Strategic Applications of Activity Based Management in Air Transportation Jessie Class
Embry-Riddle Aeronautical University
This paper attempts to link the benefits of Activity Based Management and Activity Based Costing to the strategic success of the air transportation industry. The paper hypothesizes that the failure or suffering of the air transportation industry is connected to its use of an unfitted traditional cost accounting method. The resolution to the situation is to apply activity based accounting methods in the management of aviation related industries to produce a strategic, competitive advantage and resurrect the industry from bankruptcy.
Strategic Applications of Activity Based Management in Air Transportation Business strategy, until twenty years ago, was usually based upon the idea of doing things “the way they’ve always been done.” Business strategy today, however, is based upon Total Quality Management (TQM), constant evolution, and a company’s need to establish a long-term competitive advantage. Just as the dynamics of business have changed since 1988, it logically follows that so should the operations of business. However, the air industry seems to be stuck in the last century. Although, the air transportation industry is going through a major international and economic re-engineering process, the air industry is struggling to make a profit; this may be in part to their use of conventional cost accounting methods, instead of a more contemporary cost accounting method. To develop and establish a competitive advantage, strategic managers utilize cost/resource analysis tools to help them make decisions about the best uses of company resources. Conventional, or traditional cost accounting (TCA), methods, used primarily until the 1980s, allocates all costs to one primary cost driver and one specific product or service. As effective as this system is for a simple, or single-product manufacturing company, its effectiveness is lost when applied to business conditions outside these parameters, as many 21st century aviation organizations have become. Traditionally, cost accountants arbitrarily add a broad percentage of expenses onto the direct costs to allow for the indirect costs. However, as the percentages of indirect or overhead costs rise, this technique becomes increasingly inaccurate because the indirect costs are not caused equally by all the products. For example, one product might take more time in one expensive machine than another product, but since the amount of direct labor and materials might be the same, the additional cost for the use of the machine would not be recognized when the same broad 'on-cost' percentage is added to all products. Consequently, the “true” cost of business cannot be accurately calculated, costs are inflated and vague, and this type of irrelevant information provides no value to decision-makers trying to develop a competitive strategy. The need for a different costing in today’s business system is apparent. One alternative to the traditional costing system is a costing method that allocates costs according to the company’s value-chain functions instead of its products. This type of cost system is known as Activity Based Costing (ABC). ABC is the systematic assignment of costs from resources to activities and then from activities to cost objects. In Garry Bradley’s analysis, he states more specifically “Activity Based Costing (ABC) is an approach to costing that considers the resources consumed by activities in order to create and deliver a product or service. Whereas the underlying assumption of a conventional costing system is simply that products cause costs, an activity based costing system assumes that cost objects (e.g. a subject) creates the...