Cost Management

Cost Management

Introduction: Our case study is on the Columbia City Bank. First of all we would like to talk about the general inner workings of a bank. A bank generates a profit from the differential between the level of interest it pays for deposits and other sources of funds, and the level of interest it charges in its lending activities. In recent history, investors have demanded a more stable revenue stream and banks have therefore placed more emphasis on transaction fees, primarily loan fees but also including service charges on an array of deposit activities and ancillary services.

Lending activities, however, still provide the bulk of a commercial bank’s income. Beside, Banks make money from card products through interest payments and fees charged to consumers and transaction fees to companies that accept the cards. To increase its share of the checking account market, Columbia City Bank in Seattle took two actions: It establish a customer call center to respond to customer inquiries about account balances, checks cleared, fees charge ,etc and it paid year-end bonuses to branch managers who met their branch’s target increase in the number of customers.

While 80% of the brunch managers met the target increase in the number of customers, Columbia City Bank ‘s profits continued to decline. John  Diamond, the CEO ,didn’t understand why profits were declining, even though the bank was serving more customers. The Pierce County branch manager , Rose Perez, noticed that while small retail customers flocked to the bank, the number of business customers was declined. Columbia City Bank’s costing system, develop back in 1988, is straightforward. No costs are traced directly to customers.

The bank simply assigns the total indirect costs to customer lines (retail customer line or business customer line) based on the total number of checks processed. The definition of a retail customer is basically any customer other than an institutional customer. ( which are: governments, schools, hospitals to name a few) 1A) Old cost system based on number of checks processed: Number of checks processed: Retail customers = 2280 Business customers= 9120 Total checks processed= 11400 Indirect cost allocation rate: 2850 000/ 11400 000 = RM 0. 25 per check processed 1B) Indirect cost for retail customers : 2280 000 x RM 0. 5 = RM 570 000 Indirect cost for business customers: 9120 000 x RM 0. 25 = RM 2280 000 1C) Proportion of the total indirect cost Assigned to retail customer: (570 000/ 2280 000) x 100% = 20 % Assigned to business customer: (2280 000/ 2850 000) x 100% = 80% 1D) Indirect cost per retail account: Number of retail accounts= 150 000 Indirect cost for retail accounts= RM 570 000 570 000/ 150 000 = RM 3. 80 indirect cost per retail account Indirect cost per business account: Number of business accounts= 50 000 Indirect cost for business accounts= RM 2280 000 2280 000/50 000 = RM 45. 60 indirect cost per business account E) Average profit per account of retail customer : Average revenue per retail customer account – average indirect cost per retail customer account 10. 00- 3. 80 = RM 6. 20 average profit per retail customer account Average profit per account of business customer: Average revenue per retail business account – average indirect costs per business account 40- 45. 60 = – RM 5. 60, loss of RM 5. 60 per business account 1F) From the traditional cost analysis, amongst the decisions that a manager might take is to increase the number of retail accounts as they generate a high profit margin.

This can be achieved by creating superior value and service for customers, which would in turn make them feel at ease with the bank, they know that their money is in good hands. More promotion and advertising would be necessary. Another action that might be taken is to decrease the amount of business lines as they are contributing losses for the bank. This can be done by concentrating more resources on the retail customer lines to woo new retail customers. A drastic action would be to shut down its business customer line altogether as it is turning into a liability.

Though this is not recommended as such, instead the bank should find ways to cut the costs of operating the business line. 2. Signs that Columbia City Bank’s original cost system was broken and in need of refinement is that it showed that its profit continued to decline even though 80% of the branch managers met the targeted increase in the number of customers. Another sign is that the numbers of business customers reduced in proportion to retail customers. In other words business customers who contribute a lot of capital were leaving the bank for certain reasons whereas at the same time retail customers continued to increase in numbers. A) Check payments: activity rate for it is the number of checks processed Retail customers: 2280 000 Business customers: 9120 000 Total number of checks processed: 11 400 000 Check payment costs: Activity: salaries of check-processing personnel = RM 440 000 Depreciation on check –processing equipment = RM 9120 000 Total number of checks processed = RM 1140 000 Allocation rate for check payments: Total check payment costs/ total number of checks processed RM 1140 000/11400 000 = RM0. 10 per check processed Teller withdrawals and deposits, activity rate is number of teller transactions Retail customers: 320 000

