Harvard Case - Tidal Cloud: Cost Allocation in the Cloud
"Tidal Cloud: Cost Allocation in the Cloud" Harvard business case study is written by Robert Raney. It deals with the challenges in the field of Accounting. The case study is 12 page(s) long and it was first published on : Jun 30, 2022
At Fern Fort University, we recommend Tidal Cloud implement a hybrid cost allocation model combining activity-based costing (ABC) with a usage-based approach for its cloud services. This model will provide a more accurate and transparent allocation of costs, enhancing profitability, decision-making, and customer satisfaction.
2. Background
Tidal Cloud is a rapidly growing company offering cloud computing services. As their business expands, they face challenges in accurately allocating costs across different services and customers. Their current cost allocation model, based on a simple flat-rate approach, is becoming increasingly inadequate, leading to potential underpricing of some services and overpricing of others. This situation threatens Tidal Cloud's long-term profitability and competitive advantage.
The case study focuses on the dilemma faced by Tidal Cloud's management team, particularly the CEO, who recognizes the need for a more sophisticated cost allocation system. The team grapples with the complexities of implementing a new system, considering its impact on various stakeholders, including customers, employees, and investors.
3. Analysis of the Case Study
Tidal Cloud's current cost allocation model suffers from several drawbacks:
- Lack of Accuracy: The flat-rate approach fails to capture the varying resource consumption of different services and customers, leading to distorted cost allocation.
- Limited Transparency: The simplicity of the current model hinders transparency, making it difficult for customers to understand the pricing structure and for management to track profitability.
- Inefficient Decision-Making: The inaccurate cost allocation hinders effective decision-making regarding pricing, resource allocation, and service development.
To address these challenges, a more robust cost allocation model is needed. Activity-based costing (ABC) offers a potential solution by allocating costs based on the actual activities involved in delivering services. This approach can provide a more accurate picture of the cost drivers for each service and customer.
However, implementing a pure ABC model in a cloud environment can be complex and resource-intensive. Therefore, a hybrid approach combining ABC with a usage-based model appears more feasible. This model would allocate fixed costs using ABC and variable costs based on actual usage.
4. Recommendations
Tidal Cloud should implement a hybrid cost allocation model with the following steps:
- Identify Key Activities: Conduct a thorough analysis of the key activities involved in delivering cloud services, including infrastructure management, software development, customer support, and billing.
- Assign Cost Drivers: Identify the cost drivers associated with each activity, such as server hours, network bandwidth, support tickets, and customer interactions.
- Develop a Cost Pool: Allocate fixed costs to each activity based on the cost drivers identified.
- Implement Usage-Based Pricing: Charge customers for variable costs based on their actual usage of resources, such as storage, processing power, and bandwidth.
- Develop a Transparent Pricing Structure: Communicate the pricing structure clearly to customers, explaining the components of the cost allocation model.
- Implement a Monitoring and Evaluation System: Regularly monitor the performance of the new cost allocation model, analyzing variances and making adjustments as needed.
5. Basis of Recommendations
This recommendation considers the following factors:
- Core Competencies and Consistency with Mission: The hybrid cost allocation model aligns with Tidal Cloud's goal of providing high-quality, cost-effective cloud services.
- External Customers and Internal Clients: The model provides customers with a more transparent pricing structure and enables management to make informed decisions about pricing and resource allocation.
- Competitors: The model allows Tidal Cloud to remain competitive by ensuring accurate cost allocation and pricing.
- Attractiveness - Quantitative Measures: The model is expected to improve profitability by accurately allocating costs and potentially leading to more efficient pricing strategies.
6. Conclusion
Implementing a hybrid cost allocation model combining ABC with a usage-based approach will provide Tidal Cloud with a more accurate, transparent, and efficient cost allocation system. This will enhance profitability, improve decision-making, and foster customer satisfaction, ultimately strengthening Tidal Cloud's competitive position in the cloud computing market.
7. Discussion
Other alternatives considered include:
- Maintaining the current flat-rate model: This option would be the simplest to implement but would continue to suffer from accuracy and transparency issues.
- Implementing a pure ABC model: While providing a more accurate cost allocation, this option could be complex and costly to implement.
The chosen recommendation, the hybrid model, balances the benefits of both ABC and usage-based pricing, minimizing the risks and complexities associated with each approach.
Key assumptions include:
- The cost drivers identified are accurate and reflect the actual resource consumption of different services and customers.
- The pricing structure is competitive and attractive to customers.
- The model is implemented effectively and monitored regularly.
8. Next Steps
Tidal Cloud should implement the hybrid cost allocation model in a phased approach:
- Phase 1 (Months 1-3): Conduct a detailed analysis of key activities and cost drivers, develop a cost pool, and design the pricing structure.
- Phase 2 (Months 4-6): Implement the new cost allocation model for a pilot group of customers, monitor performance, and make adjustments as needed.
- Phase 3 (Months 7-9): Roll out the model to all customers, continue monitoring performance, and refine the model based on feedback.
By following these steps, Tidal Cloud can successfully implement a more accurate and transparent cost allocation model, enhancing profitability and competitiveness in the dynamic cloud computing market.
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Case Description
This case uses a contemporaneous setting to introduce core managerial accounting concepts related to cost allocation, cost systems, activity-based costing and cost analysis for strategic decision making. The case is set in July of 2016 with Tidal Cloud, a late-stage startup with three products that differentially consume indirect costs of the company. Tidal has benefited from a period of high growth and the potential of a lucrative exit is on everyone?s mind. But, with the emergence of AWS and other cloud competitors it is increasing difficult to sustain the growth of recent years and achieve the profitability metrics acquirers are looking for. In particular, the management team is struggling both to develop an appropriate response to recent competitor actions and to update its strategic plan going forward. This process is complicated by an outdated cost system that distorts the relative performance of Tidal?s three products.
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