Allocating fixed costs is a really, really tricky thing. Arthur Thomas first identified the problem of arbitrary allocations back in the seventies. To our knowledge his conclusion that the allocation of fixed costs must be arbitrary has not been gainsaid in forty plus years. The allocation problem leads to lots of controversies about prices in areas with high fixed costs like drugs and airlines.
The latest example of the allocation problem is Amazon and the US Postal Service. Josh Sandbulte, writing in the WSJ says:
In my neighborhood, I frequently walk past “shop local” signs in the windows of struggling stores. Yet I don’t feel guilty ordering most of my family’s household goods on Amazon. In a world of fair competition, there will be winners and losers.
But when a mail truck pulls up filled to the top with Amazon boxes for my neighbors and me, I do feel some guilt. Like many close observers of the shipping business, I know a secret about the federal government’s relationship with Amazon: The U.S. Postal Service delivers the company’s boxes well below its own costs. Like an accelerant added to a fire, this subsidy is speeding up the collapse of traditional retailers in the U.S. and providing an unfair advantage for Amazon.
Later he partially admits to the allocation problem:
But with a networked business using shared buildings and employees, calculating cost can be devilishly subjective. When our postal worker delivers 10 letters and one box to our home, how should we allocate the cost of her time, her truck, and the sorting network and systems that support her? What if the letter-to-box ratio changes? [Emphasis added]
Now if Josh changed the bold selection to is arbitrary we would have nothing to talk about. But he didn’t so Josh appeals to authority:
In 2007 the Postal Service and its regulator determined that, at a minimum, 5.5% of the agency’s fixed costs must be allocated to packages and similar products. A decade later, around 25% of its revenue comes from packages, but their share of fixed costs has not kept pace.
So Josh seems to think that fixed costs should be allocated based on revenue. It is one of many arbitrary choices. Then he cites Citigroup (the link connects to the company rather the report) as concluding it should be $1.46 more for each package. Since Josh didn’t connect to the report we can’t say anything other than there are lots of ways to allocate fixed costs and Arthur would say it is impossible to prove any of them right. We side with Arthur rather than Josh on this one.