Managing Head Office Costs

Managing head office costs can be achieved in a number of ways:

  1. Linking HO costs to Products and Services
    1. By calculating unit costs for the services provided by HO to the operating divisions
    2. By allocating the costs to the operating divisions based on estimated usage
  2. Budgeting as a means of Managing HO Costs
    1. Through zero based budgeting to justify the costs of HO activities in relation to outcomes
    2. Through the separation of fundamental and discretionary costs and managing them differently
    3. Through normal budgetary reviews.

Linking HO costs to Products and Services

The first two methods assume that it is important to link the expenditures of HO to the products and services provided by the company. This is important if prices are calculated on a cost-plus basis or fully absorbed costs are required as input to pricing decisions, but it can be seen as a means of hiding the costs of HO functions in operating divisions and may allow some executives to abdicate responsibility for managing their own costs. Managers should have responsibility for the costs that they can directly control and for which they can be held accountable. If the manager of an operating division can not purchase goods and services from outside but must use HO services, he can not be held responsible for those costs. The costs may be allocated for information but the performance metrics should exclude these figures.

Calculating Unit Costs

Unit costs can be calculated for all services provided to the operating divisions using activity based or standard costing but this still leaves the costs of central functions which do not provide services to the operating divisions such as the Corporate Marketing function, Chief Executive's Office, Public Relations Department, Regulatory Reporting and Audit Support functions. Should these costs be apportioned out to operating divisions or not?

Allocating Costs based on Usage

Allocating costs based on estimated usage can be a simple calculation if usage can be easily identified but it still leaves the costs of central functions which are not used by the operating divisions.

The costs of central functions can only be allocated out on an arbitary basis but whatever basis is chosen should be seen as equitable by those receiving the charge. Common bases of allocation include: direct cost, turnover, revenue, staff numbers, product volumes, profit before allocation. Various bases should be discussed and a method for each function agreed (for example: Corporate Marketing may be allocated on the basis of turnover; but Regulatory Reporting may be better allocated based on the range of products offered).

Budgeting as a means of Managing HO Costs

The last three methods of HO cost management listed above all rely on strong budgetary control.

Justifying the costs of HO activities in relation to Outcomes

This method has become more common in the last decade. Each function must define its "outcomes" for the year and assign costs to each outcome. Any increase in costs from one period to the next must be justified as the outcome should also change (perhaps be delivered faster, better quality, fewer errors etc.).

Separating Fundamental and Discretionary Costs

In this method each function should separate its activities into those which must be done to stay in business (fundamental) and those which the company has discretion about. Fundamental activities include regulatory reporting, security, accounts payable etc.. Discretionary activities include management reporting, corporate marketing, training - these activities may not be totally discretionary but the management team can decide how much of these activities can be performed. Fundamental activities can not be eliminated but must be done to a legal or statutory standard as efficiently as possible. Discretionary activities must be seen to add value to the company and the value can be monitored in relation to the cost.

Normal Budgetary Review

Some organisations include full cost allocation in their budgetary process. This may help to manage the costs if the receiving departments can dispute the charges but in many instances the process may just ensure that HO managers become very good at justifying costs and balancing one recipient against another. Our experience suggests that the cost control should be separated from the allocation. The total costs of a function should be managed using one of the budgetary methods suggested above. Allocation of costs according to usage or any other means can then follow if necessary.

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