Cost accounting has something interesting in common with the prisoner’s dilemma.

25 July 2025

The optimal strategy for the prisoner’s dilemma depends on whether you play the game once (defect) or multiple times (cooperate).

When it comes to management decisions, cost allocation makes sense if used for a single decision, but it dramatically reduces the organization’s profitability when used across multiple decisions.

This is because the impact of a decision on indirect costs is very likely to be bimodal. The decision will either cause no increment in indirect costs or trigger a considerable increase.

Now, if you consider these two outcomes, the first is much more probable (most organizations carry much more excess capacity than they care to admit), but the second will have a much larger (negative) impact on profitability.

Cost accounting (as it’s commonly used) is weighted toward the second outcome. For example, it makes it much less likely that a manager would say “yes” to a request for a volume discount. This decision, in isolation, is defensible.

But, imagine what happens if managers process 100 similar requests every month and refuse all of them. We now have an organization that is stagnant and that, in due course, will almost certainly become unprofitable.

I’m sad to say that this is not just a thought experiment. We have worked with a number of organizations that make decisions like this and then build sales teams, hoping that salespeople will be the solution to their problem!
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