Activity-Based Costing 141represents the large majority of the cost, this probably doesn’t cause us any
material error. In total we estimate that at the current level our systems cost us
about $1.35 million a year in depreciation of hardware and amortization of
software. We are writing off the technology over a three-year life, which is
reasonable. So we estimate that it will cost us in total about $2.1 million a year
($1.35 million in systems and 0.75 million in personnel) at our current level of
operations. This pool is a fixed pool since both the people and systems costs
are independent of volume—our people now are nowhere near capacity but
you can’t hire a half-person.
The driver for this cost pool is clearly the number of transactions
processed, but arriving at the proper measure was difficult. For the order-entry
and payment-processing systems a transaction is measured at the order level.
But for the fulfillment and database systems, transactions are dependent on the
line items in the order. Once that was understood we found that we were cur-
rently handling about 20,000 transactions per day on average, which annualizes
to about 7.3 million per year (20,000×365). Dividing this total into the cost to
run the system—people and systems—we estimate that it costs us just under
$0.30 for each transaction that is processed by our system ([$750+1,350]/7,300
≈$0.29). This cost is far above our target price of between $0.10 and $0.15 per
transaction.
“How do you plan to become more competitive?” Denise asked.
“ We were hoping you could help us,” was the answer.
Denise had a number of questions. “Okay, first, a lesson. Driver identifi-
cation is different for variable- and fixed-cost pools. For variable pools, drivers
are usage based—for ETN/ W, the customer-qualification cost pool driver was
the number of reports outsourced; for materials cost pools in car manufactur-
ing, it is cars produced; and for fuel cost pools in freight hauling, it is miles dri-
ven. But for fixed-cost pools, the causal factor is capacity, not usage—the $2.1
million gives you the capacity to handle a given number of transactions; the
number that you do deal with is not meaningful other than as an indication of
the capacity utilized. And when we talk about capacity, we have to be aware of
the distinction between usedand useful.You said that you are processing about
20,000 transactions per day. Is every day the same?
“Absolutely not,” Dave shot back. “Christmas and special holidays such as
Mother ’s Day are our busy time.”
Denise then asked Carol, “How does this impact your area?”
Carol thought she understood. “ When I planned the system, I had to use
our peak demand forecasts as the long-run target for the capacity. Unfortu-
nately, just as you can’t build an apartment complex apartment by apartment to
meet demand, you cannot build a system such as ours in small increments.
Right now our system is larger than what is needed, and it is built to meet a
projected peak demand, not today’s average demand.”
Denise asked, “Do you have that data?”
“No, but I can get it within the week. Why don’t you let us build this into
our model, and we will have a “version 2.0” transaction processing cost for you
next week?”