Readers who have had some exposure to accounting, either in practice or through formal course work will appreciate the role of accountants. Firms are required to report to external constituencies, such as investors and government regulators, and must do so using very specific, if not always logical or internally consistent, rules. Financial accountants play an important role in getting these external reports right (and by doing so, inform current and potential investors and help firms avoid large fines and even jail time for managers if the reports are not right). Marketers should appreciate the high stakes associated with generating these external reports, which are largely about financial performance. There are very good reasons to focus on financial performance.
Other accountants manage internal reporting within the firm, that is, the reports that go to operating managers who must allocate resources and who are responsible for resource allocation. To most people, a cost is an easy and very tangible thing to understand. People go to the store and pay for a product. There is a simple link between the cost (what is paid) and what is received. Even in households, where multiple people live, there is rarely an effort to allocate the cost of a meal to each individual at the dinner table or the cost of a cable television subscription based on how many hours each member of the household watches television. The reasons for this are simple. There is nothing much to be gained, and potentially a lot to lose, in such efforts at allocation.
The world of business is different. There are often large and very real costs that are difficult to allocate. The costs of producing a specific product may be easy to determine, but how are the costs of utilities to be allocated in a building shared by people who manage, produce, and market many different products. In fact, even allocation of the costs of production of a product can differ depending on whether the specific product was the first one produced or the 50 millionth product produced. Nevertheless, there are very real costs associated with buildings, people not directly involved in the production or sale of identifiable products (like the cleaning crew, accountants, and human resources professionals) whose costs must be covered. There must be rules for the allocation of such costs. The contribution of any individual product or service can be made large, small, or even negative based on how such costs are allocated. The role of managerial accountants or cost accountants is to try to come up with fair rules for the allocation of such costs and for applying these rules for the analysis of expenditures within the firm. There is no allocation of “unallocated” costs that is “correct.” Various rules are applied in an effort to be fair. So, the more employees who work on a particular product and are located in a specific building, the more the costs of that building may be assigned to that product based on square footage occupied by the staff dedicated to the product who have offices in the building.
Most allocation rules employed by accountants are an attempt to be “fair,” that is, to avoid advantaging or disadvantaging any particular business activity in the firm. The “rules” they establish rarely capture the value of a resource and there are few “rules” for capturing value. Thus, the office occupied by the chief loyalty officer, who spends all day assuring that otherwise long-term, loyal customers who have had a poor experience are not lost, is allocated the same cost as the person hired to deal with parking. The cost allocation rule may be fine, but there must be an off-setting value for the contribution to the business and its business model. It is important that marketers make clear the value being created by their activities, even as they accept cost allocation rules.
Many internal reports fail to include the value of such assets as brand, customer relationships, and loyalty. Marketers would do well to remind others in the organization of the value being created by the costs for which they are responsible. In addition, marketers need to be aware of how costs are being allocated. Good management accounting systems allow users to examine in depth the drivers of specific costs. Reports can be wrong and, even if nominally correct, allocation rules may create a misleading picture. Many costs are not readily obvious and how they are allocated is often subjective. Frequently, costs are reported without a link to revenue. An increase in costs that is accompanied by an even larger increase in revenue is usually a good thing.
It is also important to recognize that different firms allocate costs in different ways. This is further evidence that there is no right answer when it comes to the allocation of costs. In fact, what is considered marketing, and therefore a marketing cost, can vary widely across firms. However, there should be consistency within a firm. For example, the cost of a promotion involving a price reduction could be viewed as a marketing cost. On the other hand, the price reduction could be viewed as a lowering of price with a consequent reduction in revenue. Either approach is justifiable, but a firm should not treat some promotions as a marketing cost and other promotions as a price reduction.
Marketers need to understand costs because the costs they are assigned or allocated can make a big difference in how the outcome(s) of marketing actions and expenditures appear. In addition, costs can behave in unusual ways that really do change the economics of market offerings. The cost of increasing production is often not identical to the cost savings associated with decreasing production by the same amount. A production line or service operation that is already at full capacity may require additional machinery and/or additional personnel just to meet the demand of one additional sale. Such circumstances can create steep malfunctions in costs. Insofar as the role of marketing profitably matches supply and demand, an understanding of such cost structures is critical for the success of marketing.
A common approach to managing costs is Activity-Based Costing (ABC). ABC seeks to explicitly link costs to the activities that produce them. For some costs, this is easy. It is clear that the costs of purchasing media for advertising is a marketing cost that should be assigned to whatever product(s) are being advertised. But what is to be done with the CEO’s salary and bonus?
ABC classifies costs into different buckets: direct costs, indirect costs, and allocated fixed costs. Direct costs are generally easy to assign because there is a clear link to an activity. For example, if a bakery puts two eggs into every cake it makes, the cost of the two eggs is a direct cost associated with producing the cake. However, even direct costs can be complex because there are often multiple ways to define an activity. For example, should costs be assigned based on each sale or based on managing the overall relationship with a customer who buys many different products? While either approach can make sense, one or the other must be adopted. Generally, the choice would, or should, be driven by the definition of the activity most relevant to the creation of value for the customer and the firm. For example, if there is little interaction with customers beyond the individual sales transaction, the better definition of the relevant activity is likely to be the individual sale. On the other hand, if there is a great deal of interaction associated with account management and some or much of this activity is not tied to a specific sale, it is likely more appropriate to define the activity as account management.
In contrast, there are indirect costs, that is, costs that are not easily assigned to any particular activity, product, or service encounter. These costs are often called overhead and dismissed. But, like direct costs, there are identifiable drivers of these costs. The problem is that it is not so easy to link these costs to specific revenue-generating activities. It is not difficult to count the number of people in a customer service center and determine their salaries. However, it is often difficult, if not impossible, to assign the time spent on an individual call to a specific product or service. As discussed above, accountants try to create fair and meaningful rules for the allocation of such costs.
A special case of indirect costs revolves around the allocation of fixed costs, that is, costs that will be incurred regardless of sales. Most firms must have office space, furniture for employees, utilities, and a host of other things regardless of how many sales are made. Again, accountants generally try to come up with fair and meaningful rules for allocating these costs, but such allocation always includes political dimensions.
The lessons for marketers are (1) don’t ignore costs, (2) understand how costs are allocated, (3) include an understanding of cost drivers in planning marketing actions, (4) push back on allocation rules that seem unfair, and (5) whenever possible in internal reports, link revenue generation and profitability to the costs that generated them.