In order to effectively compare software services with other software development activities, it is necessary to define the meaning of Throughput for a service. This requires that the business model for the service provider be recast in terms of Throughput Accounting rather than cost accounting. In order to understand this, it is first necessary to understand the existing cost accounting-focused model for service providers:
EBITDA=ARPU-CCPU
This equation states that earnings per subscriber before interest, tax, depreciation, and amortization is the average revenue per user per month, less the cash cost per user per month. Calculating EBITDA rather than a pure Net Profit allows the high cost of sunk capital to be ignored, which enables the service to be evaluated based on free cash flow of the on-going business. EBITDA is primarily a psychological number. It is used to project the long-term value of a service after the sunk cost is depreciated. EBITDA by highlighting free cash flow is supposed to help the stock price.
The EBITDA equation looks a little like our Net Profit equation. However, we should not mistake ARPU for T or CCPU for OE. Why not? ARPU represents the sales per subscriber to the service. The figure is averaged over the aggregated subscriber base. The sales figure for a given time period is ARPU multiplied by the number of subscribers. ARPU does not deduct out any direct costs. Hence, it is not an equivalent for T. Service industries assume that marginal costs are low. However, the direct costs are important. For example, if a customer spends $10 per month on Yahoo! email but pays by credit card, the cost of the credit card transaction is a direct cost. If this is 50 cents, Throughput is at most $9.50. In traditional service industry cost accounting, this cost is assigned to CCPU.
What else gets assigned to CCPU? Cash Cost per User is an average of the total operating expense divided by the number of subscribers, where operating expense does not include any carrying costs for investment in capital equipment. Investment in inventory is assumed to be nil (or negligible) because there is no inventory in a service business. Hence, there is no figure for investment.
However, inventory is seldom negligible. Phone companies carry subscriber equipment, such as handsets, as inventory. Cable TV companies carry set top boxes as inventory. Even pure Internet operators such as Yahoo! are carrying ideas for their next version as inventory.
In theory, the CCPU figure can be multiplied by the number of subscribers to give us a figure for normal operating expense for the business, including any amount of direct cost associated with the generation of ARPU. How useful is this figure? Is CCPU really a variable cost? And does it vary directly?
If next month, 100,000 subscribers leave the service, will the operating expense decrease by 100,000 times the CCPU? Were some staff laid off? Were the overheads reduced? Were any computer systems switched off? Was the power consumption on the network reduced? Was the capacity of the service reduced? Of course not! The truth is that a reduction in the number of subscribers creates a jump in CCPU. Why? Because a large proportion of CCPU is fixed operating costs rather than variable costs associated directly with the subscriber.
Wait a minute! Am I proposing that the standard method used as a management tool for most service businesses, such as telecommunications, is wrong? Yes! Cost accounting was born of an era where direct costs were by far the largest contributor to operating expense. However, cost accounting is obsolete. In a world in which more than half (and probably most) of the operating expense is overhead, it is simply not useful to try to assign those costs. Hence, a new mental model and financial framework is needed to usefully evaluate the contribution of development of new services. A holistic systems thinking approach is required.
The Throughput Accounting approach to a service industry treats the whole service as a system. Throughput is the total sales for a time period less the direct costs of servicing those sales. Direct costs include the cost of sending a subscriber a bill through the mail and the cost of accepting the payment. No attempt is made to break out the Throughput figure per subscriber.
Tservice=TotalSales-TotalDirectCosts
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