We here at Apogee Consulting, Inc. are not DCAA-haters. We admit, though, that it’s tough to find a complimentary word about the Defense Contract Audit Agency on this blog. We assert that situation arises not from any inherent bias on our part, but instead from an objective assessment of the factual reality of the current defense contract audit environment.

While DCAA may be in the process of implementing corrective actions that will lead to Solomon-like audit conclusions while streamlining quality review processes to permit issuance of audit reports faster than a speeding bullet, as of this date we have yet to experience the wonderful goodness that is the promised future state of the Defense Contract Audit Agency. Instead, we and our clients continue to be mired in the same old miasmic swamp of conclusions unsupported by evidence; misinterpretation of applicable statutory, regulatory, and contractual language with the apparent goal of generating as much questioned costs as possible; and auditors who seem far more interested in creating pretty working papers than in getting to the facts.

The next time your DCAA auditor refuses to accept your 5 year-old spreadsheet as sufficient transaction support (the one that was created by the accountant who retired two years ago, and that’s been stapled to the original Journal Entry in the box that you’ve been paying a third-party to store for you in anticipation of an eventual DCAA audit)—and instead requires you to rehost your entire legacy cost accounting system for the sole purpose of observing your personnel actually downloading accounting data into that spreadsheet—we suspect you’ll empathize with the experiences of our clientele. You perhaps may even start to feel our frustration and angst with the current DCAA approach to performing contract audits.

Regardless of our feelings on the matter, we were happy for DCAA that the Office of the Inspector General of the United States Postal Service had very complimentary things to say about DCAA audits performed on a reimbursable basis for the USPS over the past three Government fiscal years (2009-2012). The USPS OIG said very complimentary things about DCAA in its recent report. And the USPS OIG said those complimentary things a lot. There was so much repetition, it got irksome.

And we think the USPS OIG got it wrong. We looked at the same data the IG auditors looked at, and we would have reached different conclusions than the IG auditors did.

But let’s start with the happy words from the “Highlights” section of the IG report.

DCAA audits are cost-effective tools that help Postal Service contracting officials negotiate lower contract costs and manage contracts. These audits have consistently contributed to significant savings and averaged a return on investment of $105 for every dollar spent over the last 4 fiscal years. During FYs 2009–2012, DCAA audits identified more than $185 million in unallowable and unsupported contract costs; and disclosed internal control weaknesses related to contractors’ accounting systems, financial capabilities, and labor charges. These results assisted contracting officials in negotiating lower contract prices and settlements.

Now let’s review the wording from the “Conclusion” section of the IG report—

DCAA audits are cost-effective tools that help Postal Service contracting officials negotiate lower contract costs and manage contracts. These audits have consistently contributed to significant savings and averaged a return on investment of $105 for every dollar spent over the last 4 fiscal years. During FYs 2009-2012, DCAA audits identified more than $185 million in unallowable and unsupported contract costs. They also disclosed internal control weaknesses related to contractors' accounting systems, financial capabilities, and labor charges. These results assisted contracting officials in negotiating lower contract prices and settlements.

Now let’s look at Page 2 of the body of the IG report—

DCAA audits are cost-effective tools that help Postal Service contracting officials negotiate lower contract costs and manage contracts. These audits have consistently contributed to significant savings and averaged a return of $105 for every dollar spent over the last 4 fiscal years. During FYs 2009-2012, DCAA audits identified more than $185 million in unallowable and unsupported contract costs due to reviews of price proposals, termination claims, and equitable adjustments. They also disclosed internal control weaknesses related to contractors' accounting systems, financial capabilities, and labor charges. These results assisted contracting officials in negotiating lower contract prices and settlements.

The entire audit report (excluding Appendices) weighed in at a lengthy eight pages. Within that page count we found three Tables and many bulleted points. So as you can see, repeating the same conclusion over and over took up a significant portion of the total report page count. Plus (as we noted) it was irksome. Look USPS OIG report drafters, we heard you the first time. You didn’t need to tell us three times. (Oh, wait. Let’s go back and see to whom the report was addressed. Maybe the report drafters did know their audience….)

And the thrice-repeated conclusions are wrong, in our view. Let’s dig into some details, shall we?

