3. COST ACCOUNTING AND RATE DETERMINATION › 3.6 Pricing Strategy Selection
3.6 Pricing Strategy Selection
Accurately determining the operating cost of the load centers
is only part of the accounting process. The critical
consideration is in determining just how these costs are
going to be charged back to the users.
In making this decision, you should consider the break-even,
capacity, profit, and market-based pricing approaches. Your
organizational environment will determine which among these
is the most applicable philosophy. Then you can determine
billable rates.
BREAK-EVEN CHARGEBACK TECHNIQUE
The break-even chargeback technique charges users of data
processing services an amount equal to the IS organization's
cost for rendering those services. Often referred to as a
variable rate system, this method distributes the IS costs
among the users for the accounting period. Each accounting
period results in a different level of use, which causes the
charges to the users to vary. The break-even chargeback may
occur monthly, quarterly, or even yearly. The longer the
fiscal time period, the less variable the charges for the
users.
The break-even approach is the most commonly used method, but
it can have some serious disadvantages from the corporate
standpoint. There is no direct incentive for the data
processing organization to minimize costs. They know that
whatever they spend will be charged back to the users,
allowing them to maintain their break-even position. This
approach can result in large, centralized, computer complexes
replete with an abundance of computing power, sophisticated
software, and technical staff that uses significant amounts
of money.
In using the break-even approach, the organization must
estimate the level of utilization that each load center will
realize. This level of utilization could then be divided
into the load center cost figure to arrive at the unit rate
that would be used to charge for services rendered by this
load center. To illustrate this situation, assume that for a
fiscal year the cost of the tape drive pool is $120,000 and
the projected usage for the year is 6,000 tape hours. The
unit rate to be used to recover this load center's costs will
be $20.00 per tape hour ($120,000 / 6,000).
CAPACITY CHARGEBACK TECHNIQUE
The capacity chargeback technique assumes that a unit rate
for charging is not based on estimated utilization, but is
based instead on the estimated capacity of the services. The
only time break-even occurs is when the load center is
operating at full capacity. In other words, this approach
considers a budgetary loss to be a normal situation. The
important control concept is that the level of loss really
reflects either a waste or an underutilization of resources.
By identifying the wasted resource, the system provides
management with a new and valuable piece of information.
Additionally, the users of data processing services are not
penalized for inefficient data center operation or excessive
hardware and software capabilities. This type of reporting
system provides an incentive for IS management to keep its
costs down, maximize the utilization of current hardware and
software capabilities, and discourage unnecessary additions
in the form of hardware, software, and personnel.
The example of the tape drive pool also illustrates the
capacity chargeback method. Remember that with capacity
chargeback, the estimated capacity of the load center should
be used, instead of the estimated utilization level. Also
note that the estimated capacity used by this system is quite
different from a load center's theoretical capacity. To
support this, consider the following:
There are 10 tape drives on a system. In a 24-hour
period there is a theoretical capacity of 240 tape hours.
In reality, no resource is ever used to its theoretical
capacity. The potential or actual capacity of a load
center is what must be determined.
To arrive at the actual capacity, all down or unavailable
time would first have to be deducted from the theoretical
capacity. In addition, based upon the workload of the
installation, it must be determined how much of the load
center could be used if it were utilized at a capacity
level. In determining this unused load center time, the
time from schedule conflicts, resource conflicts, and
overhead requirements must also be deducted from the
theoretical time to arrive at capacity time.
Capacity time = (Theoretical time - (Unavailable
time + Conflict time))
It might be determined that the actual capacity of the tape
drive pool is, for example, 18,000 tape hours or three times
the level of utilization projected. This actual capacity
level of 18,000 would result in a unit rate of $6.67 per tape
hour ($120,000/18,000). If the actual utilization was 6,000
tape hours, $79,980 would be designated as direct loss due to
the level of under-utilization. This difference between
budgeted and recovered costs provides management with an
effective cost control and evaluation tool.
PROFIT CHARGEBACK TECHNIQUE
The profit chargeback technique allows the IS organization
to plan for a profit at the end of the fiscal period.
Service bureaus use this technique. An internal IS
organization can also add a profit margin to the costs and
assess its users. It can use this profit for expansion of
user services or merely as a measurement tool. A profit
technique also increases the user community's awareness of
the strategic importance and business nature of the IS
organization.
MARKET-BASED PRICING
A variation of the profit technique is the market-based
pricing method. This approach views the IS organization as
any other profit-making data processing organization. Thus,
IS management sets its rates competitive with other vendors
that provide computing products and services. It also
supplements basic data processing with services such as
technical support, application development, technology
migration, and technical training.
When the enterprise's management allows users to purchase the
same services from vendors outside the organization, the IS
organization is forced to set its prices low enough to be
attractive to customers who now have an alternative. While
prices must be low enough to be competitive, the IS
organization must also provide the other key factor for
attracting users: a high standard of service. Users will
purchase the in-house "product" only if the service that
accompanies it is comparable to or better than what an
outside vendor will provide.
Implementing this pricing policy requires a comprehensive
management commitment. The new rate structure should be
developed and reviewed according to management's objectives
and financial resources. Rate setting should focus on
lowering prices enough to attract a high volume of business.
Among the features that an organization can offer are volume
discounts, flat rates for dedicated use of resources such as
DASD, and special rates for technology conversion.
The fundamental actions that an organization needs to take
for a successful market-based pricing policy are the
following:
o Obtaining detailed cost accounting
o Continually assessing the cost effectiveness of available
products and services
o Setting realistic prices compared to other vendors
o Staying at the forefront of technological change
o Providing a consistently high level of user services
