Our case study focuses on the Columbia City Bank and how it operates. Banks generate revenue by earning the difference between interest paid on deposits and other funding sources, and interest charged on loans. However, in recent times, there has been a shift towards banks prioritizing transaction fees to ensure more stable income. These fees cover loan charges, deposit-related activities, and extra services.
Although lending activities continue to generate the majority of revenue for commercial banks, they also earn money from card products via consumer interest payments, fees, and transaction fees from accepting companies. Columbia City Bank in Seattle implemented two measures in order to expand its presence in the checking account market. Firstly, it established a customer call center that addresses customer queries regarding account balances, cleared checks, and fees. Additionally, branch managers who achieved their branch’s target increase in customer numbers received year-end bonuses.
Despite 80% of brunch managers achieving the target increase in the number of customers, the profits of Columbia City Bank continued to decline. John Diamond, the CEO, was puzzled by this decline in profits considering the bank’s growth in customer base. Rose Perez, the branch manager of Pierce County, observed a decrease in the number of business customers while small retail customers increased. The costing system of Columbia City Bank, which was established in 1988, is simple and does not allocate costs directly to customers.
The bank allocates all indirect costs to customer lines (retail customer line or business customer line) according to the total number of checks processed. A retail customer is defined as any customer except for institutional customers, such as governments, schools, hospitals, and others.
- Old cost system based on number of checks processed: Number of checks processed: Retail customers = 2280 Business customers= 9120 Total checks processed= 11400 Indirect cost allocation rate: 2850 000/ 11400 000 = RM 0. 25 per check processed
- Indirect cost for retail customers : 2280 000 x RM 0. 5 = RM 570 000 Indirect cost for business customers: 9120 000 x RM 0. 25 = RM 2280 000
- Proportion of the total indirect cost Assigned to retail customer: (570 000/ 2280 000) x 100% = 20 % Assigned to business customer: (2280 000/ 2850 000) x 100% = 80%
- Indirect cost per retail account: Number of retail accounts= 150 000 Indirect cost for retail accounts= RM 570 000 570 000/ 150 000 = RM 3. 80 indirect cost per retail account Indirect cost per business account: Number of business accounts= 50 000 Indirect cost for business accounts= RM 2280 000 2280 000/50 000 = RM 45. 60 indirect cost per business account
- Average profit per account of retail customer : Average revenue per retail customer account – average indirect cost per retail customer account 10. 00- 3. 80 = RM 6. 20 average profit per retail customer account Average profit per account of business customer: Average revenue per retail business account – average indirect costs per business account 40- 45. 60 = – RM 5. 60, loss of RM 5. 60 per business account
- From the traditional cost analysis, amongst the decisions that a manager might take is to increase the number of retail accounts as they generate a high profit margin.
In order to create a sense of trust and satisfaction among customers, the bank should focus on delivering exceptional value and service. This would assure customers that their money is secure and well-managed. Additional promotional and advertising efforts are needed to spread awareness about the bank. To mitigate losses, it may be necessary to reduce the number of business lines. By reallocating resources to prioritize the retail customer segment, the bank can attract new retail customers. Alternatively, a more radical measure would involve shutting down the business customer line entirely, as it has become a liability.
While it is not recommended, the bank should find ways to reduce operating costs instead of doing this. Additionally, signs that Columbia City Bank’s initial cost system was flawed and required improvement include the fact that profits continued to decrease despite 80% of branch managers achieving the targeted customer increase. Another indication is the decreasing number of business customers relative to retail customers. In other words, business customers, who contribute significant capital, were leaving the bank for various reasons, while retail customers continued to grow in numbers.
The bank can achieve this by providing excellent value and service to its business customers. This will make them feel confident and assured that their money is secure with the bank. Additionally, reducing the number of retail lines may be necessary as they are causing financial losses. This could be attributed to the limited amount of cash deposits, resulting in a smaller loan capacity and minimal interest revenue for the bank. Another option would be to completely close down the retail customer line due to it becoming a liability.
Although it is not advised, we propose strategies for cost reduction in the retail sector. One option is to introduce a nominal fee for the customer hotline rather than using toll-free lines. Another possibility is to enhance revenue from retail accounts by increasing borrowing costs, such as interest rates, for customers seeking loans. If these options are not feasible, an alternative approach would be for the bank to invest in higher-return assets to improve profits.
According to our perspective, the Columbia City Bank’s incentive plan, centered on bonuses, is an unwise approach as it disregards quality and solely emphasizes quantity. Our belief stems from the bank’s inability to boost profits despite serving a greater number of customers.
According to the bank’s historical records, the business customer account generates more revenue (RM 40) compared to the retail business account (RM 10). This is because business accounts usually have a higher amount of deposited cash, which the bank can use to provide loans and earn interest. Based on the ABC analysis, it is recommended that the bank focus more on its business line, which offers a higher profit margin, and allocate fewer resources to unprofitable business lines. Implementing this strategy would yield several benefits for Columbia City Bank.
ABC offers the benefit of enhanced information for informed decision-making, enabling companies to compare prices with competitors and assess profitability at lower price points. Additionally, ABC aids in identifying competitive advantages. For Columbia City Bank, our ABC analysis shows that the business customer line emerges as the preferred choice over retail customers. Manufacturing and distribution firms utilize ABC systems to pinpoint cost reduction opportunities by setting targets based on reducing costs per unit across various activity areas. The goal is to decrease costs while upholding customer service and perceived value.
ABC has become essential for non-accounting managers in today’s business world due to three main reasons. Firstly, the rise in product diversity has led to companies offering a variety of services such as credit cards, e-banking, ATM, and debit cards. These services require different levels of resources due to variations in volume, process, and complexity. Secondly, there has been an increase in indirect costs in the business world today.
The utilization of technology, such as computer integrated manufacturing (CIM), has become essential for operating a profitable firm. These advanced technologies have resulted in higher indirect costs and lower direct costs, particularly in terms of direct manufacturing labor expenses. Effectively managing complex technology entails allocating more resources to support functions like production scheduling and process design, which cannot be accurately measured by direct manufacturing labor costs. Therefore, the traditional practice of allocating indirect costs based solely on direct manufacturing labor often fails to provide an accurate depiction of resource utilization across different products.
The aggressive competition in today’s markets has prompted managers to seek more precise cost information. Accuracy in pricing and product mix decisions is crucial in such competitive landscapes, as rivals are quick to seize opportunities resulting from a company’s missteps. Implementing these improvements is made possible by advancements in information technology.
CONCLUSION
In summary, the application of the ABC approach allows the bank to obtain accurate information about their business costs. Furthermore, the use of ABC reveals that the bank’s current costing method is flawed, and despite an increase in the number of customers, their revenue continues to decline. Given this decline, it is advisable for the bank to prioritize their business customers, as they generate a higher revenue rate.
They can increase their business customer base by providing special services and offers. In order to compensate for the low revenue generated by retail customers, they should eliminate unnecessary costs as identified by the ABC analysis, which shows that each retail customer results in a loss of RM1.15. Ways to boost revenue include investing in areas with higher returns and increasing the interest rate for lending money.
To reduce costs, a company can charge a minimal fee for customer hotline calls instead of using toll-free numbers. This helps offset the costs of hotline staff. By offering beneficial services to business customers, companies can transfer some retail costs to the business line, enabling them to charge higher premiums and earn higher profits. Banks should attract more customers through targeted advertising and promotions in the business line, but they must do so wisely as this will increase indirect costs.
