Special: Service Based Costing™

Want to know the TCO of a business application or consider to outsource the whole network service? Then you need to know all the underlying products, activities and resources and how there costs can be accounted to the service. Difficult to capture this complexity? Not with Service Based Costing (SBC).

SBC is a major innovation to existing methods, such as cost centres and Activity Based Costing (ABC). SBC includes both the managerial foundation and the methods to account, manage and control costs up to the level of services. SBC provides new methods for budgetting, accounting, charging, strategic and tactical management accounting & control. Through the combination of managerial, business economical and IT methods and techniques it is one model that can be used for both non-IT or corporate and IT businesses or departments. Enabling top management to plug and play, improve, insource and outsource their business straight from the level of their corporate mission.

The managerial foundation is layed in seven easy steps:

• Step 1: breakdown activities into a value system
• Step 2: functions of organization units in activities:
  • organisational structure
  • relation activities - organization units
• Step 3: means of production per value chain:
  • means of production and goods per organization
  • raw materials to produce goods
• Step 4: elaboration of each value chain in business processes
  • composition of value system - value chains - value activities - processes - business processes
  • elaboration of relation activities - organization units
  • roles of durable means of production and personnel in processes and business processes
• Step 5: service chain
• Step 6: use cases of each good (functions, transactions, etc.)
• Step 7: business use cases on the inputs and outputs of business processes

Then you're ready for all SBC cost accounting and management accounting-methods with unmatched simplicity and accuracy to control and reduce costs and increase revenues.

Step 1: breakdown activities into value system

The first step to reduce the complexity of the business is to look at the different type of organizations the business is made up of.

Each can be seen as a business subsystem that performs different primary activities than the other subsystems. For example: the operations of a developper produce specifications and instructions, where as a manufacturer produces goods. Each business subsystem performs it's own different value chain.

In step 4 these value chains are further decomposed into the different processes that are unique to each line of business.

In the next step the business subsystems and their interrelations set the context for the organizational structure of the business.

Step 2: functions of organization units in the activities

As the table on the right illustrates, complex organizations and market systems can be made up of a lot of organization types.

The interrelations in the value system of the previous step set the context for the organizational structure. And by that we don't mean an organization chart, which is only usefull to show the hierarchical relations. What we're interested in here, is how the organization works as a system. So what we analyze and design here are the interfaces between the organizational units, through which they collaborate. And with that of course the high level activities they perform in the value system.

Step 3: means of production per value chain

Step 4: elaboration of each value chain into business processes

Usually processes are decomposed into sub-processes, which in turn are further detailed into sub-sub-processes, etc. That is not to be recommended, because this approach only leads to increasing complexity, whereas the purpose of modelling should be to reduce complexity.

Instead the value activities of each business subsystem can be decomposed into process patterns and modules. The real world business processes (typical end-to-end workflows) are assembled from these modules. This way processes can be standardized throughout the enterprise and successes in one business subsystem can easily be transfered to others, by just replacing that part of their business processes. This is what is discussed at level 5 in maturity models (!).

Throughout this structure organization roles and process roles map the personnel and durable means of production to the activities they perform.

On the right you find an example of an IT business process to order and deliver CI's to the customer. It illustrates the combination of ITIL and logistics process modules. Consider the difference with complex process flowcharts you might be used to.

This way SBC offers the managerial foundation for cost accounting en management accounting & control on services:

SBC-budgetting
Budgets are the assigned and permitted costs per cost centre per period of time, based on cost and price estimations. First an estimate is made from the forecasts of customer demand per service. Through the use of drivers and normative indicators the required capacity of use cases, business use cases, goods, activities and finally means of production is calculated from the service demand estimate. All costs are consolidated on those cost centres, where estimates get the function of task setting. Traditionally the organizational units, but one can as well budget on processes, goods or services.

SBC-Accounting
Accounting accounts for the utilization of budget. Like is written in the IT Infrastructure Library (ITIL) ‘particularly the ability to identify costs by Customer, by service, by activity’. Well, just like in budgetting SBC provides the structure to do just that. Costs arise from the deployment of means of production to meet the demand on services. These costs are accounted to the point where there consumption has meaning to customers, i.e. the services. Like ABC the costs of durable means of production and personnel are accounted through their activities to the resulting cost objects, which are the business use cases. SBC includes the simplifying managerial structure to cope with the complexity of activities, which is not part of ABC. Unlike ABC we don't confuse activity results with the material results. The costs of raw materials are accounted to the goods and their resulting use cases separately. All costs are consolidated per service and from their accounted to their depending services. Budget utilization is controlled by consolidating the actual costs per cost centre. Using SBC control is possible per organizational unit, activity, service and customer. This way cost accounting becomes a job of plugging and playing with ready to use managerial and financial business objects. Instead of the usual headache giving drudgery, accounting becomes a fun job, like building with lego.

SBC-Charging
Besides accounting, the same structure can be used to determine the cost price. First the standard or manufacturing cost price is calculated. These are the direct costs plus the accounted indirect costs between services , excluding the costs of sales. Dividing the sales costs by the normal turnover provides the sales cost percentage. The sales price to be charged is then calculated by dividing the standard cost prices by one minus the netprofit and sales cost percentage. Government and non-profit can use a netprofit percentage of zero, to just cover the costs. The cost price equals to the standard cost price plus the sales cost percentage times the sales price. Nothing new of course, but way easier using SBC.

SBC-Strategic Management Accounting & Control
Traditionally financial instruments, such as ratio and Du Pont analysis, are used to assess and control the influences on the organization's earning power from capital development and the results from turnover and costs. With SBC these factors can be determined per organization unit via the organization types. SBC handles full or absorbing costing likewise to influence the relevant costs on the long term, because the fixed costs of personnel and durable means of production can be determined from service down to the organization units. This makes strategic choices, such as changes in assortment, a lot easier. SBC takes the tradional product-market-combinations to the level of service-market-combinations.

SBC-Tactical management accounting & control
Likewise the differential costs that can be influenced on the short term, can be calculated per organization unit in relation to the services. Using SBC the strategy and service level agreements can be underpinned down to the organization units. This provides each unit manager with clear margins within which variabel costs of f.e. raw materials and temporary staff can be altered.

SBC-applications
SBC has proven it's practice in TCO-calculations of information systems, for it's especially useful in complex organizations, such as large IT-Departments. SBC has been developped with and applied within the Tax Department of the Dutch Ministery of Finance in applications, such as the estimate for road pricing ('rekeningrijden'), the redesign of yearly tactical financial planning and the cost pricing of service management services.

SBC trademark and copyright
Service Based Costing™ is a registered trademark of HIT BV. The models presented here are the intellectual property of HIT BV. You are free to use these models though in your own organization, with the only restriction that you include a reference to HIT BV as the deviser and developper of Service Based Costing with a link to our website www.hit.nl. Thank you in advance.