Using data envelopment analysis for costing bank p

UsingdataenvelopmentanalysisforcostingbankproductsAndreasC.Soteriou*,StavrosA.Zenios1DepartmentofPublicandBusinessAdministration,UniversityofCyprus,Kallipoleos75,P.O.Box537,Nicosia,CY1678,CyprusReceived18December1996;accepted20January1998AbstractAnimportantproblemthatmanybanksfaceistoprovidesatisfactorycostestimatesforthevarietyofproductsandservicestheyo€er.Accurateproductcostestimatescanbeusedtosupportbetterproductmixandpricingdecisions.Inthispaperwepresentamethodforprovidingecientandreliablecostestimatesofbankproductsatthebranchlevel,basedonthenon-parametricbenchmarkingtechniqueofDataEnvelopmentAnalysis(DEA).Resultsfromanem-piricalstudyundertakeninabankingenvironmenttodemonstratetheapplicabilityofthemethodarealsopresent-ed.Ó1999ElsevierScienceB.V.Allrightsreserved.Keywords:DEA;Bankproductcostallocation;Bankbrancheciency1.IntroductionMarketglobalizationand,inmostcountries,deregulationof®nancialserviceshasintroducednewopportunitiesbutalso®ercecompetition.Inthebankingindustry,itisnowdiculttoidentifyabankthatdoesnotemphasizecostreductionandwasteelimination.Tothisend,anumberofbanksreportre-structuringtheirtraditionalcostaccountingsystemtowardsActivityBasedCosting(ABC)(CooperandKaplan,1992),inanattempttoprovideabetterproduct-costingaccountingsystem.ActivityBasedManagement(ABM),thebroaderphilosophybehindABC,eliminatesthefunctionalsegmentswhicharethefocalpointoftraditionalaccountingsystems,andemphasizeslongtermimprovementinthedeliveryoftheactivitiesinvolvedinserviceproduction.Unliketraditionalaccountingsystems,themainfocusofABMistoprovidemanagementwiththenecessaryinformationtoimplementsuccessfulstrategiesandbecomecompetitiveinthemarketplace.Continuousimprovementresultsfromsheddinglighttothepitfallsofthesystem,aprocesswhichbeginswiththeidenti®cationofthecostdriversforeachactivity,andofthecostassociatedwitheachdriver.ThisEuropeanJournalofOperationalResearch114(1999)234±248*Correspondingauthor.Tel.:[phone];fax:[phone];e-mail:[e-mail]1e-mail:[e-mail]@wharton.upenn.edu0377-2217/99/$±seefrontmatterÓ1999ElsevierScienceB.V.Allrightsreserved.PII:S0377-2217(98)00253-7isnoeasytaskandthedicultiesinimplementingsuchcostaccountingsystemsinthebankingindustryhavebeenidenti®edintheliterature(PerryandSmilansky,1994).Inthispaperwefocusonthespeci®cproblemofallocatingtotalbranchcosttotheproductmixthatthebranchesofabanko€ertotheirclientele,andobtainingareliablesetofcostestimatesfortheseproducts.Ifservicescouldbestocked,productcostingwouldbeessentialfortheevaluationofabranch'sperformance,sinceitwouldservethepurposeofestablishingthecostofgoodssold.Mostservicesare,however,per-ishable(Sasseretal.,1978)andsincemostoperatingcostsaretypicallyconsideredassunkcosts,productcostingmaynotbeessentialfortheevaluationofaserviceunit'sperformance.Goodproductestimatescan,however,aidbetterdecisionmakingforproductmixspeci®cationorpricing.Providedthatbranchman-agershavetherightincentives,theycanacttowardspromotingacertainproductmix.Sincemanybankstreattheirbranchesaspro®tcenters,suchinformationcanalsoguidetheheadoceintoprovidingin-centivestobranchmanagers.Ofcourse,itshouldbenotedthatpricingdecisionsarenotmadebythebranchmanagers;however,pricingdecisionscanbebasedongoodproductcostestimateswhich,inturn,canbeobtainedbyconsideringindividualbestperformingbranches.Wewouldliketoemphasizeherethatthegeneralproblemweaddressistheonewherebranchtotalcost(includingoverhead,computer®xedcost,etc.)isallocatedtothevariousproductsandserviceso€eredbythebranch.Werecognizethatbyfocusingonbranchtotalcosts,theallocationofbankheadquarters'costs±whichbyitselfisadicultproblem±isnotconsidered.Theallocationofsuchnon-branchrelatedcostscanbeconsideredseparately.Goodcostallocationestimatesshouldnotonlyidentifythecostassociatedwiththeproductionofabankservice,butalsoprovideincentivestoencourageecientproduction.ABMattemptstoachievesuchcostestimatesthroughcontinuousimprovement:improvementbyfocusingandimprovingthoseactivitieswhichdriveindirectproductioncosts.Dicultiesinidentifyingsuchcostdriversinservices,inprovidingaccurateestimatesoftheresourcesinvolvedintheproductorserviceproduction,andindevelopingacompanyplantomovefromtheABCdatacollectionandanalysisstagestothedecisionmakingstages,arejustfewoftheproblemswhichcanresultinnewandexpensiveaccountingsystemsoftentoberegardedasunproductive(CooperandKaplan,1992;Kaplan,1992).Thus,itispossibleforresultingproductcostestimatestoincorporateandre¯ectthecostofpossibleinecienciespresentinthesystem.Furthermore,theresultingproductcostestimatesmaynotuncovereconomiesofscopeamongproducts.2Goodcostestimatesshouldalsotakeintoconsiderationeconomiesofscope,whenpresent.Thanassoulis(forthcoming)describesthegeneralproblemofestimatingmarginalresourcelevels,whicharetypicallyusedinresourceallocation.Whentheresourcesinvolvedaremeasuredin®nancialterms,marginalresourcelevelsbecomecostsperunitofactivitysuchas,forexample,costpercheckingaccount.AsThanassoulispointsout,marginalresourcelevelsresultingfromregressionanaly