Table 1 of the report lists the audits that DCAA performed for the USPS by year between 2007 and 2012. There weren’t that many of them. In the most hectic year (2009), DCAA performed 29 audits for USPS; in the least hectic years (2011 and 2012), DCAA performed 11 audits (per year) for USPS. The OIG noted that the decline in audit workload “may” be attributable to an overall decrease in Postal Service spending. However (as the report stated), “management indicated they did not strongly pursue additional DCAA audit requests during this period because of concerns regarding DCAA’s audit quality and timeliness.”

Appendix B of the report provides details regarding the types of audits that DCAA performed for the USPS. Between 2009 and 2012, DCAA performed a total of 58 audits. 14 of the 58 (24%) were audits of “price proposals”—i.e., audits of cost proposals submitted to the USPS for evaluation prior to award of a contract. Three of the 58 audits were audits of proposed contract “equitable adjustments”—which are contractor proposals to modify contracts based on changes made by the USPS. Let’s add to those two audits of Termination Settlement Proposals, which are contractor proposals to establish final contract prices after a Termination for Convenience. That makes a total of 19 audits out of 58. Roughly a full third of all the DCAA audits performed for USPS related to contractors’ proposed costs.

How did DCAA do in that area?

According to the USPS OIG, DCAA questioned “unallowable or unsupported costs” in the amount of $181,204,699—or roughly 98 percent of all the DCAA audit “return on investment” calculated by the OIG in its report. That $181.2 million was found on 12 of the contractor proposals audited. One proposal had no opinion because DCAA found the contractor’s proposal to be inadequate for audit, and another proposal has zero questioned costs. Here’s what the USPS IG reported about that $181.2 million in DCAA findings—

Six of the 12 proposals contained $153,723,825 in unsupported costs primarily because the contractor did not provide adequate supporting documentation for subcontractor costs, direct material, and overhead rates.

As you know, we have been skeptical of such claimed taxpayer savings. Our position is that questioned costs save taxpayers nothing, unless a contract is awarded that includes negotiated reductions based on the DCAA findings. Happily for us, the USPS IG report provided some details as to how the USPS Contracting Officers handled the DCAA findings in their negotiations with contractors.

The following is taken verbatim from the IG report. Our analysis is in parentheses.

• One price proposal disclosed unallowable costs of $10.9 million and unsupported costs of $143.5 million. The CO was able to negotiate the proposed price of $382.1 million down to a negotiated final price of $346.8 million, for a savings of $35.3 million. ($154.4 million questioned; $35.3 million sustained. Sustention rate = 22.86%.)

• Another price proposal contained unallowable costs of $3.9 million. Based on the DCAA findings, the CO negotiated the original proposed price of $49.8 million down to a final negotiated price of $47.1 million, for a savings of $2.7 million. ($3.9 million questioned; $2.7 million sustained. Sustention rate = 69.23%.)

• For a price proposal containing $6.2 million in unallowable costs, the Postal Service later cancelled negotiations and issued a separate solicitation, which it subsequently placed on hold indefinitely. ($6.2 million questioned; zero sustained. Taxpayer savings = zero.)

Looking at the termination settlement proposals and equitable adjustment proposals, DCAA found “unallowable costs totaling about $3.3 million, or about 90 percent of total claimed costs.” $812,171 in questioned costs related to two TSPs; and $2.51 million in questioned costs related to one of the three equitable adjustment proposals. The following is taken verbatim from the IG report. Our analysis is in parentheses.

• One contractor submitted a termination claim for $702,230, $475,322 of which DCAA questioned based on the comingling of terminated proposal costs, unallowable fee costs, and disallowed subcontractor estimated-to-complete costs included by the prime contractor. The Postal Service terminated this contract for convenience and settled the questioned cost of $475,322. (While we are not sure what “settled” means in this context, we think if savings had been obtained, they would have been reported. So we are going with: $475,322 questioned; zero sustained. Sustention rate = zero.)

• Another contractor submitted a termination claim for $336,849 and the entire claim was questioned due to inadequate cost and pricing data. The Postal Service was able to negotiate a lower price of $73,475, a reduction of about 78 percent of the claimed cost. ($336,849 questioned; $263,374 sustained. Sustention rate = 78%.)

• A contractor submitted an equitable adjustment that resulted in $2,514,232 in questioned costs out of $2,639,618 total claimed costs. The questioned costs were primarily due to excessive labor costs claimed for holiday staffing, nonconforming mail, and excess staffing due to truck schedule changes. The DCAA report was a useful tool for the CO to use during claims negotiations and for substantially reducing contract settlement amounts. As a result, the CO negotiated the claim down to $16,562. ($2.514 million questioned; $2.514 sustained. Sustention rate = 100%.)