Business customers: 80 000 Total number of teller transactions: 400 000 Teller transactions costs: Activity: Teller salaries: RM 1200 000 Total Teller transaction costs: RM 1200 000 Allocation rate for teller transactions: Total teller transaction costs/ total number of teller transactions RM 1200 000/400 000 = RM 3 per teller transaction Customer service call center, activity rate is the number of calls Retail Customers: 95,000 Business Customers: 5000 Total number of customer calls to all centers: 100,000 Costs of customer calls to call retailers:- Activity: Tall-Free phone lines at customer call center: RM60,000

Salaries and customer’s representation at call center: RM450,000 Total cost of customer calls to call center: RM510,000 Allocation rate for customer service call center: Total costs of customer calls to call center / Total number of customer calls RM510,000/100,000 = RM5. 10 per customer call to call center 3B) |Activity |ABC rate |Total Indirect Cost Assigned to |Total Indirect Cost Assigned to | | | |Retail Customer line |Business Customer line | |Check Payments |RM0. 0 |2,280,000 x RM0. 10 =RM228,000 |9,120,000 x RM0. 10 =RM921,000 | |Teller Withdrawal and Deposits |RM3. 00 |320,000 x RM3. 00 =RM960,000 |80,000 x RM3. 00 =RM240,000 | |Customer Call Center |RM5. 10 |95,000 x RM5. 10 =RM484,500 |5000 x RM5. 10 =RM25,500 | |Total Indirect Cast | |RM1,672,500 |RM1,177,500 | 3C) Activity |Proportion Of Activity Resources Used By Retail |Proportion Of Activity Resources Used By Business| | |Customer Line |Customer Line | |Check Payments |{228,000/(288,000+912,000)} x 100% = 20% |{912,000/(228,000+912,000)} x 100% = 80% | |Teller Withdrawals and Deposits |{960,000/(960,000+240,000)} x 100% = 80% |{240,000/(960,000+240,000)} x 100% = 20% | |Customer Call Center |{484,500/(484,500+25,500)} x 100% = 95% |{25,500/(484,500+25,500)} x 100% = 5% | 3D) Total indirect costs assigned to retail customer lines: RM1,672,500 Number of retail accounts: 150,000 Indirect Cost Per Retail Customer Line: Total indirect costs assigned to retail customer line / Number of retail accounts RM1,672,500/150,000 = RM11. 15 Total indirect costs assigned to business customer lines: RM1,177,500 Number of business accounts: 50,000 Indirect Cost Per Business Customer Line: Total indirect cost assigned to business customer line / Number of business accounts RM1,177,500/50,000 = RM23. 55 E) F) Average Profit per Retail Customer Account:

Average revenue per retail customer account – Indirect cost per retail customer line RM10-RM11. 15 = RM1. 15 less generated per retail costumer line Average Profit per Business Customer Account: Average revenue per business customer account – Indirect cost per business customer line RM40-RM23. 55 = RM16. 45 profit generated per business costumer line From the ABC analysis, amongst the decisions that a manager might take is to increase the number of business accounts as they generate a high profit margin. This is due to the vast sums deposited into the bank which is in turn used for loans thus the bank can give out bigger loans and higher profits.

This can be achieved by creating superior value and service for business customers, which would in turn make them feel at ease with the bank, they know that their money is in good hands. Another action that might be taken is to decrease the amount of retail lines as they are contributing losses for the bank. This might be due to the small amount of cash deposits put into the bank which in turn means that the bank can only loan out a small amount of money, thus the interest earned by the bank from that loan which constitutes its revenue is very little. A drastic action would be to shut down its retail customer line as it is turning into a liability.

