Value chain, VBM, ABM and business process re-engineering

Value Chain, VBM, ABM, and Business Process Re-engineering

Welcome to one of the most practical and high-scoring chapters in APM Section B: Performance Optimisation! In business, success is not just about measuring results at the end of the year; it is about optimising operations, streamlining processes, and focusing every activity on creating real value.

In this chapter, we explore four powerful strategic management accounting frameworks designed to analyse and transform operational performance:

• Porter's Value Chain: Dissecting the organisation into discrete activities to identify where value is created or destroyed.
• Activity-Based Management (ABM): Using activity-level cost data to eliminate waste and focus on what customers actually care about.
• Value-Based Management (VBM): Aligning corporate strategy, operational drivers, and performance metrics directly with shareholder wealth creation.
• Business Process Re-engineering (BPR): Tearing down inefficient, legacy ways of working to achieve radical performance breakthroughs.

Don't worry if these sound like grand consulting buzzwords. By breaking each one down into simple steps, practical business analogies, and APM-style exam applications, you will be able to evaluate them with confidence.

1. Porter's Value Chain

What is the Value Chain?

Developed by Michael Porter, the Value Chain models an organisation as a sequence of discrete, value-creating activities. Value is defined as the amount buyers are willing to pay for what an organisation provides. An organisation is profitable if the total value it creates exceeds the collective costs of performing all the activities in the chain. The difference is called the Margin.

Porter divides these activities into two main categories: Primary Activities (directly related to producing and delivering the product or service) and Support Activities (which underpin and enable the primary activities).

The Anatomy of the Value Chain

Primary Activities:

• Inbound Logistics: Receiving, storing, handling, and disseminating inputs (e.g., warehousing raw materials, inventory management, supplier scheduling).
• Operations: Transforming inputs into final goods or services (e.g., machining, assembly, packaging, testing, equipment maintenance).
• Outbound Logistics: Collecting, storing, and physically distributing the finished goods to buyers (e.g., order processing, warehousing finished goods, delivery fleet operations).
• Marketing and Sales: Inducing buyers to purchase the product (e.g., advertising, pricing, sales force management, promotion, distribution channel selection).
• Service: Enhancing or maintaining product value post-sale (e.g., installation, training, repair services, parts supply, customer complaint handling).

Support Activities:

• Procurement: The function of purchasing inputs used across the entire value chain (e.g., negotiating vendor contracts, buying raw materials, machinery, office supplies).
• Technology Development: The know-how, procedures, and technology embedded in processes and equipment across all activities (e.g., product R&D, process automation, IT software development).
• Human Resource Management: Recruiting, hiring, training, developing, and compensating all personnel across primary and support functions.
• Firm Infrastructure: General management, strategic planning, legal, accounting, finance, and quality management systems that support the entire structure.

Memory Trick (Primary Activities): Think of the natural journey of a physical product: Input comes in (Inbound) \(\implies\) Operations makes it \(\implies\) Output goes out (Outbound) \(\implies\) Marketing sells it \(\implies\) Service supports it. (I-O-O-M-S).

Linkages: Where the Real Magic Happens

In APM, you will rarely score marks just for listing the nine activities. High marks come from evaluating linkages—the relationships and coordination between activities.

• Internal Linkages: How one activity affects the cost or performance of another. For example, spending more on high-grade component testing in Operations may drastically reduce post-sale warranty and repair costs in Service. Alternatively, poor communication between Inbound Logistics and Operations can cause factory downtime.
• External Linkages (The Value System): An organisation does not operate in a vacuum. Its value chain connects with the value chains of upstream suppliers and downstream distributors/customers. For instance, linking your electronic data interchange (EDI) systems directly with key suppliers allows just-in-time material arrivals, slashing storage costs for both parties.

Everyday Analogy: Think of baking and delivering artisan cakes. If you buy cheap, low-grade flour (Procurement), your baking time and scrap rate increase (Operations), delivery drivers face complaints of dry cakes (Outbound Logistics & Service), and marketing spend must double to convince customers to return. Optimising the value chain means coordinating the whole system, not just squeezing costs in one isolated department.

Value Chain Analysis in Performance Optimisation

When an APM scenario asks you to analyse performance across the value chain, evaluate:

1. Cost Leadership: Which specific activities incur the highest costs? Can costs be reduced without damaging customer-perceived value (e.g., by reconfiguring warehouse layout or automating order handling)?
2. Differentiation: Which activities directly create the features, brand prestige, or service speed that allow the firm to charge a premium price?
3. Eliminating Non-Value-Adding Steps: Can intermediate storage, double inspections, or administrative hand-offs be eliminated?

