SYMBIOSIS INSTITUTE OF MANAGEMENT STUDIES

Operations in Service Industry

Assignment on

Cost Management in Service Industry

Submitted to:

Date: 01/10/10Submitted By:

Mrs. SheetalHajareKundan S Yadav , E 14

Introduction
M withi ll w th b i it p i t iz ti ,t p i with th p th i i f k i f t lf i t. f it xp b tt ll th h t t l p ti xp / p h th w ll, t th h thl i ti i f b i ti . l ti t it t t f it ti t i i th t will

with th b i t t i ,h wt pl bl t th

t b b tt thi p it l p ,

q ipp l b

i th i h ll

b i th

t b i p will b h t

ffi i tl th i b k pt

ffi i tl . f tf .

b l

Cost Management and pricing in Service Industry

Lik th i t , i i .C t i l , t i . t t b i ti , t l i t i t t h l : it t t / xp tb i t ll

ffi i tl if it w t t f *B *A *U * R fl t *B * f w tif t t i i t xt h l it ll f l , ltipl iq t t i i t , f ti iti

l t l i ti it l w li k

ti it , li k l with p ppli with ppli t t i q t ti ). t ( t , i ,

t th i i i ti ,

/ b kw

t bli h

Elements of cost management in service industry: Fixed costs: Fix p q ip ti t (t l ph t ti t h ,f x , f t p t t ffi h p t )i , ( t , tiliti xp p t . th t if t t i t i t

), ffi

Variable costs: Variabl t are expenses that do vary with the amount of servi e provided. They include cost

such as hourly pay for a contractor on a specific project, raw material, travel expenses etc. Some available costs dont depend specifically on the number of product but are still variable such as advertising or promotion expenses. Pricing: The purpose of the business is to maximize profits and therefore, pricing of services would have to be done carefully to ensure that the same can be achieved. Other pricing objectives could be to help achieve the targeted sales, to maintain or enhance market share or to meet or prevent competition. Prices could be set at a level that reflects the average industry price, with small adjustments made for unique features of the companys specific offerings. Firms that adopt this objective must work backwards from price and tailor cost to enable the desired margin to be delivered. Commonly used pricing model in service industry: Price = cost + Markup Markup % on cost = (markup/cost)*100 Markup % on Price = (markup/price)*100 Example: Price of a hotel room per night:Rs.350 Cost incurred in providing room for one night by management: Rs. 250 Markup/profit = 350 250 = 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 be better understand with an example from hospitality industry.

Example of a Hotel:
The basis for each example is a hotel with 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 of rooms that are filled. f there are 50 guests, they will use 50 soaps (one would hope). If there are 60, then 60 soaps would be used. Fixed Cost Costs are identified as fixed if they do not change as volume changes. For instance, a late night registration desk would be attended by one person, whether there 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 of fixed 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, but in increments. If housekeeping staff can clean no more than 10 rooms each, a count of 51 guests would require six staff. If nine more guests arrive to bring the total count to 60, the number of housekeeping staff needed is still only six. The next guest after that will 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. Why Variable Costs Are Important The goal of a business is to make a profit while providing a product or service. An understanding of costs can help with the decisions needed to make that profit. In the situation of a count of 51 guests, there are comparatively fewer additional costs up to 60.

In this case, it benefits the hotel to 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, condohotels and any service that has a large amount of variable cost. Converting Variable to Fixed Costs When a business is growing, it is often better to convert variable to fixed cost. A smaller hotel may pay for laundry at a rate per pound to an outside vendor. As it grows, it may be worth making a one-time purchase of washing machines. If volume is declining, it is best to convert fixed 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 of conventional 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 traditional way of accounting. 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 that identifies the cost pools, or activity centers, in an organization. It assigns costs to products and services (cost drivers),based on the number of events or transactions that are taking place in the process of providing a product or service. As a result, Activity Based Management can support managers to see how shareholder value can be maximized and how corporate performance can be improved.

Historically, cost accounting models related indirect costs on the basis of volume.

TYPICAL BENEFITS OF ACTIVITY-BASE

COSTING:

Identify the most profitable customers, products and channels. Identify the least profitable customers, products and channels.

Determine the true contributors to- and detractors from- financial performance. Accurately predict costs, profits and resources requirements associated with changes in

production volumes, organizational structure and costs of resources. Easily identify the root causes of poor financial performance. Track costs of activities and work processes. Equip managers with cost intelligence to stimulate improvements. Facilitate a better Marketing Mix Enhance the bargaining power with the customer. Achieve better Positioning of products

With the costing now based 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's profitability. This method of dealing separately with the customer costs and the service costs, enables the identification of the profitability of each customer. And Positioning the services accordingly.

Continuous Improvement

The implementation of ABC 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 can be implemented and the benefits can be realized. This is a continuous improvement process 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 for better quality services at competitive prices. Analyzing the service profitability and customer profitability, the ABC method has contributed effectively for the top management's decision making process. With ABC, enterprises are able to improve their efficiency and reduce the cost without sacrificing the value for the customer. Many companies also use ABC as a basis for a balanced scorecard.

This has also enabled enterprises to model the impact of cost 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 to both its stakeholders and customers.