Question to consider as your read the case: Should municipal departments be able to influence the size of the overheads allocated to them?

The overhead incurred by municipalities could be quite substantial due to all kinds of government regulations, which makes it expensive. Moreover, due to the way overhead is allocated (using direct labor hours), the cost of doing business, even in departments that dont require a lot of administration could be quite substantial. All the overhead costs are added up and then each department is allocated overhead costs that are proportionate to the number of employees in the department in question. This calculation method puts some departments at a disadvantage: Especially departments with large number of employees.

Hank Jacobs, the director of the finance department suggests in his report that a considerable part of the overheads allocated to each of the departments should be proportionate to the actual services provided to the department in question. This will allow department heads to look for more competitive solutions to providing services which will reduce the overall cost of running their department. Several of the municipalitys managers are in favor of this. For this reason, they do not like the response of the alderman, Linda Tolsma. She says:

At the beginning of every council term, I come to an agreement with the public sector personnel unions on the number of people employed by our municipality. Last time I agreed to decrease the number of employees by 5% (from 620 to 590 full time equivalents). After such an agreement has been made, it is translated into so-called target numbers of employees per organization unit (i.e. per department) on the basis of policy-based

proposals for new policies and savings. I cannot face the unions if the agreement has not been honored. If you, as managers, were free to deviate from fixed target numbers of employees, for example to decrease the size of the overheads allocated to you, then I would run the risk of ending up with a total number of employees equaling 570 full time equivalents instead of 590 full time equivalents. Well, that would be a disaster. So I think you should stick to the agreements on employment that are reached at the beginning of each council term. The matter can be reconsidered before a new council term. And another thing, it is vitally important to prevent any unrest in our organization, so we must see to it that we do not have to negotiate every single adjustment to the number of employees with the unions. The kind of complete agreement I make gives a sense of security and clarity, not only to the employees, but also to us.

The head of the welfare department, Richard van Delden, is speaking for many of his colleagues when he says: How can you be held accountable for providing services and products and for managing the money involved if you are not given a free rein to decide for yourself how you are going to use your resources? The costs involved include not only your own costs, such as the direct staff costs of your department, but also the support department costs that are allocated to you. In this municipality all of us have decided to use integral management. So we are supposed to be fully accountable for both the policy-based and the financial aspects of the work done by our departments. If I interpret the aldermans response correctly, we are going to be judged on the products agreed on, although our hands are tied by the agreed way of using resources. I am not allowed to use freelancers for certain projects, for example, although it would be a good idea - even if their hourly wages are a bit higher than the permanent staffs. If my department was allowed to use freelancers, it would not run the risk of understaffing and it would be not be allocated so many overhead costs.

Required

1. Analyze Richard van Deldens response.
2. Under what conditions will direct labor be a valid basis for allocating overhead?
3. What are the implications of using direct labor as a cost driver when it is not appropriate? Use specific examples from the case.
4. What cost structure does the welfare department currently have? What cost structure does Richard van Delden think will be most appropriate for the welfare department?