The Cooperative Bank

1. Cost and profitability information on Personal Service Products

Background

As the first attempt, the bank consolidated personal and corporate account processing task. For example, the back office tasks of personal banking operators, previously processed in branches, were consolidated into a Personal Customer Service Center. At the same time, the bank increased cross-selling activities and offering many kinds of financial products and service. However, still its cost-income ratio was high and it was a small player in U.K.

So, the bank started the second project to classify unprofitable products and customers, to improve its cost-income ratio by modifying its products and services. Key elements were overhead reduction, re-engineering of business process, product profitability, customer profitability, and segment profitability.

Cost Information - Applying ABC

Existing cost system was based on a traditional responsibility accounting system that measured expenses for geographic and departmental cost centers. The bank measured product revenues using fee income and net interest, but the estimated costs of producing these revenues were not identified. The bank tried to change it to Activity based Costing system, and allocate operating expenses to products and customers. To establish ABC model, cross-functional team was formed and began to gather process data. At the same time, the bank hired consulting company in order to assist mode development and obtain advice for re-organization and action-implication.

The team considered in terms of its activities, cost driver (product or customer base), and period. They identified about 210 resource cost pools divided into operational staff, infrastructure, and miscellaneous from last 3 months. And they identified 235 activities undertaken at the bank and mapped them. Matching resource costs to the activities, the team assigned the total costs to each activity. The cost of each activity was traced to the bank products. To do that, the team defined activity cost drivers for each activity, and calculated activity cost driver rates. The team identified 50 similar product groups. Product costs were calculated by determining the quantity of each activity cost driver used by each of the products, multiplying these quantities by the associated activity cost driver rate, and summing all the activities used by the individual products.

As an exemption, sustaining costs, costs of resources that were not directly related to any products, were not assigned to product costs because they supported the organization as a whole.

Profitability Information

Product profitability was calculated by subtracting the cost of all activities from the new interest revenue earned from each product plus the fees of customer services. Regarding asset and liability products, a transfer interest rate, LIBOR+1/4%, was used to represent the rate at which excess funds were invested.

Since ABC analysis revealed each product costs clearly, the profitability of each business was revised. In fact, some were failing to generate adequate returns, while some were actually highly profitable products.

In addition to ABC analysis, the team analyzed the entry product at the customer profitability analysis. All cross sales were assigned to entry product. The results showed the vast majority of cross sales originated from Current Accounts.

2. Process of developing cost and profitability information

Developing process of cost information

The bank changed its costing system to Activity based Costing, and allocate operating expenses to products. To establish ABC model, cross-functional team was formed.

The team considered in terms of its activities, cost driver (product or customer base), and period. They identified about resource cost pools which were processing transactions and maintaining accounts. While this classification was acceptable, the sample was not appropriate. Because their data came from past data, it will limit the accuracy for its costs. In addition, since ABC uses the past data basically, it will be varied in the future. This is a limitation of ABC.

Finally, they identified activities. Matching resource costs to the activities, the team assigned the total costs to each activity. Above is the process of cost measurement.

At the final step, the team did not assign sustain costs to product cost. We disagree with this decision. All costs should be allocated to product cost.

Developing process of profitability information

Regarding profitability information, the profitability is calculated by subtracting the cost of all activities from the new interest