The city of Indianapoliswants to privatize its municipal services. Preceding the privatization process,the government wishes to determine the prevailing cost of performing theseservices with its employees. The present financial system has no relevantinformation about the cost of what the municipal workers did and has no meansto measure how effectively a certain job was performed.
The city forms a team tostudy the cost of filling potholes and develops Activity Based Costing (ABC)system. It displays the ABC cost estimates to the union and enable the workersto initiate new cost-saving procedures so they can compete and face bidding withprivate sectors. This case study outlines how the ABC model is developed andhow does it benefit the city workers with the information received from the newcost system.
Shouldgovernment perform a cost analysis before privatizing government services? Whynot “just do it”?We believe that government should perform a costanalysis before privatizing government services, this is because cost analysiswill provide government with costinformation for them to accurately price the bid for privatization. How couldthey know what to expect if they don’t have the cost of the services they wantto outsource? This will also bring to light the benefit and justification ofoutsourcing some government functions to private companies. Especially if theyfound out they are expending more in the process than the bid they got fromprivate companies. The taxpayers willalso know how much government services cost, like filling potholes etc.
In the case of Indianapolis, their financialsystem record does not have information aboutthe services provided by the municipal worker. However, using proper costanalysis method like activity-basedestimates gave the municipal worker adequate information about the cost oftheir activities. Also in doing the cost analysis,they could submit their own bid with private companies; with that, they will know if they are competitivewith the private companies. Inaddition, this will give the workersopportunity to improve their performance. With proper cost analysis, they could look at a specific service and know how mucheach activity will cost and thereby lookat ways to eliminate certain cost or at least reduce cost.
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Development of ABC modelThe newly formed project teamfocuses on a service that is easily understood and is important to everycitizen.The study for ABC model wasscheduled during pothole repair contract. The following strengths andweaknesses are based on ABC analysis while carrying out work on pothole repaircontract. Thestrengths of ABC analysis in this project are as follows:1) Decrease in investment: with ABCanalysis, cost drivers which are of high value can be lowered as much as possible.This will also help in reducing the investment in materials used for a specifiedjob.
For example:putting a ton of asphalt in potholes is a cost object for studying cost offilling potholes.2) Strict control: tight control can beexercised on the cost drivers that have highest value.Example:The cost of carrying multiple tasks with the same resources, such as patchingcrew was waiting for the asphalt to be picked up and delivered to the pothole,the crew had been used for doing other jobs, like sweeping a bridge or pickingup limbs. 3) Economy: ABC analysis is economic as itgives detailed information on cost required to do a specific work with lowvalue.Example:Removing 50% of the supervisors and changing the crew assignments for fillingpotholes, from eight down to four or six and improving efficiencies in the useand assignment of equipment which lead to cost reduction. The weaknesses of ABC analysis in this project are as follows:1) This method can’t be efficient if thecost drivers are not assigned into the groups appropriately for instance, theteam initially faced difficulty in defining outputs for some activities forexample, filling potholes, fixed asset and indirect support costs to potholefilling.2) ABC analysis doesn’t have standardclassification for cost driver grouping, which makes it difficult to assignmaterials or cost drivers.
3) Difficulty in implementing change inlarger organizations. The team had to convince union to incorporate all theactions needed to lower cost such as removing supervisors, managers…etc. Shouldthe city have allowed the municipal employees to see the ABC estimates andgiven them the opportunity to reduce their costs?The government sector had no relevant data andcosting system to check what employees did, what was the cost incurred in doingtheir task and how efficient their task was. For instance, the pothole-fillingteam had not been aware of the number of take-home vehicles allocated to them,their annual supplies budget, and their costs for rent and maintenance of boththeir facilities and their vehicles. In many cases, the ABC estimatedemployees’ hourly wages to be only 20% of the fully loaded cost. Whereas beforeABC, management might have placed that number at 80%–90% of the cost.Before attempting to privatize the municipal services, it is recommendedthat the city managers should have allowed the Subject Matter Experts ofmunicipal department to view the ABC estimates to help them understand thecosting involved in doing a certain job.
It would have made them aware of thecost, and given them a chance to make efforts to improve it. They would alsodeal with a bid process based on ABC costing so that both the municipalemployees and the private firms would be convinced that ABC costing wasjustifiable.
