advantage of management by exception is that problematic issues are
identified rapidly and managers are able to use their time and energy more wisely for
important issues rather than for less important ones that could provoke delays in their
daily operations. Additionally, managers need to work less on statistics and the
frequency of making decisions becomes less, which saves time. As managers take fewer
decisions, employees have more responsibility, which increases their motivation.

Disadvantage of management by exception

Occurrences of mistakes in calculating budgets results in large variance differences and
finding the errors can be time-consuming (thus expensive). Furthermore, financial
analysts responsible for calculation variances are increasing overhead costs of a
company. If the financial analysts are not performing well, it will become a waste of time
and money. Another disadvantage is that only managers have the power over really
important decisions, which can be demotivating for employees at a lower level.
Furthermore, it takes time to pass the issues to managers. Managing employees who
deviate from the normal procedures because of compliance failures are considered
difficult to manage and typically find themselves with limited job duties and ultimately
dismissed/terminated.

SWOT analysis 

SWOT analysis is a tool for auditing an organization and its environment. It is the first
stage of planning and helps marketers to focus on key issues. SWOT stands for
strengths, weaknesses, opportunities, and threats. Strengths and weaknesses are
internal factors. Opportunities and threats are external factors. A strength is a positive
internal factor. A weakness is a negative internal factor. An opportunity is a positive
external factor. A threat is a negative external factor.
 Diagram: A SWOT Analysis

We should aim to turn our weaknesses into strengths, and our threats into
opportunities. Then finally, SWOT will give managers options to match internal
strengths with external opportunities. The outcome should be an increase in ‘value’ for
customers – which hopefully will improve our competitive advantage.

The main purpose of the analysis has to be to add value to our products and services so
that we can recruit new customers, retain loyal customers, and extend products and
services to customer segments over the long-term. If undertaken successfully, we can
then increase our Return On Investment (ROI).
Simple rules.
 Be realistic about the strengths and weaknesses of your organization.
 It should distinguish between where your organization is today, and where it
could be in the future.
 It should always be specific. Avoid grey areas.
 Always apply the tool in relation to your competition i.e. better than or worse
than your competition.
 Keep your audit short and simple. Avoid complexity and over analysis
 It is subjective.
Once key issues have been identified with your SWOT analysis, they feed
into marketing objectives. The tool can be used in conjunction with other tools for audit
and analysis, such as PEST analysis and Porter’s Five-Forces analysis. So SWOT is a very
popular tool with marketing students because it is quick and easy to learn. During the
SWOT exercise, list factors in the relevant boxes. It’s that simple. Below are some FREE
examples of SWOT analysis – click to go straight to them.
Strengths and weaknesses are internal factors.
For example:
 A strength could be:

 Your specialist marketing expertise.

 A new, innovative product or service.
 Location of your business.
 Quality processes and procedures.
 Any other aspect of your business that adds value to your product or service.

A weakness could be:

 Lack of marketing expertise.

 Undifferentiated products or services (i.e. in relation to your competitors).
 Location of your business.
 Poor quality goods or services.
 Damaged reputation.
Opportunities and threats are external factors.
For example:

An opportunity could be:

 A developing market such as the Internet.

 Mergers, joint ventures or strategic alliances.
 Moving into new market segments that offer improved profits.
 A new international market.
 A market vacated by an ineffective competitor.

A threat could be:

 A new competitor in your home market.

 Price wars with competitors.
 A competitor has a new, innovative product or service.
 Competitors have superior access to channels of distribution.
 Taxation is introduced on your product or service.

Enterprise Resource Planning (ERP)

The acronym ERP stands for enterprise resource planning. It refers to the systems and
software packages used by organizations to manage day-to-day business activities, such
as accounting, procurement, project management and manufacturing. ERP systems tie
together and define a plethora of business processes and enable the flow of data
between them. By collecting an organization’s shared transactional data from multiple
sources, ERP systems eliminate data duplication and provide data integrity with a
“single source of truth.”
 Today, ERP systems are critical for managing thousands of businesses of all sizes and in
all industries. To these companies, ERP is as indispensable as the electricity that keeps
the lights on.

ERP Fundamentals
ERP systems are designed around a common, defined data structure (schema) that
usually has a common database. ERP systems provide access to enterprise data from
multiple activities using common constructs and definitions and common user
experiences.