Key Takeaway: The Value Chain helps management view the organisation as an interdependent system of activities. Optimisation requires managing trade-offs and linkages across departments rather than judging performance in functional silos.

2. Activity-Based Management (ABM)

From ABC to ABM

You may recall Activity-Based Costing (ABC) from your earlier management accounting studies. ABC is an analytical costing tool: it assigns indirect overhead costs to activities using resource cost drivers, and then assigns those activity costs to cost objects (such as products, services, or customers) using activity cost drivers.

Activity-Based Management (ABM) is the active management use of that cost information. ABM uses the granular visibility provided by ABC to redesign processes, eliminate waste, improve product design, and make strategic pricing decisions.

In short: ABC provides the data; ABM takes the action.

Operational ABM vs. Strategic ABM

ABM operates at two distinct levels:

1. Operational ABM ("Doing things right"):
Focuses on operational efficiency, business process improvement, and asset utilisation. It analyses activities to lower costs while maintaining or improving output quality.
• Value-adding activities: Activities that enhance the product or service from the customer’s viewpoint and for which the customer is willing to pay (e.g., precision machining, assembling, delivering promptly).
• Non-value-adding activities: Activities that consume resources and time but add no value to the customer (e.g., moving materials back and forth between temporary storage, waiting for setup instructions, rectifying assembly errors, re-inspecting work). Operational ABM aims to eliminate, reduce, or automate non-value-adding activities.

2. Strategic ABM ("Doing the right things"):
Focuses on strategy, product mix, customer profitability, and market positioning.
• Customer Profitability Analysis (CPA): ABC often reveals that 20% of customers generate 80% of profits, while some high-revenue customers consume massive amounts of non-standard support, expedited shipping, and frequent order changes, making them net loss-makers. Strategic ABM allows management to reprice contracts, introduce minimum order sizes, or alter service terms.
• Product Portfolio Decisions: Highlighting which low-volume, complex products consume disproportionate setup and quality-inspection overheads, guiding decisions to redesign, reprice, or discontinue them.

Common APM Pitfall with ABM

Examiner Warning: Do not spend your time in an APM exam doing pages of routine overhead absorption calculations unless explicitly asked to calculate an ABC rate! APM tests evaluation and scepticism. Candidates must evaluate whether ABM data is reliable, whether the high cost of collecting activity driver data is commercially justified, and how managers might behave when their activities are scrutinised.

Key Takeaway: ABM shifts management attention from "How much did the department spend?" to "What activities did the department perform, why did they perform them, and did they add value for the customer?"

3. Value-Based Management (VBM)

The Core Philosophy of VBM

Value-Based Management (VBM) is a holistic management approach that aligns an organisation’s overall strategy, analytical techniques, performance measurement systems, and management culture with one supreme objective: maximising shareholder value.

Traditional accounting measures like Gross Profit, Operating Profit, or Earnings Per Share (EPS) can be misleading. A company can report rising accounting profits simply by investing huge amounts of capital into projects that earn less than the company's cost of capital—effectively destroying shareholder wealth. VBM prevents this by ensuring that every strategic and operational decision is evaluated against the cost of the capital tied up in it.

The Four Core Pillars of VBM

VBM is implemented through a connected cycle often described in four steps:

1. Strategy Formulation: Explicitly defining which markets, products, and investments will generate long-term economic value above the weighted average cost of capital (\(\text{WACC}\)).
2. Identifying Value Drivers: Identifying the operational levers at the business-unit and shop-floor levels that have the greatest impact on value creation.
3. Target Setting and Performance Measurement: Setting targets based on economic profit metrics—most notably Economic Value Added (\(\text{EVA}\))—rather than distorted traditional accounting metrics.
4. Remuneration and Reward: Tying management bonuses and employee rewards directly to value-creation metrics to align manager behaviour with shareholder interests.

Understanding Value Drivers

Operational staff on the factory floor or frontline customer service reps cannot directly control corporate \(\text{EVA}\) or \(\text{WACC}\). Therefore, VBM requires management to translate high-level value creation into cascading, tangible operational value drivers.

Consider the calculation convention: \(\text{EVA} = \text{NOPAT} - (\text{Capital Employed} \times \text{WACC})\).