Looking just at the foregoing, we can see that the USPS realized savings of about $40.78 million. That’s a good result; there’s nothing to criticize anybody for. But it’s a far cry from the $185 million in repetitively claimed savings and “return on investment.” If the $185 million in DCAA questioned costs resulted in a “return on investment” of $105 for every dollar spent, then the real ROI (based on sustained findings) is more like $23 for every dollar spent. Again, that’s not bad—not bad at all. But it’s significantly different from the amount reported by the OIG. One is tempted to say it’s so far off, it’s actually misleading.

Looking at the totals for this area, we can see that the USPS CO’s sustained about $40.78 million out of $181.205 million initially questioned by DCAA, for an overall sustention rate of 22.5%--meaning that 87.5% of questioned costs were not sustained. We believe that the sustention rate is the one metric that best measures the quality of DCAA’s audit findings. In our view, that is not a superlative sustention rate; indeed, one is tempting to say it’s a pathetic sustention rate.

Regardless of our difference in opinion with that of the USPS OIG, it is important to report (again) that DCAA didn’t just question costs: the audit agency “also disclosed internal control weaknesses related to contractors' accounting systems, financial capabilities, and labor charges.” Let’s dig into those reported findings, shall we?

DCAA performed 18 “reviews” in this area (31 percent of all DCAA activity in the review period covered by the USPS OIG). 12 of the 18 were reviews of contractor financial capability; the less said about them, the better. (We will note for the record that, with respect to one review, the IG reported that “the CO felt the findings did not accurately reflect the supplier’s financial capability.”)

Of the other six reviews, four were reviews of USPS contractors’ “business systems” (3 Accounting System reviews and 1 Estimating System review). Before getting into the details, we need to note that the adequacy criteria were not disclosed by the OIG in its report. It’s not clear whether DCAA used the Accounting System adequacy criteria found in its standard audit programs for Internal Controls Adequacy (ICAPs)—which would be based on inapplicable DFARS criteria—or if the auditors tailored the audit program for USPS requirements. That matters, a lot.

In any case, the USPS IG reported—

The DCAA reports disclosed that two of the three accounting systems reviewed were unacceptable for accumulating and segregating costs on Postal Service contracts. One accounting system review was initiated prior to awarding a fixed-price contract.

It should be noted that the two Accounting System reviews that found the contractors’ systems to be inadequate were issued in 2009. 2009 was a banner year for DCAA; it was the year in which its external peer-reviewed quality control system opinion was pulled because of systemic quality failures—particularly in the area of business system adequacy reviews. We’re not saying that DCAA reached wrong conclusions in those two reports; but we are saying that one should be skeptical of DCAA’s opinions issued at that time.

In contrast, the report of the Estimating System review was issued in 2012, when all the corrective actions taken by DCAA since 2009 should have resulted in a solid, supportable, opinion as to the adequacy of the contractor’s Estimating System. The company upon which this helpful review was visited was Accenture.

Here’s what the DCAA reported to the USPS, with respect to Accenture’s Estimating System—

This audit disclosed several weaknesses in the system, including not:

-- Using historical experience.
-- Monitoring and tracking estimates against actual costs.
-- Subjecting estimates to periodic internal reviews.
-- Requiring periodic training on the Estimating Manual.
-- Reviewing management documentation sufficiently.
-- Reviewing subcontractor costs adequately.
-- Documenting policies, procedures, and practices.

The funny thing about the foregoing is that they are, largely, policy deficiencies and not deficiencies in actual practice. The other funny thing is that they are deficiencies only when measured against DFARS adequacy criteria. The DFARS is not applicable to USPS contracts, and we would be shocked to see the DFARS Estimating System Adequacy contract clause (252.215-7002) in a USPS contract. Indeed, as the USPS IG itself noted in separate audit report, “While the Postal Service is not subject to the FAR or DFARS, it does not currently have specific policies and procedures or clauses that address supplier estimating systems.”

In other words, it appears that DCAA applied the wrong adequacy criteria to Accenture when concluding that the Accenture Estimating System was inadequate. That does not strike us as the basis for a high-quality conclusion.

