Optimizing Cost Allocation for Rockynet's Telecommunications Services

1. Product Cost Allocation Rockynet.com, Inc. Boulder / Northern Exposure XBUS 6210 – Management Accounting and Control Systems March 26, 2005

2. Rockynet: communications services provider Rockynet’s target market includes small to medium sized businesses. SERVICES Dedicated T1 circuits Lit-buildings or “TNet” Co-location facilities VoIP telephone service Managed servers Web hosting Equipment sales Technical consulting services 85% of Revenues Focus of Analysis

3. Network Architecture • Denver POP • T3 circuits to Saavis, MCI & Internap • 100-BaseT ethernet to Cogent • 1000-BaseFX fiber to Yipes Boulder POP Connects to Denver POP via two T3 circuits from different providers.

4. Description of data services • Dedicated T1 circuits • connections that are not shared • provide all capacity and speed available to a customer • A premium product • Lit buildings (TNET) • buildings or commercial campuses where tenants lease space • tenants share one or more T1s • Cost effective tenant-level support and service • Co-location facilities • specialized for housing servers and providing internet connectivity • allows customers to locate servers in a controlled environment • provides T1 and T3 circuits and backup power is available • Specialized state-of-art facilities

5. Voice service introduced in 2002 VoIP (Voice Over Internet Protocol) delivers voice lines over data lines • VoIP benefits • Place & take phone calls anywhere with network access • Voicemail to email .wav files • Advanced features such as sim-ring, find-me follow-me Value proposition: Incorporate voice and data into one service at lower cost, using a local, responsive provider.

6. Current cost analysis methods • Costs include… • technical labor • administrative, management and sales labor • office space • advertising • equipment • co-location rent and utilities • circuit and bandwidth charges • G&A, sales, office expenses, etc. are spread as overhead • *Allocated as 42.5% of total sales • Revenues include… • monthly use charges • installation fees

7. Current product line income statement Per month average for past 4 months

8. There’s a better way to allocate costs Analyze costs for 4 product groups three data products new voice product Allocate using activity-based costing Can labor (including G&A) cost allocation be improved? Restate costs, margins and profits for previous 4 month avg Does ABC tell us anything new? Report to Rockynet Management

9. Analysis of Rockynet Costs and Activities

10. Cost allocation process Define activities new customer acquisition installation continuing operations G&A (running the business) Interview staffExecutive staff Provisioning coordinator Technical staff Sales staff Total the activity costs Calculate the rates & Allocate the costs

11. Allocation of non-labor costs • T1 circuits • a per circuit charge • relevant to all products in our analysis • These costs can be directly allocated to each of the four products • T3 circuits • larger “pipes” that multiplex 24 T1s • allocation of T3s is a batch level cost is determined by the number of T1s • Equipment • Switches, routers, aggregation and interface equipment • Allocate these expenses directly to products as Cost of Goods sold

12. Staff contributions to activities Interviews with staff provided the following: Key finding: Executive staff spend 55% of time on non G&A activities

13. Cost drivers for activities • New customer acquisition cost • estimated number of hours spent gaining customers • estimated fraction of time spent on voice and data • Cost driver is $ / new customer acquisition hours • Installation cost • found # tech hours to install each product • found # provisioning hours to install each product • Cost driver is $ / install • Continuing operations • totaled the costs to keep the networks running • Cost driver is the number of customers • Allocated labor costs using these activities and drivers

14. Tech Staff Data lines Provisioning coordinator Exec staff Sales Staff Equipment Continuing operations New customer acquisition Install G&A $ per hour of continuing ops $ per install $ per customer $ per acq hour TNET Co-Lo Voice T1 Activity-based costing model

15. Other overhead costs Other costs allocated Advertising cost 100% allocated to voice Office rental costs (based on occupants) Suite 1: Acquisition pool Suite 2 & 3: continuing operations pool Suite 4: 25% continuing ops / 75% G&A Equipment space rent and utilities cost this cost only applies to CoLo G&A: allocated by continuing ops labor hours

16. Costs using new allocation

17. Margins using new method

18. Issues, Insights and Recommendations

19. What happened?? • G&A was previously spread over all products • this ignores significant effort toward voice product sales • CoLo direct costs increased with ABC • previously, CoLo rent/utilities were spread as overhead • now applying directly to CoLo product • T1 non-direct costs decreased significantly. • T1 product needs little support • number of customers is a better cost driver for direct costs

20. What about voice?? • Voice losses expected at this point • a new product introduction • a substantial growth opportunity • Acquisition costs for voice are causing a loss • review sales force compensation / change sales incentives • Is the CEO salary a relevant cost?? • Effective cost control will be key to the product’s success • consider strategies for decreasing installation costs • learning curve for installations • reduce VOIP equipment costs through partnering

21. Conclusions Accurate costing is a beautiful thing

22. Questions?