CFOS Unit One

Some Basic Concepts of Cost Analysis

Objectives

By the end of this unit, you will be able to: describe the various sub-systems in a simple model of an open and distance learning (ODL) institution; discuss the difference between direct and indirect costs and categorise different items of expenditure; provide definitions and examples of fixed costs, variable costs and semi-variable costs; explain how some costs can be classified as committed and others as managed; discuss the concept of cost drivers and identify those driving costs in your institution.

Introduction

Any expenditure of money on materials, labour, equipment or services is referred to as a cost. Costs may be either notional or actual.

Definition

Notional costs are ideal or average figures that are used to estimate future expenditure. The term actual costs is used to refer to the exact amount spent in the past, as reflected in an institution’s accounts.

Like any education institution, open schools must spend money on a variety of things in order to provide courses to their learners. However, when compared to conventional education, the pattern of expenditure in ODL institutions is quite distinct. This unit looks at some of these differences and introduces a basic vocabulary for categorising and analysing costs incurred by open schools.

Systems Model of Open and Distance Learning

Rumble (1986, pages 15-17) proposes a simple model which looks at the operations in ODL institutions in terms of four inter-related sub-systems. The value of such a model is that it clearly identifies the main areas of activity in an ODL institution and defines the relationships between them. It also suggests an analogy between a factory producing items for consumption and the ‘quasi-industrial processes’ of an ODL institution. Just as in a factory, ODL involves the specialisation of tasks and the division of labour between different units.

The four sub-systems in Rumble’s model are:

Materials Sub-System

The first major sub-subsystem includes all activities involved in the design, production and distribution of self-instructional materials, whether these are primarily print-based or involve other media.

Student Sub-System

Once learning materials have been developed and distributed to learners, they are passed over to the Student Sub-system. This sub-system comprises all of the activities, staff and other resources that are involved in facilitating learning by students and managing their progress through a programme.

Logistical Sub-System

The Materials and Student Sub-systems are supported by other units which procure and manage resources for the institution. Those units which look after finances, human resources and information and communications technology (ICT) comprise the Logistical Sub-System of any open school, college or university.

Regulatory Sub-System

Finally, overall management and guidance comprise the Regulatory Sub-System, which is sometimes referred to as the ‘Brains’ of the institution. All activities related to strategic planning, policy formulation and monitoring the institution’s performance in meeting its goals are part of this sub-system.

Rumble’s model is illustrated in Figure 1a.

Unlike a conventional school or college, an ODL institution devotes a large part of its resources (staff time and office facilities, as well as funds) to its Materials Sub-System. Much of its expenditure on materials development is incurred before any students enrol for that course. On the other hand, an open school is not the same as an educational publishing company, because the ODL institution also includes a Student Sub-System which supports the learning process.

Activity

Exercise 1.1 This exercise may be done on your own, with a partner or in a small group. Looking at Figure 1a, think of some examples of costs that are incurred in carrying out the activities in each of the four sub-systems. Write these down along the left-hand margin of a blank piece of paper. Draw four vertical lines to the right of your list to form four additional (narrow) columns. Feedback: Some examples of the types of cost you might have listed can be found in Table 1.1 Hold on to this sheet of paper for use in future activities.

Direct and Indirect Costs

The costs of providing educational services through ODL can be classified in a number of different ways. Understanding the terminology used to categorise costs is important in analysing how they arise and how they will behave. The first distinction that must be made is between direct and indirect costs.

Definition

The term direct cost refers to any expenditure that CAN be directly related to a particular product or service. For example, many open schools employ part-time workers to mark assignments submitted by students. The fee paid for this task is an example of a direct cost since it can be directly linked with a specific course. An indirect cost, on the other hand, is any expenditure that CANNOT be directly related to a particular product or service. Indirect costs are often referred to as overheads. Examples of indirect costs include rental or maintenance of offices, general office equipment, and the salaries of support staff, such as the institution’s chief accountant or the secretary for its director. It is difficult to link expenditure on these things directly to any of the institution’s courses or programmes.

When a course could not go ahead without a particular item of expenditure, then it can be classified as a direct cost. If the relationship between an item of expenditure and the running of the course is less clear, then it should be categorised as an indirect cost. In some cases, a particular activity (and its related costs) can be attributed to two or more courses or products. For example, some ODL institutions run a workshop once a year to train writers for all their courses. Expenditure on such a workshop should be classified as a direct cost though, for the purposes of analysis, it will need to be apportioned to the different products.

Activity

Exercise 1.2 Look at the list of costs that you wrote out for Exercise 1.1. Decide whether each cost should be categorised as Direct or Indirect. In some cases, the expenditure may be direct cost in some cases, but indirect in others. In the first blank column, write either a ‘D’ (for Direct), an ‘I’ (for Indirect) or ‘D/I’ (for either Direct or Indirect, depending on the circumstances). Feedback: Refer to Table 1.2 to see some examples of how different costs can be categorised as either direct or indirect. Please retain your work for future use.

