About the case:
Thursday 2 January 2020
His prospective clients claim that they get a better deal from DJ’s competitors. DJ is the
commercial director of Brains Retail Intelligence and Consulting Ltd. (BRIC), a company
specialized to (re-) developing retail networks. Their services include: strategy, marketing,
organization, operations, technology, transformation, digital, advanced analytics, and
sustainability.
Problems
DJ is astonished by how little knowledge he and other decision makers have of BRIC’s own
cost structure while at the same time BRIC’s consultants do successfully advise its clients on
how to efficiently structure its operations and to develop costing systems that provide
actionable insights into its clients costs structure.
His prospective clients claim that they get a better deal from DJ’s competitors.
According to the current method, the five resources are almost completely randomly
allocated to three cost pools. This method turns the likelihood of creating an accurate
allocation basis to almost zero.
The assumption that the biggest cost pool follows the consumption pattern of finance.
A bad product costing system significantly influences the accuracy of reported costs used in
the product- and capacity planning decisions. For that reason, it is hard to make these
decisions.
Unable to fully use the potential of synergy between service units
Business model
Value proposition:
Their services include: strategy, marketing, organization, operations, technology,
transformation, digital, advanced analytics, and sustainability.
BRIC for instance was able to design spectacular cost savings programs and put into work
systems to standardize customers' experience in retail shops belonging to the same network.
Resources:
Employees(consultants)
Process:
BRIC produces five different service lines (S1, S2, S3, S4, S5). To perform their activities
BRIC’s consultants operate from within a service unit. For each service line, the firm creates a
so-called engagement team who prepares and helps implement a plan for the client firms. This
engagement team is led by the engagement leader who prepares the bids based on the cost
relations that are assumed to exist for each separate service line.
Profit formula
There are five different service lines. These provide different potentials in revenue. The direct
costs are not mentioned in the case. The indirect costs however, are allocated randomly, leading
to negative consequences. Because they are unable to effectively allocate the different costs of
the units to the service lines, they are unable to make decisions effectively regarding productand capacity planning. The reason for that is that it is impossible to disentangle the different
contributions to the five service lines.
Calculations
Cost pools:
Finance (€50,000/month); each 5 year, 20% each year = 10,000
Strategy (€40,000/month),
Agile (€10,000/month),
Performance improvement (€80,000/month), 50% to S1, 50% to S2
Operations and ICT advice (€90,000/month) 60% to S1, 20% to S2, 5% to S3, 5% to S4 and
10% to S5.
BRIC produces five different service lines (S1, S2, S3, S4, S5). To perform their
activities BRIC’s consultants operate from within a service units. For each service
line the firm creates a so-called engagement team who prepare and help
implement a plan for the client firms. This engagement team is led by the
engagement leader who prepares the bids based on the cost relations that are
assumed to exist for each separate service line.
On 2 March 2020 Carine Lacor, Christine Shih, Isabelle Auger and Peter Cardinal join the
“allocation meeting.”
According to the current method, the five resources are almost completely randomly
allocated to three cost pools. This method turns the likelihood of creating an accurate
allocation basis to almost zero.
Carine argues to first select the three biggest resources and then allocate the other resources
to these biggest cost pools randomly
Isabelle thinks it is better to randomly create cost pools altogether.
Peter argues that it is better to create just one cost pool and to determine an exact estimate of
the resource consumption pattern of the biggest cost pool that is included in the system
Aishwarya d advises that the current revenues are taken as a proxy for the demand for
services and that the revenues are used as an allocation base. That is, all costs are collected in
one big cost pool and the costs are subsequently allocated based on the revenue. The idea is
that the activities that can bear the highest costs are allocated the highest cost level.
Christine applauds the idea put forward by Aishwarya but she adds that the
current revenue is biased as the revenue is determined by the current demand
for the different services, and this demand is affected by the current allocation
method. She, therefore, advises to take the potential revenue distribution that
would come into being if every bid was won. She further advises to first subtract the variable
costs of the three services and then allocate the costs accumulated
in the cost pool.
Ajanee had developed an algorithm that helped her ascertain the consumption patterns in
activity pools. Ajanee offered on a no-cure-no-pay basis to develop an algorithm for BRIC.
Among other data she collected data on how often the firm had meetings with clients on the
services that the different departments delivered. More meetings would suggest more
resource consumption. Her estimates resulted in the following resource consumption pattern
estimate
Finance, costs are equally distributed to all the services.
Strategy, 50% to S1, 10% to S2, 5% to S3, 30% to S4, and 5% to S5.
Agile, 60% to S1, and the rest is equally distributed among 4 remaining services.
Performance improvement, 50% to S1 and 50% to S3.
Operations and ICT advice, 60% to S1, 20% to S2, 5% to S3, 5% to S4, and 10% to S5.