Regardless of our opinion about the basis of DCAA’s conclusion, the USPS OIG used the DCAA conclusion to initiate its own probe of Accenture’s Estimating System, so that it could reach its own conclusion. The IG report on Accenture is right here. While the USPS IG did not, as DCAA did, use the DFARS Estimating System adequacy criteria as the basis for its audit conclusions, it did reprint them in full in Appendix C of its report—and call them out as being “best practices”. So it seems that the USPS OIG believes that the quasi-private, civilian, entity that is the United States Postal Service would be better served if it ran its contracting operations like the Department of Defense.

Words fail us.

Accenture’s response to the original DCAA audit report and/or to the follow-up OIG audit report, were not provided. We wonder what they said.

In conclusion, we offer the foregoing as constructive criticism of the USPS OIG and its decision to use DCAA. We suggest that DCAA still has a measure of distance to travel, in terms of improving its audit quality (as measured by the sustention rate) and in improving the timeliness of its audit reports. Although the USPS OIG was seemingly much taken with the use of DCAA as outsourced auditors, we thought that the love was not so very much warranted.

But perhaps that’s just us. If you think we’re wrong, feel free to leave your comment below.

Part 1 of this series can be found here. We discussed why this is an important—nay, critical—topic for you, worthy of an investment of your time and expense.

Part 2 of this series can be found here. We discussed why you need input from a diverse group of stakeholders. You will want to solicit input from a number of diverse perspectives because your cost allocation decisions—including your decision regarding the emphasis you place on maximizing the amount of direct charges—can affect your corporate culture in perhaps unexpected ways.

In today’s article we want to explore the concept of precision as it impacts cost allocation decisions. But before we do that, we’ve got to address your organization structure. Your organization structure is the starting point for your cost allocations.

The reason we start with your organization structure is that government contract cost accounting embraces the concept of full absorption costing. That phrase means that (simply put) all your costs need to be accounted for, and all indirect costs need to be allocated and absorbed by the benefiting “final cost objectives” of your cost accounting system. Your organization structure and its building blocks—whether you call them “cost centers’ or “departments” or “whatevers”—is the framework within which you collect costs for budgeting and costing purposes. The first step in designing the cost allocation pools and bases is to examine your current organization structure and see how the business is managed and run from a budgetary and cost accumulation perspective.

This first step isn’t too difficult—assuming you’re already happy with your current organization structure. If one assumes that all your departments are grouped as you want them and that your management team is working together to get your projects and programs executed, then we can proceed directly to dollarizing those groupings and looking at appropriate allocation bases. If one assumes that you’ve thoughtfully organized your entity into logical groupings of functions and activities, and that there’s a fairly clear relationship between the organization structure and how the business is managed, then we’re good to go.

Based on our experience, this is a huge assumption that often turns out to be wrong.

If you’re happy with your current org structure and believe it supports logical cost groupings and allocations, you can skip the next nine paragraphs. Otherwise, we suggest you keep reading.

You need to do is to look at your organization structure and make sure it reflects how you want to run your business, both now and in the near term future. This is not an easy task. If you’ve been in business for any length of time and have experienced a modicum of growth, it’s more likely than not that you’ve got a patchwork org structure that reflects how individual leaders grew their empires, rather than how the business was intended to be managed. In other words, we suspect your org structure consists of a hodgepodge of individual fiefdoms, rather than being reflective of any particular management theory regarding how the business ought to be run.

For example, one of our past clients had several sales channels within its company. One focused on commercial services while another focused on government services. The purchasing department—which supported all procurements, both direct and indirect—was located in the commercial services group and reported up to the Commercial Services Vice President. This reporting relationship was the result of company history, and not at all the result of any conscious decision-making on behalf of the leadership team. We suggested that the purchasing department be moved into a corporate central services group, which reported to the CFO (there was no Chief Operating Officer at the time), so that its costs could be allocated cleanly to all sales channels that the function supported. That suggestion did not go over well with the Commercial VP.

The problem illustrated by the above anecdote is that changing the existing org structure will very likely be perceived as a threat to certain individual fiefdoms. Some “leaders” who see their corporate world as solely consisting of winners and losers may think that their empires are under threat, and thus they will set themselves in opposition to whatever org changes make logical senses from a cost allocation perspective.

Thus: it is important to have high-level sponsorship of the cost allocation structuring project. You will need somebody who can convene an Executive Steering Committee and push for what makes sense (in contrast to what’s perceived to be in the best political interests of certain stakeholders).

