On the Allocation of Fixed and Variable Costs from Service Departments

In this paper, a service department chooses a fixed/variable cost combination based on the forecasts of two operating departments. The operating departments then make service usage decisions, and the service department provides the level of service demanded. The allocation of fixed and variable service department costs is used to: (1) encourage efficient short term use of the service and (2) encourage accurate forecasting by the operating departments. Three approaches are used to achieve these objectives - incentive compatible allocations, a modified Soviet incentive scheme, and a Groves allocation scheme - and we discuss conditions under which these schemes are successful.