Activity-Based Profitability at Northbridge Business Bank
Northbridge Business Bank serves Micro, SME and Corporate customers. Last year direct contribution was $9.6m, $7.2m and $2.0m respectively. The bank has 40,000 Micro accounts, 8,000 SME accounts and 1,200 Corporate accounts. Total overhead is $4.8m and is currently allocated by number of accounts. An activity review produced four pools: account maintenance $1.2m (driver: accounts), transaction processing $1.8m (driver: transactions: 600,000 Micro, 900,000 SME, 500,000 Corporate), loan processing $1.2m (driver: loan applications: 2,000 Micro, 5,000 SME, 1,000 Corporate) and complaint handling $0.6m (driver: complaints: 3,000 Micro, 1,500 SME, 500 Corporate). The Corporate relationship manager argues that Corporate is the most profitable segment and should receive more sales resource. The Micro product head wants to cut account fees because Micro looks weak under the current allocation. A consultant warns that some overhead is committed capacity and the driver volumes reflect only used capacity.
1. Calculate the current overhead allocation and segment profit, then calculate ABC rates and ABC segment profit. Show the reallocation effect.
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Total accounts = 40,000 + 8,000 + 1,200 = 49,200. Traditional overhead rate = $4.8m / 49,200 = $97.561 per account. Micro gets $3.902m, SME $0.781m and Corporate $0.117m. Profit: Micro $9.6m - $3.902m = $5.698m; SME $7.2m - $0.781m = $6.419m; Corporate $2.0m - $0.117m = $1.883m. ABC rates: account maintenance $1.2m / 49,200 = $24.390 per account; transaction processing $1.8m / 2.0m = $0.90 per transaction; loan processing $1.2m / 8,000 = $150 per application; complaints $0.6m / 5,000 = $120 per complaint. ABC cost: Micro = $975.6k + $540k + $300k + $360k = $2.176m; SME = $195.1k + $810k + $750k + $180k = $1.935m; Corporate = $29.3k + $450k + $150k + $60k = $689.3k. ABC profit: Micro $7.424m; SME $5.265m; Corporate $1.311m. Reallocation versus traditional: Micro gains $1.727m, SME loses $1.155m and Corporate loses $0.572m. The traditional method overcosts Micro because it has many low-activity accounts, and undercosts SME and Corporate because they consume more transactions, loans and complaints per account.
2. Interpret why the traditional allocation misleads the two managers and whether Corporate should receive more sales resource.
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The traditional method treats the number of accounts as the only cause of overhead. That is plausible for account maintenance but not for transaction processing, loan processing or complaints. Corporate has only 1,200 accounts but 500,000 transactions, 1,000 loan applications and 500 complaints, so it consumes far more service effort than its account count suggests. SME is also undercosted. Micro looks weak only because it absorbs a large share of overhead through its 40,000 accounts. On ABC, Micro is the strongest segment at $7.424m profit, while Corporate remains profitable at $1.311m but much less than reported. Corporate profit per account is $1,092, still the highest, so more sales resource may be justified, but it should be targeted at profitable corporate relationships rather than at all corporate volume. Cutting Micro fees would be premature; the bank should first simplify Micro processes and reduce transaction and complaint costs. The consultant's point about used capacity matters: if the bank has spare capacity, ABC rates based on actual driver volumes may overstate the cost of growth.
3. How should the bank treat unused capacity in the ABC model, and what pricing or process actions follow?
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Unused capacity should not be spread across customer segments as if it were caused by them. The bank should estimate practical capacity for each activity, calculate a capacity-based rate, and identify the cost of unused capacity separately. That cost should be assigned to management or to the period, not to Micro, SME or Corporate. If the bank uses actual driver volumes, a fall in transaction volume raises the rate and makes segments look worse just as demand falls. Pricing actions should follow cost-to-serve: Corporate should be charged for high transaction, loan and complaint consumption, while Micro should be encouraged to use digital channels and simplified products. The bank should also set service-level targets, reduce complaint root causes, and review loan processing productivity. Any fee change should be tested against customer elasticity and retention, because a price increase that drives away profitable corporate relationships can destroy more value than it recovers.