A comparative study of central cost allocation methodologies at private research universities

Resource allocations are among the most important decisions for any organization. Nonprofit organizations are no different than their for-profit counterparts—effective resource allocation is the best way to achieve strategic objectives. While the for-profit goal is primarily shareholder wealth, nonprofit goals are more complex—the links between resource allocation and productivity are not always clear. In the 1970s, many higher education institutions faced austere times and were forced to consider organizational structure changes that improved their chances for long-term survival. Several moved from a centralized allocation system to a decentralized system—deciding that local leaders had better information on which to base decisions and could move faster to make academic program adjustments in a changing educational marketplace. One of the notable decentralized models is Responsibility Center Management (RCM). Because all of the revenues are allocated to the unit that earns it, the RCM model requires a methodology to charge revenue-generating units for their share of central administrative activities. There is no evidence that any one of the allocation methodologies reviewed in this study is completely effective in allocating central costs. Most of the methodologies are based on averaging, and, since the average does not represent any individual unit, the methodologies can become dysfunctional over time. A review of financial data finds that fast-growth academic units in this study benefited most from the various allocation methodologies in place. While some administrators interviewed thought the system fairly allocated costs, the majority felt that it was less than perfect in aligning benefits with allocations. Many pointed to the lack of defined service levels for activities funded through the allocation system, which is an important element in perceived fairness. Even though there were issues in how the allocation systems worked, it was clear that there was strong support of the decentralized model. When developing or revising cost allocation methodologies, institutions should focus on five areas: (a) determine the cost drivers of administrative activities, (b) create allocation pools based on cost drivers, (c) distribute costs on a consistent basis, (d) move from average to marginal cost rules, and (e) create reasonable transition periods for change