To improve \(\text{EVA}\), a business can:

• Increase Operating Profit (\(\text{NOPAT}\)): Boost sales volume, optimize pricing, reduce operating expenses, or eliminate non-value-adding activity costs.
• Reduce Capital Employed: Minimise working capital (e.g., speed up debtor collections, reduce inventory holding days) or divest unproductive fixed assets.
• Optimise Financing Cost (\(\text{WACC}\)): Achieve an optimal capital structure (within prudent financial risk boundaries).

Example: A warehouse manager cannot control \(\text{WACC}\), but by reducing inventory holding days from 45 to 25 days, they release tied-up cash, reduce Capital Employed, eliminate warehousing rental overhead, and directly boost \(\text{EVA}\). In VBM, "inventory turnover days" becomes that manager's operational value driver.

Benefits and Practical Challenges of VBM

Benefits:
• Establishes a single, coherent objective throughout the enterprise.
• Prevents over-investment in empire-building projects that look profitable on paper but earn less than the cost of capital.
• Encourages a long-term capital discipline mindset.

Challenges & Sceptical APM Critique:
• Short-termism: Managers might slash valuable R&D, staff training, or preventative maintenance to artificially inflate current-year \(\text{NOPAT}\) and \(\text{EVA}\).
• Complexity: Calculating accounting adjustments for \(\text{EVA}\) (e.g., capitalising R&D, adjusting for leases) can make targets difficult for non-financial managers to understand and trust.
• Neglect of other stakeholders: Hyper-focusing purely on shareholder returns can alienate employees, suppliers, customers, and local communities, undermining sustainable performance.

Key Takeaway: VBM ensures capital is treated as an expensive resource. Its operational success relies on successfully breaking down corporate financial value into manageable day-to-day operational drivers.

4. Business Process Re-engineering (BPR)

What is BPR?

Introduced by Michael Hammer and James Champy, Business Process Re-engineering (BPR) is defined as:

"The fundamental rethinking and radical redesign of business processes to achieve dramatic improvements in critical, contemporary measures of performance, such as cost, quality, service, and speed."

Notice the four key words in that definition:

• Fundamental: Ask basic questions: "Why do we do this at all?" and "Why do we do it this way?" Challenge all long-held assumptions.
• Radical: Going to the root of things; not making marginal tweaks or superficial adjustments, but completely reinventing how work is done.
• Dramatic: Aiming for quantum leaps in performance (e.g., an 80% reduction in lead time or a 50% cost drop), not minor 2% annual improvements.
• Processes: Focus on end-to-end collections of activities that create value for a customer (e.g., order fulfillment, claims processing, product development), cutting across functional department walls.

BPR vs. Incremental Improvement Techniques

In the APM exam, candidates often confuse BPR with continuous improvement methods like Kaizen or Total Quality Management (TQM). Keep this clear contrast in mind:

• Incremental Improvement (Kaizen / TQM): Starts with existing processes and refines them continuously in small, evolutionary steps. Low risk, bottom-up involvement, culturally gentle.
• BPR: Starts with a clean sheet of paper (zero-based thinking) and asks how the process should look if built today from scratch. High risk, top-down driven, disruptive, revolutionary.

Key Principles of BPR

1. Organise around outcomes, not tasks: Have one person or a multi-skilled case team handle the entire process from start to finish rather than passing a file through six separate departmental silos.
2. Have those who use the output of the process perform the process: For example, letting departments order small supplies directly via pre-approved electronic catalogs rather than submitting forms to a central purchasing department.
3. Subsume information-processing work into the real work that produces the information: When goods arrive at a receiving dock, the receiving staff scan barcodes directly into the corporate system, automatically matching against purchase orders and generating payment approvals, eliminating invoice-matching clerks.
4. Treat geographically dispersed resources as though they were centralised: Use unified corporate databases and networks so regional teams share resources seamlessly.
5. Capture information once, at the source: Stop entering data onto paper forms only for another person to key it into a computer system later.

BPR, Systems Development, and Organisational Performance

Modern information technology is usually the primary enabler of BPR. However, simply using IT to automate an existing, flawed process is not BPR; that is just "paving cow paths." BPR uses technology to enable entirely new ways of working.

Real-World Illustration: In a traditional consumer loan application, a customer fills out a paper form, which is posted to a branch, vetted by a clerk, forwarded to a risk officer for underwriting, sent to legal for documentation, and returned to administration for disbursement—taking 14 days. A re-engineered process uses an online customer portal, automated credit-scoring algorithms, and instant bank verification, disbursing the funds in 14 seconds. The departmental silos are replaced by an end-to-end digital workflow.

