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Operations in Service Industry

Assignment on

Cost Management in Service Industry

Submitted to: Date: 01/10/10Submitted By:

Mrs. SheetalHajareKundan S Yadav , E 14

SYMBIOSIS INSTITUTE OF MANAGEMENT STUDIES

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Variable costs:

Varia bl tare expenses that do vary withthe amount ofservi eprovided. They include cost

such as hourly pay for a contractor on a specificproject, raw material,travel expenses etc. Some

available costs dont depend specifically on the number ofproductbut are still variable such as

advertising orpromotion expenses.

Pricing:

Thepurpose ofthebusiness is to maximizeprofits and therefore,pricing ofservices would have to

be done carefully to ensure that the same can be achieved. Otherpricing objectives could be to

help achieve the targeted sales, to maintain or enhance market share or to meet orprevent

competition.

Prices couldbe set at a levelthat reflects the average industryprice,with small adjustments made

for unique features ofthe companys specific offerings.Firms that adoptthis objective mustwork

backwards fromprice and tailor costto enable the desired margin tobe delivered.

Commonly usedpricing modelin service industry:

Price = cost + Markup

Markup % on cost = (markup/cost)*100

Markup % on Price = (markup/price)*100

Example: Price ofa hotel roomper night:Rs.350

Costincurred inproviding room for one nightby management:Rs. 250

Markup/profit = 350250 = 150

Therefore, Markup % on cost:(150/250)*100 = 75%

Markup % on Price:(150/350)*100 = 42.86%

The various costs involved on a service business can bebetter understand with an example from

hospitality industry.

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Example of a Hotel:

Thebasis for each example is a hotelwith 100 rooms.

Variable Cost

Variable costs are the total expense changes as volume changes. Room supplies are a common

variable cost. The supplies are directly related to the number ofrooms that are filled. fthere are 50

guests,they will use 50 soaps (one would hope). Ifthere are 60,then 60 soaps wouldbe used.

Fixed Cost

Costs are identified as fixed if they do not change as volume changes.Forinstance, a late night

registration deskwouldbe attendedby oneperson,whetherthere was one guest or one hundred.

Often buildings and their associated costs are considered fixed, since they are not affected by

small changes in volume.Interest and depreciation are other examples offixed cost.

Step-Variable Costand Semi-Variable Cost

An additional category, referred to as step-variable or semi-variable,is for costs that change with

volume,butin increments. Ifhousekeeping staffcan clean no more than 10 rooms each, a count of

51 guests would require six staff.

Ifnine more guests arrive tobring the total countto 60,the number ofhousekeeping staffneededis still only six. The next guest afterthatwill require going to the next step, or seven staff.

Costs over the Long Term

An important distinction about the classification relates to the time period being discussed. An

economic maxim is that in the long run all costs are variable. In the example, large changes in

volume can necessitate adding rooms, or separate registration desks, or additional night staff.

WhyVariable Costs Are Important

The goal ofabusiness is to make a profitwhileproviding aproduct or service.An understanding

ofcosts can helpwith the decisions needed to make thatprofit. In the situation ofa count of51

guests,there are comparatively fewer additional costs upto 60.

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In this case, itbenefits the hotelto add guests, even at a lower rate. This is why hotels can offer

discount rates for additional guests. This situation is common for airlines, restaurants,condo-

hotels and any service thathas a large amount ofvariable cost.

Converting Variable to Fixed Costs

When a business is growing, it is often better to convert variable to fixed cost. A smallerhotel

maypay forlaundry at a rateperpound to an outside vendor.As it grows,it maybe worth making

a one-timepurchase ofwashing machines. Ifvolume is declining, it isbestto convertfixed cost

into variable.

ABC (Activity based accounting) model for service industry

The rapid advancement of enormously expanding information technologies and vigorous global

competition have caused the irrelevance ofconventional management accounting systems (MAS)

in providing useful information to assist managements decision making,planning and control in

both service and manufacturing organizations.

Activity Based Costing (ABC)is an alternative to the traditionalway ofaccounting. Traditionally

it is assumed that high volume customers are profitable customers. A loyal customer is also a

profitable customer. And profits will follow a happy customer. Studies about customer

profitability have unveiled that the above ideas are not necessarily true.ABC is a costing model

thatidentifies the costpools, or activity centers,in an organization. It assigns costs toproducts and

services (cost drivers),based on the number ofevents ortransactions that are taking place in the

process ofproviding a product or service.As a result, Activity Based Management can support

managers to see how shareholder value canbe maximized and how corporateperformance canbe

improved.

Historically, cost accounting models related indirect costs on thebasis ofvolume.

TYPICAL BENEFITS OF ACTIVITY-BASE COSTING:

Identify the mostprofitable customers,products and channels. Identify the leastprofitable customers,products and channels.

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Determine the true contributors to- and detractors from-financialperformance. Accuratelypredict costs,profits and resources requirements associated with changes in

production volumes, organizational structure and costs ofresources.

Easily identify the root causes ofpoorfinancialperformance. Trackcosts ofactivities and workprocesses. Equip managers with costintelligence to stimulate improvements. Facilitate abetterMarketing Mix Enhance thebargainingpowerwiththe customer. AchievebetterPositioning ofproductsWith the costing nowbased on activities, the cost of serving a customer can be ascertained

individually. Deducting the product cost and the cost to serve each customer, one can arrive at

customer'sprofitability. This method ofdealing separately withthe customer costs and the service

costs, enables the identification oftheprofitability ofeach customer.And Positioning the services

accordingly.

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Continuous Improvement

The implementation ofABC can make the employees understand the various costs involved. This

will then enable them to analyze the cost, and to identify the activities that add value and those

that do not add value.Finally,based on this, improvements canbe implemented and thebenefits

can be realized. This is a continuous improvementprocess in terms of analyzing the cost, to

reduce or eliminate the non value added activities and to achieve an overall efficiency.

ABC has helped enterprises in answering the market need forbetterquality services at competitive

prices. Analyzing the service profitability and customerprofitability, the ABC method has

contributed effectively forthe top management's decision makingprocess. WithABC, enterprises

are able to improve their efficiency and reduce the cost without sacrificing the value for the

customer.Many companies also use ABC as abasis for abalanced scorecard.

This has also enabled enterprises to modelthe impact ofcost reduction and subsequently confirm

the savings achieved. Overall,Activity Based Costing (ABC)is a dynamic method for continuous

improvement. With Activity Based Costing any enterprise can have a built-in competitive cost

advantage, so it can continuously add value tobothits stakeholders and customers.