A key ERP principle is the central collection of data for wide distribution. Instead of
several standalone databases with an endless inventory of disconnected spreadsheets,
ERP systems bring order to the chaos so that all users—from the CEO to accounts
payable clerks—create, store, and use the same data derived through common
processes. With a secure and centralized data repository, everyone in the organization
can be confident that data is correct, up to date, and complete. Data integrity is assured
for every task performed throughout the organization, from a quarterly financial
statement to a single outstanding receivables report, without deploying error-prone
spreadsheets.
The Business Value of ERP
It’s impossible to ignore the impact of ERP in today’s business world. As enterprise data
and processes are corralled into ERP systems, businesses are able to align separate
departments and improve workflow, resulting in significant bottom-line savings.
Examples of specific business benefits include:

 Improved business insight

o From real-time information generated by reports

 Lower operational costs

o Through defined and more streamlined business processes

 Enhanced collaboration

o From users sharing data in contracts, requisitions, and purchase orders

 Improved efficiency

o Through a common user experience across many business functions and

managed business processes
 Consistent infrastructure

o From the back office to the front office, all business activities have the
same look and feel

 High user-adoption rates

o From a common user experience and design

 Reduced risk

o Through improved data integrity and financial controls

 Lower management and operational costs

o Through uniform and integrated systems

The History of ERP

From Paper Cards to Mobile Devices
The history of ERP goes back more than 100 years. In 1913, engineer Ford Whitman
Harris developed what became known as the economic order quantity (EOQ) model, a
paper-based manufacturing system for production scheduling. For decades, EOQ was
the standard for manufacturing. Toolmaker Black and Decker changed the game in 1964
when it was the first company to adopt a material requirements planning (MRP)
solution that combined EOQ concepts with a mainframe computer.
MRP remained the manufacturing standard until manufacturing resource planning
(called MRP II) was developed in 1983. MRP II featured modules as a key software
architectural component and integrated core manufacturing components including
purchasing, bill of materials, scheduling, and contract management. For the first time,
different manufacturing tasks were integrated into a common system. MRP II also
provided a compelling vision of how organizations could leverage software to share and
integrate enterprise data and boost operational efficiency with better production
planning, reduced inventory, and less waste (scrap).

As computer technology evolved through the 1970s and 1980s, concepts similar to MRP
II were developed to handle business activities beyond manufacturing, incorporating
finance, customer relationship management, and human resources data. By 1990,
technology analysts had a name for this new category of business management software
—enterprise resource planning.

ERP Today
From On Premises to the Cloud 
From the 1990s until the beginning of the twenty-first century, ERP adoption grew
rapidly, as more organizations relied on ERP to streamline core business processes and
improve data visibility. At the same time, the cost of implementing ERP systems began
to climb. Not only were on-premises hardware and software expensive capital
investments, enterprise ERP systems often required the additional costs of custom
coding, consultants, and training.
Meanwhile, ERP technology evolved to embrace the internet, with new features and
functionality, such as embedded analytics. As time went on, many organizations
discovered that their on-premises ERP systems couldn’t keep up with modern security
demands or emerging technologies, such as smartphones.

Enter the cloud—or the software-as-a-service (SaaS) delivery model—for ERP. When

ERP software is "in the cloud," it simply means that it is kept on a network of remote
servers, instead of at a company’s location. The cloud offers a more affordable
alternative for ERP that lowers both operational expenses (OpEx) and capital expenses
(CapEx) because it eliminates the need for companies to purchase software and
hardware or hire additional IT staff. With no costly infrastructure to support, resources
can be invested in growth opportunities. Employees can shift their focus from managing
IT to more value-added tasks.

Next-Generation ERP
Built for Any Size Business
While the legacy ERP systems of the past were often too expensive for small to medium
businesses (SMBs), the cloud has broken that barrier. With a SaaS solution, smaller
companies can leverage the same proven, industrial-strength ERP software that larger
enterprises have been using for years. A cloud-based ERP solution can be implemented
quickly, with no CapEx investment. For small to medium businesses looking to innovate
quickly and seize new business opportunities, cloud ERP offers the flexibility to quickly
add new users and support changing business needs.

