Indirect Costs

Indirect costs are those expenses that are not directly attributable to a single cost center or cost object (product line, service, etc.) Indirect costs may include shared resources or overhead.

Administrative costs, website costs, IT infrastructure, and similar expenses fall into this category.

One of the big challenges with indirect costs is that they cloud the issue of profitability for individual products.

Imagine your company has a bustling loading dock that serves the entire company. Now imagine that you have two product lines, one of which accounts for the lion’s share of the activity on the dock. Your accountants will have to come up with some way to determine whether these types of indirect costs render a product unprofitable.

Indirect costs also have the added challenge that they are often part of cost centers and not profit centers. For a profit center, the leaders know that reducing their costs has a direct impact on profit. They can tell if they buy a new machine or hire a new employee what the effect will be on the bottom line.

For cost centers, it is not as clear. There is no specific linkage between whether 10 people on the IT staff is appropriate, or if it should be 11. Obviously, the costs of that extra person is knowable, but the impact is not precise in the same way that an 11^th person turning wrenches on an assembly line is.

Indirect costs also open up a lot for debate when determining how to allocate them. This happens when one product consumes a disproportionate portion of a shared resource. One group might be space intensive, and another group may be people intensive. Both situations drive different costs. Using one fixed rate of indirect cost allocation would mislead your accounting staff about profitability.

Continuous Improvement and Indirect Costs

Indirect costs provide a great opportunity for improvement activities. There are several challenges, though.

1. Many indirect cost centers are small with limited continuous improvement experience. Even if there are Lean resources in the company, a small group may struggle to get support.
2. Indirect cost centers serve many groups. It can be hard to make changes that benefit one without affecting others.
3. Small groups that provide critical support have a hard time shutting down to improve processes. Plan around this. Schedule projects during low demand periods or use cross-training to beef up the staffing plan.
4. Some indirect costs are under the radar. A manager may not even realize how his or her actions drive costs.
5. Some indirect cost centers are just looked at as the cost of doing business. There is no understanding about how much value that group actually provides. For example, it can be hard to quantify how beneficial HR costs are to the company as a whole, and even harder to determine how those costs, when distributed to the product lines, impact profitability. Without knowing value, it is impossible to determine whether something is waste or not.

All of these challenges are surmountable and should not be a deterrent to continuous improvement. They should, however, be planned for.