Risks and Performance Management Challenges of BPR

While the rewards of BPR can be immense, failure rates are historically high:

• Severe Cultural Disruption and Resistance: Radical change breeds fear, job insecurity, and resistance from middle managers whose departmental empires are dismantled.
• Operational Turmoil: Scrapping proven legacy systems before new processes are stable can result in catastrophic customer service failures during the transition.
• Loss of Control and Specialisation: Cross-functional generalist roles may lack the deep technical expertise previously housed in specialist departments.
• Performance Dip: Performance typically drops significantly before it improves (the "valley of despair"), which demands patient, committed executive leadership.

Key Takeaway: BPR is an all-or-nothing, clean-sheet redesign of cross-functional processes. It delivers dramatic performance breakthroughs when enabled by modern IT, but carries high operational and human risk.

5. Comparing the Four Techniques

To help you select and evaluate the right technique in an APM scenario, review this comparative summary:

• Porter's Value Chain:
Primary Focus: Strategic activity mapping and linkage analysis.
Key Question: Where across primary and support activities do we generate competitive advantage or incur excess cost?
Best Used When: Analysing strategic positioning (cost leadership vs differentiation) and diagnosing multi-departmental bottlenecks.

• Activity-Based Management (ABM):
Primary Focus: Operational and strategic cost driver management.
Key Question: Which activities add value for the customer, and which non-value-adding activities must be eliminated?
Best Used When: Overhead costs are high, product/customer complexity causes cross-subsidisation, and processes need targeted waste reduction.

• Value-Based Management (VBM):
Primary Focus: Shareholder wealth creation and capital efficiency.
Key Question: Are our operational units and strategies earning returns that exceed their cost of capital (\(\text{EVA} > 0\))?
Best Used When: Re-aligning divisional incentives, addressing capital tie-up, and curbing managerial obsession with short-term accounting profit.

• Business Process Re-engineering (BPR):
Primary Focus: Radical, clean-sheet process redesign.
Key Question: If we designed this end-to-end customer process today using modern IT, what would it look like?
Best Used When: Legacy processes are broken, customer satisfaction is collapsing, and incremental changes are insufficient to stay competitive.

6. Applying Professional Skills in Exam Scenarios

Strategic Professional APM answers require you to demonstrate professional skills alongside your technical knowledge. Here is how examiners expect you to apply them to this chapter:

• Analysis and Evaluation: When presented with operational data (e.g., delivery times, defect rates, customer complaint counts, overhead pools), do not just state what the numbers are. Calculate variances, determine root causes (e.g., poor inbound supplier checks leading to high operational scrap), and evaluate which technique (ABM, BPR, or Value Chain linkage coordination) provides the best remedy.
• Scepticism: Challenge managerial assumptions. If a CEO proposes BPR to solve a minor 3% cost discrepancy, challenge whether the massive cost, disruption, and risk of BPR is justified, or whether incremental continuous improvement is more suitable. Similarly, be sceptical of VBM targets that encourage managers to underinvest in essential long-term assets to make short-term \(\text{EVA}\) look good.
• Commercial Acumen: Show awareness of practical, real-world constraints. Recognise that implementing ABM requires complex IT data collection systems that may cost more than the overhead savings they yield. Point out employee morale risks, union pushback, or supplier resistance when redesigning processes.
• Communication: Structure your recommendations clearly. If advising the board in a formal report, adopt an objective, professional tone, use concise headings, and present clear executive recommendations.

Chapter Quick Review

• Porter's Value Chain categorises activities into 5 Primary (Inbound, Operations, Outbound, Marketing & Sales, Service) and 4 Support (Procurement, Technology, HR, Firm Infrastructure). Managing linkages between them creates sustainable competitive advantage.
• ABM uses ABC cost driver data to manage performance. Operational ABM eliminates non-value-adding activities; Strategic ABM optimises product mix and customer profitability.
• VBM aligns operations and strategy with shareholder wealth creation by measuring economic return against the cost of capital (\(\text{EVA}\)) and translating high-level financial goals into frontline operational value drivers.
• BPR is the fundamental rethinking and radical redesign of cross-functional processes for dramatic improvements. It uses a clean-sheet approach and IT enablement, but carries high risk and severe operational disruption.