Delivering an Extended Enterprise to Fuel Opportunities

When cloud ERP extends its core financial architecture to include integrated customer
relationship management (CRM), supply chain management (SCM), human capital
management (HCM), and enterprise performance management (EPM), the system
seamlessly ties all the applications together with a single data repository and a common
user experience. An extended cloud ERP system enables all departments to be managed
with improved visibility and collaboration, as if they were a single organization. It also
provides seamless access to advanced reporting features, such as data visualization and
advanced analytics. With access to emerging technologies, such as the Internet of Things
(IoT), organizations gain a comprehensive, real-time understanding of business
activities not only in the front office, but also in warehouses and on factory floors. This
knowledge is readily available to employees on their mobile devices through social
tools.
Built for the digital age, today’s ERP cloud embraces mobile, social, and analytic tools.
Anything less won’t move an organization forward.
Future: ERP Trends
ERP Cloud Embraces the Next-Generation Workforce
ERP has moved to the cloud—and there’s no going back. The cloud is not just the proven
baseline for ERP—it is the path forward for the diminishing number of companies that
still have active on-premises systems. Unlike yesterday’s legacy ERP, cloud-based ERP
enables companies to meet the requirements of the digital economy. Today’s workforce
demands access to twenty-first century technology—such as mobile and social with an
easy-to-use interface—that enables them to easily collaborate and share information.
And they are unlikely to accept antiquated processes, out-of-date technologies, and ugly
interfaces. Organizations that fail to meet these expectations put their future at risk.
Embracing ERP
The Suite Always Wins Over Point Solutions
An important characteristic of modern cloud ERP is the unified solution or applications
suite. When compared to deploying a single-point software application—such as human
resources or sales automation—an ERP cloud suite offers the best advantage. A solution
that encompasses all core business functions integrates operational processes across
the organization. Employees gain improved visibility and insight into all aspects of the
business. An ERP cloud suite enables companies to quickly build a foundation that
meets immediate needs with the agility to respond to changing market conditions.

Supply Chain Management

If you go to a Supermarket and pick up a few items off the shelf from electronics and
white goods or even clothes and look at the labels, the chances are that you will find
them having been manufactured in China or Mexico. The coffee pods you buy to use for
your everyday use comes from Africa. Computers have been shipped out of South
American Factories and Soft furnishings on the shelves are from India and Hong Kong.

Global markets are expanding beyond borders and re-defining the way demand and
supplies are managed. Global companies are driven by markets across continents. To
keep the cost of manufacturing down, they are forced to keep looking to set up
production centers where the cost of raw materials and labour is cheap. Sourcing of raw
materials and vendors to supply the right quality, quantity and at right price calls for
dynamic procurement strategy spanning across countries.

With the above scenario you find companies procuring materials globally from various
vendors to supply raw materials to their factories situated in different continents. The
finished goods out of these different factory locations then pass through various chains
of distribution network involving warehouses, exports to different countries or local
markets, distributors, retailers and finally to the end customer.

In simple language, managing all of the above activities in tandem to manage demand
and supply on a global scale is Supply Chain Management. As per definition SCM is the
management of a network of all business processes and activities involving
procurement of raw materials, manufacturing and distribution management of Finished
Goods. SCM is also called the art of management of providing the Right Product, At the
Right Time, Right Place and at the Right Cost to the Customer.
Why SCM strategy is important for an Organization

Supply Chain Strategies are the critical backbone to Business Organizations today.
Effective Market coverage, Availability of Products at locations that hold the key to
revenue recognition depends upon the effectiveness of Supply Chain Strategy rolled out.
Very simply stated, when a product is introduced in the market and advertised, the
entire market in the country and all the sales counters need to have the product where
the customer can buy and take delivery. Any glitch in the product not being available at
the right time can result in the drop in customer interest and demand which can be
disastrous. Transportation network design and management assume importance to
support sales and marketing strategy.

Inventory control and inventory visibility are two very critical elements in any
operations for these are the cost drivers and directly impact the bottom lines on the
balance sheet.

Inventory means value and is an asset to the company. Every business has a standard
for inventory turnaround that is optimum for the business. Inventory turnaround refers
to the number of times the inventory is sold and replaced over a period of twelve
months. The health of the inventory turn relates to the health of business.

In a global scenario, the finished goods inventory is held at many locations and
distribution centers, managed by third parties. A lot of inventory would also be in the
pipeline in transportation, besides the inventory with distributors and retail stocking
points. Since any loss of inventory anywhere in the supply chain would result in loss of
value, effective control of inventory and visibility of inventory gains importance as a key
factor of Supply Chain Management function.

Activity-Based Management (ABM): Definition, Importance and Areas

Activity-based management (ABM) is a systematic, integrated approach that describes

management decisions that use activity-based costing information to satisfy customers

and improve profitability. ABM broadly includes aspects like pricing and product mix

decisions, cost reduction and process improvement decisions and product design

decisions.

Activity-based management follow this premise: products consume activities; activities

consume resources. If managers want their products to be competitive, they must know

both (i) the activities that go into making the goods or providing the services and (ii) the

cost of those activities. To reduce a product’s cost, managers will likely have to change

the activities the product consumes.

A manager who announces, “I want across-the-board cuts—everyone reduce costs by

20 percent,” rarely gets the desired results. To make significant cost reduction people

must first identify the activities that a product consumes. Then they must figure out

how to rework those activities to improve production efficiency.