In the prior article, we asserted that executive leadership needed to be involved in the direct versus indirect decisions, because those decisions affect the corporate culture. The same is true for the organization structure discussion and resulting decisions. The org structure not only affects the cost allocation methodologies, but it should also reflect the business management philosophy of the leadership.

For smaller businesses seeking growth, sooner or later you will have to address the challenge of matrix management. Most, if not all, mid-size and larger government contractors have centralized certain functions in order to achieve cost efficiencies and standardize processes. Any company that’s contemplating performing a contract that contains the DFARS Business Systems administration clause(s) will be thinking about how to implement “adequate” business systems in areas such as Property Management, Purchasing, Earned Value Management, and Estimating. Those “business systems” require documentation and consistent application of policies and procedures, if they are to be deemed adequate by Government reviewers. The easiest means of accomplishing that goal is to put all the individuals performing those related functions/activities together, reporting to one leader who can hold them accountable for policy compliance. The individuals may report (on a “dotted line” basis) to the project/programs, but they are first and foremost part of a single group that operates in one way. In summary: centralized standards and decentralized deployment and execution. This concept is generally called “matrix management”.

The question about which activities/functions need to be centralized and then deployed on a dotted-line basis is fundamentally a question about the entity’s “run rules”—i.e., how it operates on a day-to-day basis. Accordingly, reaching a consensus answer can entail a long and disputatious discussion. But as we said, sooner or later the topic needs to be discussed. Discussing it while also discussing cost allocations is as good timing as any.

Objectively evaluating the current organization chart and designing the future state organization chart is a “must do” if you want clean and logical cost allocations (and straightforward time charging, too). That doesn’t make it an easy task. One past client went through 23 versions of organization structure before we found that that the stakeholders could, mostly, align and achieve consensus upon. Twenty-three. (We counted them.) Another client when through nine different structures, involving different levels of matrix management and cross-charging between operating groups, before it found one that was to its liking. And then it didn’t like the rates that the “final” org structure produced—so it was back to the drawing board once again. This is a task that almost begs for a disinterested facilitator, one who can dispassionately identify the pros and cons of each structure that the discussion participants brainstorm.

Another question to be addressed in the org structure discussion is the number of cost centers/departments/whatevers. (Okay, we’re calling them cost centers from now on. Your mileage may vary.) Why can’t you just have one big corporate cost center and one big operations cost center? Answer: you can. But then you get one big cost allocation from Corporate to Operations, and there’s no visibility into what the project/program teams are paying for. Consequently, many companies like to create individual cost centers for individual functions and/or activities, so as to promote visibility and budgetary control.

Which brings us, finally, to the topic at hand: just how precise do you want to be?

Many companies—especially those providing engineering services—are already very precise in their cost allocations and cross-functional charging. They often do this in the name of “fairness” or “determining the real profit and loss of each organization”. They have already made sure that rent and occupancy expenses are allocated based on a pro rata share of occupied space. They have already made sure that communication expenses are charged to users based on actual usage. They have already broken-out their various IT-related functions into discrete cost groupings for charge-backs to cost centers based on complex algorithms that take into account both usage and storage. The HR function has been divided up and those individual costs are allocated separately. Ditto for Finance/Accounting. Ditto for Marketing/Business Development. They have parsed-out their costs into very small groupings, and each allocates on an individual basis, so that users receive only their “fair share” of costs based on benefits received.

Sounds great, doesn’t it? Sounds like all the work’s already been done.

Well, we here at Apogee Consulting, Inc. think it’s a huge mistake. Huge.

The Federal rules applicable to cost allocations depend on whether or not the entity is subject to the Cost Accounting Standards (CAS). But even if CAS is in play, the rules are not terribly prescriptive. The general rule is provided by FAR 31.203(c)—which states:

The contractor shall accumulate indirect costs by logical cost groupings with due consideration of the reasons for incurring such costs. The contractor shall determine each grouping so as to permit use of an allocation base that is common to all cost objectives to which the grouping is to be allocated. The base selected shall allocate the grouping on the basis of the benefits accruing to intermediate and final cost objectives. When substantially the same results can be achieved through less precise methods, the number and composition of cost groupings should be governed by practical considerations and should not unduly complicate the allocation.

[Emphasis added.]

See that part we italicized above? Yeah, that’s where we’re going with this thought. Your cost allocation structure doesn’t need to be so complicated. In fact, an overly complex cost allocation structure works against you.