In general, the more closely an activity (and its associated costs) can be linked with a particular course, the easier it is to determine that it is a direct cost. For example, printing study booklets for a given course is clearly a direct cost. As the association between the activity/expenditure and a product/course becomes more distant, it is increasingly difficult to link costs with a particular course or product. Nevertheless, when carrying out a comprehensive analysis of expenditure, it is important to apportion and attach indirect costs/overheads to different courses in order to determine the full cost of providing the service. Different ways of dealing with overheads are discussed in Unit 4.

Fixed, Variable and Semi-Variable Costs

Another way of categorising costs in ODL institutions is to consider whether a change in the level of productive activity (for example, by enrolling more students) has an impact on expenditure.

Definition

In cases where expenditure does NOT increase or decrease with changes in the level of productive activity, then this is categorised as a fixed cost. For example, regardless of whether an ODL institution has a hundred registered students or a hundred thousand, it needs to employ a chief executive officer (CEO) or director. Although the duties of the post and the salary on offer would very likely be different in the two situations, the salary of the CEO is considered a fixed cost. By way of contrast, a variable cost is any expenditure that varies in proportion to a change in the level of activity. Expenditure for printing study materials is a good example of a variable cost. For each additional student enrolled for a course, extra expenditure is incurred. Some costs seem stable for a particular level of activity, but suddenly increase with a significant increase in student numbers. For example, most ODL institutions have policies regarding the maximum number of students who can be accommodated in a class group for face-to-face tutorials. When student numbers exceed the maximum, then a second class group is formed, necessitating the employment of another tutor (or additional hours for the same part-time tutor). The term semi-variable cost refers to such expenditure which remains fixed within a particular level of productive activity, which is referred to as the range. If the level exceeds this range, then additional costs will be incurred.

Activity

Exercise 1.3 Refer to the list of costs that you wrote out for Exercise 1.1. Decide whether each cost should be categorised as fixed, variable or semi-variable. In the next blank column, write either ‘F’ (for Fixed), ‘V’ (for Variable) or ‘S-V’ (for Semi-Variable). Feedback: Refer to Table 1.3 to see some examples of how different costs can be categorised as either fixed, variable or semi-variable. Please retain your work for future use.

This exercise highlights the fact that, while many costs appear to be fixed at first glance, they are really semi-variable. Take, for example, the salary of the institution’s CEO or Director. When student numbers are low, the CEO will most likely have responsibility for many tasks related to the supervision of staff and the day-to-day running of the institution. However, if student numbers grow dramatically, it is often necessary to buy in specialised services or employ extra managerial or professional staff to take over some of these duties. Thus, even though the institution still has only one CEO, the job that he or she originally carried out has been split among a number of additional employees, with an accompanying increase in costs.

Committed and Managed Costs

A third way to categorise expenditure is based on the relative ease or difficulty of doing without the materials, labour or equipment that incurs a cost.

Where expenditure CANNOT be eliminated or cut back without a major negative impact on the institution’s objectives or profits (in the case of a commercial operation), this is referred to as a committed cost. For example, if an ODL institution entered into a long-term lease for additional office space to accommodate a planned expansion of its courses, it may be difficult to break the lease without a significant financial penalty. Likewise, once a staff member is confirmed as a permanent employee, it may be necessary to incur substantial expenditure in redundancy payments if the position is no longer necessary. In most cases, such expenditure should be categorised as a committed cost.

However, where expenditure can be delayed, reduced or eliminated without an immediate major disruption in the institution’s programme, then it should be categorised as a managed cost. For example, if resources are limited, it may be possible to postpone the revision of a particular course for one or more years. Staff training, foreign travel and entertainment expenses are often treated as managed costs.

Activity

Exercise 1.4 Refer again to the list of costs that you wrote out for Exercise 1.1. Decide whether each cost should be categorised as committed or managed. In the next blank column, write either a ‘C’ (for Committed) or an ‘M’ (for Managed). Feedback: Refer to table Table 1.4 to see some examples of how different costs can be categorised as either committed or managed. Please make sure to hold on to your work for use in Unit 3.

Cost Drivers

A final concept that is important in any analysis of expenditure is that of a cost driver, which is defined as anything that causes an overall increase (or decrease) in costs when it increases (or decreases). Student numbers are the most obvious example of a cost driver. In addition, the number of tutorial groups drives the cost of tutors, since an increase in the number of groups necessitates the employment of additional tutors. Likewise, the number of study centres is a cost driver for several different items of expenditure. Decreasing the number of study centres has an impact on the amount paid for employing centre heads, leasing/renting/maintaining buildings, electricity for centres, ICT services, etc.

In order to analyse and control expenses, it is essential to identify all of the factors driving costs for a particular activity.

Activity

Exercise Exercise 1.5 Consider all the costs associated with developing and offering one or more new ODL courses in your institution. On a blank piece of paper, write down all the cost drivers for this activity. Feedback: Refer to table Table 1.5 to see, how costs are driven.

Reading

If you would like to find out more about the topics in this Unit, please refer to the following resources: Rumble, G. 1997. Costs and Economics of Open and Distance Learning. Chapter 4, pages 21-31. Hülsmann, T. 2004. Costing Open and Distance Learning. Section 2.2: ‘Drawing up a Budget, a generic template for costing ODL’, pages 4-7 & Section 3.2: ‘Elements of Cost Analysis, fixed and variable costs’, pages 13-14.