Case study BRIC Brains Retail Intelligence and Consulting

Authors:

Jan Bouwens (Amsterdam Business School)

Ana Mickovic (Amsterdam Business School)

The situation

It was Thursday 2 January 2020 and DJ Ramanathan was worried. All his
attempts to better understand the cost relations in his firm had been in vain all
of his most current bids had bounced. His prospect clients claim that they get a
better deal from DJ’s competitors. DJ believes that one important reason to miss
out is that they are insufficiently aware of the nature of their own costs.

DJ is the commercial director of Brains Retail Intelligence and Consulting Ltd.

(BRIC), a company specialized to (re-)develop retail networks. Their services
include: strategy, marketing, organization, operations, technology,
transformation, digital, advanced analytics, and sustainability. Over the years
BRIC developed functional expertise and has found its way into how to best
create conditions to optimize the sum of the parts of a retail network, not just
the individual pieces. BRIC for instance was able to design spectacular cost
savings programs and put into work systems to standardize customers
experience in retail shops belonging to the same network.

DJ is astonished by how little knowledge he and other decision makers have of

BRIC’s own cost structure while at the same time BRIC’s consultants do
successfully advise its clients on how to efficiently structure its operations and to
develop costing systems that provide actionable insights into its clients costs
structure. Since the consultants filed several complaints about the cost

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allocations imposed on their projects DJ had considered to ask the firm’s own
consultants to advise him on the firm’s cost structure. However, instead he
decided to first arrange a meeting with his financial controller Aishwarya Rai who
said that she is able to shed light on the cost structure of BRIC. Aishwarya
identifies the following service units:

Finance (€50,000/month); Performance improvement (€80,000/month), Agile

(€10,000/month), Strategy (€40,000/month) and Operations and ICT advice
(€90,000/month).

BRIC produces five different service lines (S1, S2, S3, S4, S5). To perform their
activities BRIC’s consultants operate from within a service units. For each service
line the firm creates a so-called engagement team who prepare and help
implement a plan for the client firms. This engagement team is led by the
engagement leader who prepares the bids based on the cost relations that are
assumed to exist for each separate service line.

Typically the client firms are retail chains that seek the advice of the BRIC
consultants. All service units deliver their services primarily to each other and in
conjunction they deliver the five basic service lines of BRIC. In the context of the
firm each service unit is treated as a separate cost pool.

Current system

Aishwarya believes that a major issue resides in the complexity of the production
structure the five product lines entail. It seems that the complexity cause the
cost structure to become intractable. That is, the work performed in the 5
service units are interrelated to such an extent that it seems impossible to
disentangle the different contributions to the five service lines.

At the moment the firm has information on resource consumption for: Finance
(€50,000/month); Performance improvement (€80,000/month), and Operations
and ICT advice (€90,000/month). Finance is assumed to deliver equal levels of
activities to each of the 5 services, i.e. 20 percent to each). Performance
improvement is assumed to deliver 50 percent of its activities to S1 and the
other 50 percent to S3. Operations and ICT advice is assumed to deliver 60
percent to S1, 20 percent to S2, 5 percent to S3, 5 percent to S4 and 10 percent
to S5. BRIC decided to pool Strategy (k€40) in one department with finance

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(k€50) and Agile (k€10), and to keep Operations/ICT advice (k€90), and
Improvement (k€80) as separate departments. The cost pool that combines
three activities is assumed to follow the consumption pattern of finance.

The meeting

Aishwarya decides that the current allocation method is hard to defend and
arranges a meeting with the best four cost consultants BRIC has. On 2 March
2020 Carine Lacor, Christine Shih, Isabelle Auger and Peter Cardinal join the
“allocation meeting.” They thank Aishwarya as they have been worried for years
about the methods applied to allocate costs. Carine starts the discussion and
argues that it would be too expensive to exactly determine the resource
consumption patterns for all activities. However, according to the current
method the five resources are almost completely randomly allocated to three
cost pools. This method turns the likelihood of creating an accurate allocation
basis to almost zero. “Bids we make based on this cost allocation principle begin
to look a lot like a Russian Roulette played in reverse.” Carine asserted. She
therefore argues to first select the three biggest resources and then allocate the
other resources to these biggest cost pools randomly. The firm can subsequently
make a more accurate estimation of the consumption for these largest cost pools
over the different services. Isabelle disagrees. In her opinion it is better to
randomly create cost pools altogether. Peter argues that it is better to create
just one cost pool and to determine an exact estimate of the resource
consumption pattern of the biggest cost pool that is included in the system.

Aishwarya disagrees with everyone. She advises that the current revenues are
taken as a proxy for the demand for services and that the revenues are used as
an allocation base. That is, all costs are collected in one big cost pool and the
costs are subsequently allocated based on the revenue. The idea is that the
activities that can bear the highest costs are allocated the highest cost level.

Christine applauds the idea put forward by Aishwarya but she adds that the
current revenue is biased as the revenue is determined by the current demand
for the different services, and this demand is affected by the current allocation
method. She, therefore, advises to take the potential revenue distribution that
would come into being if every bid was won. She further advises to first subtract

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the variable costs of the three services and then allocate the costs accumulated
in the cost pool. The revenue numbers are presented in Exhibit 1.

Exhibit 1: Revenue based on current bids and market potential

Current # of Current Potential

# of bids
commissions Revenue revenue

S1 20 € 2,280,702 150 € 17,105,263

S2 30 € 2,605,263 250 € 21,710,526
S3 60 € 5,348,837 520 € 46,356,589
S4 10 € 1,122,449 95 € 10,663,265
S5 45 € 3,413,793 405 € 30,724,138

Total 165 € 14,771,044 1420 € 126,559,782

Experiment

Aishwarya made also a bold proposal to her colleagues. This was based on an
idea put forward by Christine. She had recently met a student named Ajanee
Shed at the Amsterdam Business School. Ajanee had developed an algorithm
that helped her ascertain the consumption patterns in activity pools. Ajanee
offered on a no-cure-no-pay basis to develop an algorithm for BRIC. Among
other data she collected data on how often the firm had meetings with clients on
the services that the different departments delivered. More meetings would
suggest more resource consumption. Her estimates resulted in the following
resource consumption pattern estimates.

From Performance improvement, 50% of the activities are used for S1 and 50%
for S3. From Agile, 60% of the costs are used for S1, and the rest is equally
distributed among 4 remaining services. From Strategy, 50% of the activities are
used for S1, 10% for S2, 5% for S3, 30% for S4, and 5% for S5. From
Operations and ICT advice, 60% of the costs are used for S1, 20% for S2, 5%
for S3, 5% for S4, and 10% for S5. And for Finance, costs are equally
distributed to all the services.

Aishwarya and Christine were the only ones to believe that Ajanee could be
right. The other colleagues expressed their skepticism as far as algorithms were

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concerned and insisted that all possible calculation were to be done in order for
them to select the best method.

Assignment

Based on the data provided in this case, prepare a document that helps the BRIC
to decide what allocation method they should select in order to improve decision
making in the firm.

1. What are conditions that BRIC is facing and what are consequences of
these conditions?
2. Describe the current business model of BRIC and which elements of the
business model are touched by the allocation method.
3. Present a method to evaluate the accurateness of the current allocation
method.
4. Present the evaluation of alternative allocation methods.
5. How would your allocation look if you used revenues as the allocation
base? Comment on this choice.