Though this is not recommended as such, we would instead advice to find ways to cut the costs incurred by the retail line such as charging a minimal fee for the customer hotline instead of toll free lines. Another option is to increase the revenue generated by the retail account by charging a higher cost of borrowing money that is the interest rate to customers who want to borrow money, or if that is not feasible then the bank can also invest in assets that give a higher return thus also increasing profits. 4A) In our humble opinion, the Columbia City Bank’s bonus based scheme incentive plan is not a wise strategy as it concentrates solely on quantity rather than taking into account quality as well. We say this based on the failure of the bank to increase its profits even though the number of customers it services continues to increase.

Looking into the bank’s past records we can see that the business customer account contributes more revenue (RM 40) as compared to the retail business account (RM10). This is usually due to the high capital injection of business accounts which store vast amounts of cash which the bank in return can use to loan out to customers and get returns based on the interests charged. Based on the ABC analysis, we are of the opinion that the bank should specialize and concentrate more on its business line which can contribute a higher profit margin to the business and lessen resources on business lines which are unprofitable. 4B) There are many benefits that Columbia City Bank can reap from the ABC analysis.

Amongst the benefits of ABC is that it provides better information to make wiser decisions as it allows a company to compare one’s price with a competitor’s price and see if it is possible to make a profit at a lower than the competitor. From the ABC a company can see where its competitive advantage lies, for Columbia City Bank its choice is between the business and retail customer lines, which according to our ABC analysis, the business wins head on. Manufacturing and distribution firms use ABC systems to focus on how and where to reduce costs. Managers set cost reduction targets in terms of reducing the cost per unit of the allocation base in different activity areas.

The goal is to reduce these costs without compromising customer service or perceived value (usefulness) customers obtain from the product or service. 4D) In today’s business world, there are 3 main developments why ABC has now become critical even for non accounting managers. Firstly is the increase in product diversity. Nowadays a company does not just manufacture and produce one kind of service only. For example Columbia City Bank would have to have services such as credit cards, e-banking, ATM, debit cards to name a few. These products differ in demands that they place on resources (some more, some less) needed to produce them because of the difference in volume process and complexity. Secondly is the increase in indirect costs in today’s business world.

The use of technology such as the computer integrated manufacturing (CIM) which gives instructions to run the machines and computer efficiently have become part and parcel of running a profitable firm. These advanced technologies have led to an increase in indirect costs and a decrease in direct costs especially direct manufacturing labor costs. Managing highly complex technology requires committing an increase amount for various support functions (production scheduling, process design, for example) which direct manufacturing labor does not accurately measure. Because direct manufacturing labor is not a cost driver of these costs, allocating indirect costs on the basis of direct manufacturing labor (which was the common practice) of ten does not measure accurately how resources are being used by different products.

Lastly, is the competition in today’s markets which is highly aggressive. As markets become more competitive, managers have felt the need to obtain more accurate cost information to help them make strategic decisions. Making correct pricing and product mix decisions is critical in competitive markets because competitors quickly capitalize on a company’s mistakes. Advances in information technology have enabled companies to implement these refinements. CONCLUSION: In conclusion, we can see from the analysis after applying the ABC approach that the bank can actually see and get accurate information about the cost they occur into their business.

In addition, we have learned after using ABC that the bank has a false costing method and that even though the number of costumers are increasing the bank’s revenue is still declining. Since the revenue is declining, we can recommend to the bank that they should focus more on their business customers because of the high revenue rate. They can attract more business customers by giving some special service, offers. Since the retail customers gives a low rate of revenue they should remove some extra cost that are not necessary because based on the ABC analysis each retail customer generates a RM1. 15 loss. Some examples include increasing revenues collected by investing in areas with higher returns or increasing the interest rate when lending money. This will hopefully generate higher revenue.

Whereas for the reducing costs part, a company can have a minimal charge for calling its customer hotlines instead of having toll free numbers. This would be able to help recuperate some of the costs of the staff manning the hotlines. If they can transfer some of the costs in the retail line to the business by giving beneficial services enriching the experiences of the business costumers and therefore they can charge higher premium and thus achieving a revenue rate earning them a higher profit. If the banks wants to attract more costumers they should do so wisely (by concentrating on the business line) as more advertising and promotions and this will increase the indirect cost.