The Value of Coordination in Sophisticated Cost Systems

Abstract

We examine how the demand for inter-departmental coordination changes as the firm increases the sophistication of its accounting system. In our model, a production department performs cost reduction and manufactures the product, while a marketing department sets prices and sells the final output. We vary the level of sophistication (number of cost pools) and the amount of coordination between departments. We show that as the number of cost pools rises, the firm has greater benefits from coordinating departments via either (a) having marketing forecast (budget for) production's new costs, or (b) integrating the information systems and allowing marketing to directly observe production's new costs. We also show that increasing the number of cost pools increases the profit advantage of integration over budgeting, implying sophistication leads to a greater demand for inter-departmental coordination mechanisms such as cross-functional product teams and enterprise wide systems.

JEL Classification: M40, M46