Harvard Case - Capitalization of Costs at Salesforce.com
"Capitalization of Costs at Salesforce.com" Harvard business case study is written by Darren Henderson, Chris Sturby, Jessica Kelly. It deals with the challenges in the field of Accounting. The case study is 27 page(s) long and it was first published on : Aug 22, 2012
At Fern Fort University, we recommend that Salesforce.com implement a comprehensive cost accounting system based on activity-based costing (ABC) to address the challenges of accurately capturing and allocating costs, particularly in a rapidly growing and evolving business environment. This system should be integrated with the company's existing accounting procedures and policies, providing a more accurate and insightful view of profitability across different products, services, and customer segments.
2. Background
Salesforce.com, a leading cloud-based software company, faced a challenge in accurately capturing and allocating costs across its various products and services. This was primarily due to the company's rapid growth, expansion into new markets, and the complexity of its business model. The traditional cost accounting system, based on allocating costs based on revenue, was deemed inadequate for providing accurate insights into profitability.
The case study focuses on the decision-making process of Salesforce.com's management team, particularly the CFO, regarding the adoption of a new cost accounting system. The case explores the potential benefits and challenges of implementing a more sophisticated system, specifically activity-based costing (ABC), which aligns cost allocation with the actual activities driving those costs.
3. Analysis of the Case Study
The case study highlights several key issues that Salesforce.com faced:
- Inaccurate Cost Allocation: The traditional cost accounting system was unable to accurately allocate costs across different products and services, leading to misinterpretations of profitability.
- Lack of Visibility: The company lacked a clear understanding of the cost drivers associated with its various products and services, hindering effective decision-making regarding pricing, product development, and resource allocation.
- Growing Complexity: The rapid growth and expansion of Salesforce.com's business model, including acquisitions and new product launches, further complicated the cost allocation process.
- Need for Data-Driven Decisions: The management team recognized the need for a more data-driven approach to cost analysis to support strategic decisions and optimize profitability.
Framework: The case study can be analyzed using a combination of frameworks, including:
- Strategic Framework: The need for a more accurate cost accounting system aligns with Salesforce.com's strategic goals of achieving sustainable growth and profitability.
- Financial Framework: The implementation of ABC would provide a more accurate view of the company's financial performance, enabling better financial analysis, budgeting, and forecasting.
- Operational Framework: ABC would improve operational efficiency by providing insights into cost drivers and opportunities for cost optimization.
4. Recommendations
Salesforce.com should implement the following recommendations:
- Adopt Activity-Based Costing (ABC): Implement a comprehensive ABC system to accurately allocate costs based on the activities that drive those costs. This would involve identifying and analyzing the key activities associated with each product and service, including research and development, sales and marketing, customer support, and IT infrastructure.
- Develop a Cost Allocation Model: Create a detailed cost allocation model that accurately reflects the consumption of resources by different products and services. This model should be based on the identified activities and their associated cost drivers.
- Integrate with Existing Systems: Integrate the ABC system with Salesforce.com's existing accounting procedures and policies to ensure seamless data flow and reporting.
- Develop Performance Indicators: Establish relevant performance indicators (KPIs) to track the effectiveness of the ABC system and measure the impact on profitability.
- Provide Training and Support: Provide adequate training and support to employees involved in the implementation and use of the ABC system, ensuring a smooth transition and successful adoption.
5. Basis of Recommendations
The recommendations are based on the following considerations:
- Core Competencies: The implementation of ABC aligns with Salesforce.com's core competency of providing innovative and scalable cloud-based software solutions.
- External Customers: The improved accuracy of cost allocation will enable Salesforce.com to develop more competitive pricing strategies and provide better value to its customers.
- Internal Clients: The ABC system will provide internal clients, such as product managers and sales executives, with more accurate and insightful data to support their decision-making.
- Competitors: The adoption of ABC will enhance Salesforce.com's competitive advantage by providing a more accurate understanding of its cost structure and enabling more effective resource allocation.
- Attractiveness: The implementation of ABC is expected to yield significant benefits, including improved profitability, enhanced decision-making, and increased operational efficiency.
6. Conclusion
By implementing a comprehensive ABC system, Salesforce.com can achieve a more accurate and insightful view of its cost structure, leading to improved profitability, enhanced decision-making, and a more competitive position in the market. The adoption of ABC will enable the company to make data-driven decisions regarding pricing, product development, resource allocation, and overall business strategy.
7. Discussion
Alternatives: Other alternatives considered include:
- Maintaining the existing cost accounting system: This would be a less costly option in the short term, but it would continue to provide inaccurate and misleading cost information.
- Adopting a different cost accounting system: While other cost accounting systems exist, ABC is considered the most appropriate for Salesforce.com's complex business model.
Risks: The implementation of ABC involves certain risks, including:
- Resistance to change: Employees may resist the adoption of a new system.
- Implementation challenges: The implementation process may be complex and time-consuming.
- Data accuracy: The accuracy of the ABC system depends on the quality of data collected.
Key Assumptions: The recommendations are based on the following key assumptions:
- Salesforce.com is committed to improving its cost accounting system.
- The company has the resources and expertise to implement ABC effectively.
- The data required for ABC is available and reliable.
8. Next Steps
The following steps should be taken to implement the recommendations:
- Form a project team: Assemble a cross-functional team to oversee the implementation of the ABC system.
- Develop a detailed implementation plan: Define the scope, timeline, and resources required for the project.
- Pilot test the system: Conduct a pilot test to ensure the system is functioning correctly and meeting the company's needs.
- Roll out the system: Gradually roll out the ABC system across the organization, providing ongoing training and support.
- Monitor and evaluate: Continuously monitor the performance of the ABC system and make adjustments as needed.
By taking these steps, Salesforce.com can successfully implement a comprehensive ABC system that will provide valuable insights into its cost structure and drive profitable growth.
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Case Description
An investor wishes to make an investment in a software/information technology company. The investor is intrigued by the growth prospects of firms in the cloud computing industry and is deciding on whether to make an investment in the common shares of Salesforce.com. While the industry appears to be very attractive, concerns have been raised in the financial media over the company's accounting policy decisions, particularly the decision to capitalize software development costs (internally developed intangible assets) and sales commissions. Concerns have also been raised over the company's focus on metrics outside generally accepted accounting principles. Students are asked to evaluate the company's accounting policy choices and are provided with relevant information regarding the company's business model, existing and proposed accounting standards (both under U.S. GAAP and IFRS), and the accounting policies of competitors. After evaluating the accounting policies, students may then conclude whether any adjustments should be made to the financial statements and determine how this impacts valuation.
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