Benchmark:
1. 20% finance + 50% performance + 60% agile + 50% strategy + 60% operations
0.2 * 50.000 + 0.5 * 80.000 + 0.6 * 10.000 + 0.5 * 40.000 + 0.6 * 90.000 = 130.000
2. 20% finance + 0% performance + 10% agile + 10% strategy + 20% operations
0.2 * 50.000 + 0.1 * 10.000 + 0.1 * 40.000 + 0.2 * 90.000 = 33.000
3. 20% finance + 50% performance + 10% agile + 5% strategy + 5% operations
0.2 * 50.000 + 0.5 * 80.000 + 0.1 * 10.000 + 0.05 * 40.000 + 0.05 * 90.000 = 57.500
4. 20% finance + 0% performance + 10% agile + 30% strategy + 5% operations
0.2 * 50.000 + 0 * 80.000 + 0.1 * 10.000 + 0.3 * 40.000 + 0.05 * 90.000 = 27.500
5. 20% finance + 0% performance + 10% agile + 5% strategy + 10% operations
0.2 * 50.000 + 0 * 80.000 + 0.1 * 10.000 + 0.05 * 40.000 + 0.1 * 90.000 = 22.000
Reported Cost:
1. 20% finance + 50% performance + 60% operations
0.2 * 100.000 + 0.5 * 80.000 + 0.6 * 90.000 = 114.000
2. 20% finance + 0% performance + 20% operations
0.2 * 100.000 + 0.2 * 90.000 = 38.000
3. 20% finance + 50% performance + 5% operations
0.2 * 100.000 + 0.5 * 80.000 + 0.05 * 90.000 = 64.500
4. 20% finance + 0% performance + 5% operations
0.2 * 100.000 + 0.05 * 90.000 = 24.500
5. 20% finance + 0% performance + 10% operations
0.2 * 100.000 + 0.1 * 90.000 = 29.000
Euclidian method:
√(130.000-114.000)2 + (33000-38000)2 + (57500-64500)2 + (27500-24500)2 + (2200029000)2 = 19.698
Present the evaluation of alternative allocation methods.
Carine: select the three biggest resources and then allocate the other resources to these biggest
cost pools randomly.
Size-random method allocates the n biggest resources to n activity cost pools, and the rest is
then randomly distributed to various cost pools. Assign the largest resources systematically by
size to activity pools.
Isabelle: randomly create cost pools altogether.
Correlation - random. Seed the desired number of activities pools with a random choice of
resources. Then pick like resources to add to the base resources in activity pool.
Peter: create one cost pool and determine an exact estimate of the resource consumption pattern
of the biggest cost pool.
Correlation - size. Seed the desired number of activity cost pools with the largest resources.
Aishwarya: all costs are collected in one big cost pool and the costs are subsequently allocated
based on the revenue.
Size-random method allocates the n biggest resources to n activity cost pools, and the rest is
then randomly distributed to various cost pools. Assign the largest resources systematically by
size to activity pools.
Cristine: agrees with Aiswarya, but proposes a bidding system to take out the effect of the
current allocation system. Also, she thinks the variable costs should be subtracted first. They
would offer an amount that would suit each individual line to make good for their total costs.
This would lead to exactly the right choice.While bidding seems to solve the decision problem
entirely, Manufacturing will claim that consumption patterns differ between units. This will
lead them to follow that pattern in their pricing system. These numbers will start to show up
once the decision has been made.
How would your allocation look if you used revenues as the allocation base? Comment on this
choice.
Benchmark:
1. 20% finance + 50% performance + 60% agile + 50% strategy + 60% operations
0.2 * 50.000 + 0.5 * 80.000 + 0.6 * 10.000 + 0.5 * 40.000 + 0.6 * 90.000 = 130.000
2. 20% finance + 0% performance + 10% agile + 10% strategy + 20% operations
0.2 * 50.000 + 0.1 * 10.000 + 0.1 * 40.000 + 0.2 * 90.000 = 33.000
3. 20% finance + 50% performance + 10% agile + 5% strategy + 5% operations
0.2 * 50.000 + 0.5 * 80.000 + 0.1 * 10.000 + 0.05 * 40.000 + 0.05 * 90.000 = 57.500
4. 20% finance + 0% performance + 10% agile + 30% strategy + 5% operations
0.2 * 50.000 + 0 * 80.000 + 0.1 * 10.000 + 0.3 * 40.000 + 0.05 * 90.000 = 27.500
5. 20% finance + 0% performance + 10% agile + 5% strategy + 10% operations
0.2 * 50.000 + 0 * 80.000 + 0.1 * 10.000 + 0.05 * 40.000 + 0.1 * 90.000 = 22.000
Total of cost pool:
50,000 + 80,000 +10,000 + 40,000 + 90,000 = 270,000
S1 17.1m / 126.56m * 270,000 = 36.500
S2 21.7m / 126.56m * 270,000 = 46.300
S3 46.3m / 126.56m * 270,000 = 99.000
S4 10.6m / 126.56m * 270,000 = 22.700
S5 30.7m / 126.56 m* 270,000 = 65.500
√(130.000-36.500)^2 + (33.000-46.300)^2 + (57.500-99.000)^2 + (27.500-22.700)%2 +
(22.000-65.500)^2 = 112.057