Activity-Based Costing and Activity-Based Management:

The consortium for Advanced Manufacturing International (CAM-I) (USA) defines both

the terms as follows:

Activity-based costing is defined as a methodology that measures the cost and

performance of activities, resources and cost objects. Specially, resources are assigned

to activities based upon consumption rates and activities are assigned to cost objects,

again based on consumption. ABC recognises the causal relationships of cost driver to

activities.

Activity-based management is defined as a discipline that focuses on the management of

activities as the route to improving the value received by the customer and the profit

achieved by providing this value. ABM includes cost driver analysis, activity analysis,

and performance measurement, drawing on ABC as its major source of data.

In simple terms, ABC is used to answer the question “what do things cost?” While ABM,

using a process view, is concerned with what factors cause costs to occur? Using ABC

data, ABM focuses on how to redirect and improve the use of resources to increase the

value created for customers and other stakeholders.

Importance of ABM:

ABM focuses on accountability for activities rather than costs and emphasises the

maximisation of system wide performance instead of individual performance. ABM

control recognizes that maximizing the efficiency of individual subunits does not

necessarily lead to maximum efficiency for the system as a whole.

The functional-based management control assigns costs to organisational units and

then holds the organizational unit manager responsible for controlling the assigned

costs. Performance is measured by comparing actual outcomes with standards or

budgets. The emphasis is on financial measures of performance; non-financial measures

are usually ignored.

The functional based management traces costs to individuals who are responsible for

incurring costs. The reward system is used to motivate managers to manage costs by

increasing the operating efficiency of their organisational units. This approach assumes

that maximising the performance of overall organisation is achieved by maximising the

performance of individual organisational subunits.

In ABM, both financial and non-financial measures of performance are important.

Exhibit 17.4 compares the characteristics of functional-based and activity-based

management.

Plowman comments on the importance of ABM in the following words:

“Overhead costs are the black hole in conventional management information systems.

ABM shines light into the hole. Knowledge of a business at the level of activities is the

basic building block upon which new understanding can be built of where profits are

being made and where they are being eroded.

By making visible what was previously invisible, ABM throws a spotlight on those

aspects of a business where action can directly improve business performance. Because

it deals with ‘financial numbers’, ABM is Often-seen as the preserve of the finance

function. In fact, its real strength lies in providing genuinely, useful information for all

functions in an organisation.

Managers throughout the business need the right information to understand and

address two key issues:

i. How the company can position itself better in the market—for which accurate product

and customer profitability information is vital.

ii. How it can improve its internal capability and lower unit costs—for this, it needs to

understand and change the procedures, systems and processes that create products and

deliver services to customers.”

Areas of Use:

ABM can be used by companies in the following areas:

(1) Developing Corporate Strategy:

ABM can help the firms to develop appropriate company strategy, long-term plans and

competitive advantage by focusing on and managing activities. Some firms have

competitive advantage by providing a low-cost product or manage activities to reduce

costs. To reduce costs generally requires changes in activities. Anyone can cut costs—if

the operation is closed, costs will be reduced. However, ABM has the objective of cutting

costs while maintaining quality and quantity of output.

(2) Making Activity Analysis:

ABM aims to achieve continuous improvement by making activity analysis i.e. by

classifying each activity as value-added or non-value added. A value-added activity is an

activity that adds value to a product or service from the view point of the customer. A

non-value-added activity is an activity that does not add value to a product or service

from the viewpoint of the customer.

The value-added activities make up value-chain. The value chain is a linked set of value-

creating activities leading from raw material sources to the ultimate end use of the

goods or services produced. Value chain analysis is an ongoing process in which

activities are constantly being classified, eliminated and improved.

Non-value added activities merely add to costs which can be eliminated without

reducing product quality, performance or value.

In a manufacturing firm, the following are examples of non- value added activities:

(i) Movement:

Time spent for transfer around the factory floor where value-added activities are

performed.

(ii) Waiting:

Idle time does not add value to products. Reducing the time spent between value-added

activities reduces cost of idle time.

(iii) Set up:

Time spent preparing to perform a value-added activity.

(iv) Inspection:

Time spent verifying that a value-added activity was done correctly.

(v) Storage:

Storage of materials, work-in-process, or finished goods inventory is a non- value added

activity.

The above non-value added activities are found in manufacturing organisations. In

other organisations such as government departments, hospitals, universities, colleges,

fast-food restaurants, utilities one may find a large number of non-value added

activities.
(3) Reducing Customer Response Time:

ABM helps to reduce customer response time by identifying activities that consume the

most resources in value and time. ABM also helps in reducing customer response time

by identifying and eliminating non-value added activities. This way the customer

response time and cost will decline. Customers also appreciate a quick response time to
their orders which is facilitated through activity-based management .