The Allocation Base Is a Decision
Whatever spreads the overhead pool decides which work looks profitable. The four common bases, what each penalises, and how to choose deliberately.
One £420,000 pool, spread four ways, as it falls on one job
The default; penalises labour-heavy work.
Penalises skilled work, which costs more per hour.
Penalises automated work; this job used little.
Penalises small jobs; indifferent to size.
Four defensible bases, and the same job carries between £1,960 and £4,210. The pool is unchanged; only the mechanism moved. Whichever base is chosen makes some work look profitable and other work look poor, and the choice is usually inherited rather than made. One employer's own figures, not a benchmark.
The base that spreads an overhead pool decides which work looks profitable, and in most organisations it was chosen by whoever configured the system. It is not a technical detail: it determines the answer to every question about which jobs, customers and products are worth having.
The calculation in “The Allocation Base Is a Decision” depends on reliable source records as well as a documented accounting rule. For organisations researching employee time tracking, check the product workflow in detail can supply consistent time and project context, while the allocation basis and financial interpretation remain decisions for the organisation and its advisers.
Four bases are common. Each penalises a different kind of work.
As an outside benchmark for “The Allocation Base Is a Decision”, see Harvard Business Review management resources. Keep the source record, calculation rule, approval and resulting decision visible as separate steps.
Direct labour hours
The default almost everywhere. Overhead falls in proportion to hours worked, which means labour-intensive work carries most of it.
Appropriate when the pool is genuinely driven by people: supervision, HR, premises for staff.
Direct labour cost
Overhead in proportion to wages. Skilled work carries more than unskilled, for the same hours.
Appropriate when the pool scales with the value of the people — senior management, professional indemnity — and distorting when it does not.
Machine hours
Overhead in proportion to equipment time. Automated work carries most of it; manual work carries little.
Appropriate in capital-intensive operations and the right corrective where a labour base is deterring automation.
A flat charge per job
Overhead in proportion to the number of jobs. Small jobs carry as much as large ones.
Appropriate where the pool is driven by transactions — order processing, invoicing, setup — and it is the most neglected of the four.
The honest answer: more than one
Different parts of the pool have different drivers. Supervision follows hours; order processing follows job count; machine depreciation follows machine time.
Splitting the pool into two or three sub-pools with their own bases is more accurate than any single base and is not much more work.
How many sub-pools
Two or three. Beyond that the effort exceeds the accuracy gained, and the model becomes something only its author can explain.
The usual split is a people-driven pool, a transaction-driven pool, and an equipment-driven pool where equipment matters.
What a wrong base does
Makes a class of work appear unprofitable and causes it to be declined or repriced. The work goes, the pool does not, and the remaining work carries more.
That spiral is the standard failure of overhead allocation and it is usually diagnosed as a market problem.
Testing the base
Pick the three or four largest items in the pool and ask what each actually varies with. If most of the pool does not vary with the base, the base is wrong.
One hour, and it is the whole of the analysis.
Changing it
Breaks comparability with previous years, which is a real cost. The change should be made deliberately, dated, and both bases should be reported for a transition period.
Changing it quietly makes every historical comparison meaningless and nobody notices for a year.
Who should decide
Whoever uses the job costs to make decisions, informed by whoever knows the pool. Not finance alone, because the consequences land in operations and pricing.
Changing the base changes the winners
Worth stating before the analysis is run, because the result will move cost onto some work and off other work, and the people whose work gains cost will object.
Framing it as a correction of a known distortion, agreed in advance, is the difference between a technical improvement and a political fight. The arithmetic is the easy part.
The base that is easiest to collect
Usually labour hours, because the job system already holds them. That convenience is most of why it is the default.
Machine hours and job counts are both available in most operations and both require somebody to go and get them. The effort is a day, and it is the main reason the more accurate base is not used.
Testing without changing anything
Recompute last year under the alternative base and compare the margin ranking by job type. Nothing is published and nothing changes.
If the ranking holds, the question is closed for another few years. If it reorders, the organisation has been making commercial decisions on an artefact of its allocation mechanism, and that is worth knowing before the next pricing round.
What to do when nobody can agree
Pick the base that fits the largest part of the pool, state that it is a convention for the rest, and move on. Precision here is bounded by the fact that the pool is unattributable by definition.
An allocation that is approximately right and universally understood beats one that is theoretically better and that only its author can explain.
The five facts to record
The pool contents, the base, the reason for the base, the rate per unit of base, and the date. Five facts.
They are the answer to "why does this job carry £3,840 of overhead", which is a question people ask and almost nobody can answer.