How to Allocate Costs? A Summary.

It's rare in an enterprise of significant size to have only one business line or "P&L" to which the company allocates indirect spend like market data or information services.

Equally rare is a contract footprint that doesn't have services that cross business lines and needs to be allocated accordingly. In fact, if you're doing your job correctly, you should have contracts that cover multiple business lines -- it means you're consolidating demand and leveraging purchasing power.

But that poses a challenge, partly mathematical and partly political. How do you allocate costs to the businesses using the service?

Let's take a hypothetical example.

YourCo has 3 business lines: Consulting, Tax and Managed Services.

You have a contract with Horizon Research for $100,000 with users in all three business units.

How do you allocate costs?

There are many ways to skin this cat, and what you ultimately decide will be political, but it should be defensible.

As you see from the above table, there are many dimensions by which you can allocate costs on some proportionate basis. Allocating our $100K contract by each dimension, our table now looks like this:

You can see there's a wide range of possibilities -- all of which are reasonably defensible. I have allocated resources using all of these dimensions, but the most common cross-department allocation bases I use are Users and Professionals. What you ultimately use depends on the specific use case of the resource in question, and whether a larger and more profitable business line is "willing" to subsidize a smaller business. That's a decision that's often made by senior management with cross-company P&L responsibility, not the business units in question - unless they are willing on their own to "horse-trade" allocations for resources. Unlikely! 

What's missing from this table? Usage. It is a truism often argued on this blog that all users are not created equal. So should you allocate based on usage instead of user or organizational footprint?

Perhaps, but this is a much more political and potentially fraught exercise.  You will have to argue that a user in Consulting is "worth more" than a user in Tax, for example. How do you defend this? 

You can use qualitative or qualitative arguments, or some combination of the two. 

Suppose Consulting users download 3 times as much content as users in Tax. Do you weight the user footprint allocation to reflect? What do you say to the business sponsor in Consulting when you tell him he's paying more for the same service? You can point to the higher usage in his group, but be prepared for protests that he's subsidizing Tax. 

However, quantity doesn't tell the whole story: qualitative, business value varies by group as well. One piece of content in Tax may be "worth" more to its business that a piece of content in Consulting. In this case, you might argue that raw usage stats are not a reliable gauge of value, i.e. quality versus quantity. I see this often when dividing expenses between the sellside and buyside. The buyside may download less data but its business impact is often far higher than on the sellside - thus an allocation that deviates from a raw usage allocation basis may make sense. 

Cost allocations are always political. You can get a lot of cover from senior management when divvying up the cost of doing business. But whatever method you choose, make sure you can defend your decision. 

- Kevan Huston