While it may be desirable, on a superficial level, to have multiple detailed individual cost allocations, so as to determine “true profit and loss” by function, when you think about it we hope you’ll see that there’s a price to be paid for such precision.

First, let’s think about the administrative cost associated with your multiple detailed individual cost allocations. You need accountants to make those journal entries each month; at a minimum you need accountants and programmers to make sure your fancy accounting system posts those entries each month. And what about budgeting? You’ve got to budget for each of those allocations, don’t you? And then there’s the variance analyses, where your people compare actual costs to budgeted costs, and try to figure out why there’s a difference. All those efforts cost you money and efficiency.

Next, let’s think about how your show all those multiple detailed individual cost allocations on your annual submission to establish final billing rates (popularly, but incorrectly, called the “incurred cost submission”). According to the DCAA’s Adequacy Checklist, you must include a “cost schedule for each intermediary cost pool” and show “allocation base by recipient, the percentage of the total base for each recipient, and the dollars allocated to each recipient.” In other words, your people will be spending a lot of time and effort showing those multiple detailed individual cost allocations and reconciling all the entries to the general ledger. If they don’t show all the allocations in sufficient detail, your proposal will be determined to be inadequate for audit.

And whenever your cognizant DCAA FAO schedules you for an “incurred cost audit” you’ll need to show the auditors all that detail all over again, with lots of supporting documentation. In other words, the more detailed your allocations, the more challenging the audit support will be.

For smaller companies looking to have DCAA tell them that their accounting system is “adequate” for cost reimbursement contracting, all those allocations pose a bigger challenge. Each one needs to be defended. Remember that FAR bit we quoted above? The bit about “logical cost groupings” and common allocation bases on the “basis of the benefits accruing” and all that stuff? You’re going to have to convince a skeptical auditor that each one of those detailed allocations meets the criteria. If you can’t do that, then your accounting system is not going to be found to be adequate. In other words, the more allocations you have, the more risk you have that your accounting system will be found to be inadequate.

And if you are CAS-covered, then the more allocations you have, the more risk you have that your actual practices will be noncompliant with your disclosed practices.

Truly, you only need the allocations that make sense for you to have to distribute centrally incurred costs to the benefiting cost objectives. The more cost allocations you have, the more you increase your risk profile in critical areas. This is not conjecture; we have actually witnessed this phenomenon.

We had this one client—a multi-national engineering services provider that generated more than a billion dollars in annual revenue. The company had several large cost-plus contracts. While it had had trouble in getting its annual rate submissions through audit, there had been no show-stoppers. Until the one day when DCAA told the Controller that the company’s accounting system was inadequate because it couldn’t support its intermediate allocations. The accountants simply could not document and reconcile the hundreds of individual detailed allocations used to make sure every business unit got charged for every service it used. There were too many allocations to document, and too much had been automated. They couldn’t build the Schedules that DCAA demanded. And so the company’s accounting system was found to be inadequate, as were all the pending proposals to establish final billing rates. And then the Controller moved on “for personal reasons.”

In contrast, another very successful multi-national engineering services provider we’ve worked with doesn’t even allocate Corporate costs to its business units. The business units—and by extension the project/program managers—are only held accountable for the gross margin they generate. In other words, they are held accountable for what they can control locally, and not for what they cannot control. Embedded with that philosophical decision was another decision to tie executive incentive compenstation to the performance of the overall company, and not to the performance of any particular business unit. The company made the decision that there was too little benefit from multiple detailed allocations and too much cost and risk associated with them. They decided they would not pay the price associated with precise cost allocations. And they’re doing quite well, in both commercial and governmental sales channels.

Precision has a price. More often than not, the price is too high to pay.

As the FAR states, “practical considerations” should govern your cost allocation decisions, and not abstract notions of precision and accuracy. If you want your benefiting projects/programs to pay for what they use, then you really want to make a decision to have as many costs as possible be direct costs. (See our Part 2 discussion for pros and cons of that decision.) If you’ve decided to make certain functions or activities indirect, then you have by definition surrendered some degree of precision. Let that be okay for your company. Keep the organization structure logical, keep the cost groupings to a reasonable minimum, and you’ll find that you’ll be happier with the results.

Next time we’ll talk about segmentation and intermediate home offices, as well as GOCO’s, special business units, and special facilities.