Cost Sharing Law and Legal Definition

Cost sharing is a process wherein two or more entities work together to secure savings that one alone would be unable to obtain. Such partnerships may be pursued in order to realize any number of business objectives—increased marketplace exposure, access to technology, reduce expenses through economies of size in purchasing or reducing costs, etc.—but cost savings is usually a central component of these arrangements. Costsharing partnerships can be implemented in many different operating areas, from marketing to transportation to research and development. It is a favorite tool of many small business enterprises with limited financial resources.

Cost sharing partnerships can be entered into by a business with other businesses, with its own employees, and/or with its clients and customers. Each of these cost sharing types is discussed below.

COST SHARING BUSINESS TO BUSINESS

Traditionally, the meaning of cost-sharing partnerships has been an arrangement in which one or more businesses partner to secure savings of some kind. Relatively few cost-sharing arrangements have been implemented for the actual manufacture of goods or execution of services. Instead, the majority of cost-sharing plans are in the area of marketing and advertising. "Today's direct marketing partnerships achieve impressive cost-benefit results," stated Myron Gould in Direct Marketing. He cited three primary advantages associated with cost-sharing partnerships in this operational area:

  • They enable marketers to address the competitive challenges of the rising cost of direct marketing essentials, such as postage and paper.
  • They help marketers reduce direct mail expenses because costs are shared.
  • Their effectiveness is enhanced by the development of technology tools and media outlet alternatives.

Gould cited the latter factor as particularly important for businesses seeking to engage in effective cost-sharing. "Computers have transformed [the marketing] industry and given birth to partnership opportunities. Today's computer-driven partnerships empower us to target qualified recipients and segment lists as never before. Many of our alternative direct marketing programs have traditionally taken a broadcast approach—reaching broadly defined segments. Now, partnerships offer qualified segmentation, targeting narrower, clearly defined lifestyle and demographic segments. Technical advances in imprinting and inserting also offer enhanced ability to customize the package and the offer."

Finding a Cost-Sharing Partner

"There are no rules, standards, or boundaries that should restrict your vision when seeking a partner. Rather, shared goals should guide your 'vision quest,'" wrote Gould. "Partnership can be formed in the profit and nonprofit sectors, in the same or different industries, within different divisions of the same company, and in similar market segments/ demographics in non-competitive industries."

Many small business owners seek out allies for the exclusive purpose of registering savings in their operating costs. This is a perfectly legitimate course of action, but entrepreneurs should make certain that the final agreement is a fair one that explicitly delineates the terms of the agreement. Indeed, written partnership agreements that define each partner's spending obligations should be insisted on. In addition to discussing cost-sharing matters, these documents can also provide details on agreed-upon procedures and work flow, parameters for responsibilities, and mechanisms to measure results both during and after the project. As Gould observed, carefully crafted proposals "will help you mitigate concerns about loss of control and structuring the partnership for mutual benefit. When a partnership fulfills the consumers' needs with a new, exciting, or value-added offer or program, risks are minimized for all involved."

In addition to ensuring that cost-sharing agreements are sufficiently documented, small business owners should weigh possible other benefits associated with partner alternatives when making their decision. Gould noted, for example, that a larger company might be able to provide a small business with valuable access to technology and training, while a smaller business might be blessed with a much-coveted contemporary market image. Ideally, a small business owner will be able to find a partner who not only can help him or her secure savings in one or more aspects of business operations, but also provide additional benefits.

Cost-Sharing Arrangements and the Internal Revenue Service

The Internal Revenue Service (IRS) maintains certain rules concerning how cost-sharing agreements within business groups should allocate costs. According to the IRS, a cost-sharing arrangement is defined as an agreement under which costs to develop intangibles are shared in proportion to reasonably anticipated benefits that each entity will reap. Such arrangements must include two or more participants; provide a method to calculate each controlled participant's share of intangible development costs, based on factors that can reasonably be expected to reflect each participant's share of anticipated benefits; provide for adjustments to the controlled participant's shares of intangible development costs to account for changes in economic conditions and the business operations and practices of the participants; and be recorded in an up-to-date document that provides detailed information on specifics of the arrangement.

The IRS established a "safe harbor" for actual benefits that diverge from estimates, but only if the difference is less than 20 percent. In allocating intangible development costs under a cost-sharing agreement, it is necessary to project the participant's share of anticipated benefits. That share is then compared to the participant's allocated share of the total costs. If these shares are not equal, the IRS has the authority to adjust accordingly. Benefits include additional income generated and costs saved by the use of the intangible.

COST SHARING WITH EMPLOYEES

The economic slowdown of the early 2000s combined with nearly 10 percent annual increases in the cost of health care benefits have created a situation in which many companies feel forced into passing long a greater and greater portion of health insurance costs to employees. This cost shifting is referred to in the business world as health care cost sharing. In an attempt to reduce the cost of employee benefits, many companies have begun to increase the percentage of premium costs that must be born by the employee. This is often done by increasing the amount of co-pays that employees are asked to pay for doctor visits and prescription drugs. It may also be done by an outright increase in the percentage of the premium paid directly by the employee for his or her coverage. Either way, it is a cost-sharing measure that reduces a company's costs by passing them on to employees.

COST SHARING WITH CUSTOMERS

Anyone who has put together a swing-set or computer table, pumped gasoline into his or her car, or downloaded a computer software patch has participated in a cost-sharing arrangement. A CIO Magazine article discussing the rules for successful self-service explains the trend this way: "… companies have been eager to tap into the free labor pool of customers who can be convinced to help themselves. Through self service, organizations have been able to reduce labor costs, increase revenue from orders of out-of-stock items or increase the loyalty of customers who appreciate speedier service."

The increasing use of self-serve arrangements in retail establishments and financial institutions represents the rising popularity of cost-sharing measures that share costs with customers. In order to be effective these arrangements must be seen by the customer to be beneficial in some way, at least in their early stages. The customer may be offered a reduced price for booking his or her own airline ticket, or for assembling a piece of furniture. A customer may save time by using a self check-out lane and feel that this compensates for the effort. The tools offered a customer for performing these self-service tasks are also important. They must be intuitive. "If the interface is confusing, people are not going to stand there and figure it out. They're just gone," explained Francie Mendelsohn, president of Summit Research Associates, in the CIO Magazine article. If the transaction is made easy and the customer is convinced that he or she is receiving value equal to or greater than the effort expended, cost-sharing partnerships with customers can be a means for companies to save.

SEE ALSO Barter; Cooperative Advertising; Cooperatives; Shared Services

BIBLIOGRAPHY

Baldwin III, Arthur L. "The Price of Illness: Cost Sharing and Health Plan Benefits." Medical Benefits. 15 November 2005.

Clift, Vicki. "Small Firms Benefit from a Promotional Partner." Marketing News. 23 September 1996.

Dicker, Adrian J. W. "Final Cost-Sharing Regulations." Tax Advisor. May 1996.

Dragoon, Alice. "Six Simple Rules For Successful Self-Service." CIO Magazine. 15 October 2005.

Fitzgerald, Kevin R. "Proprietary Information—Should Suppliers Share It?" Purchasing. 3 October 1996.

Gould, Myron. "Partnering for Profit—How to Achieve Impressive Cost-Benefit Results." Direct Marketing. February 1997.

Hanson, Don R., and Maryanne M. Mowen. Cost Management. Fifth Edition. Thomson South-Western, 2005

"Health Care Cost Sharing." The Controller's Report. August 2005.

Kaplan, Todd R., and David Wettstein. "Cost Sharing: Efficiency and Implementation." Journal of Mathematical Economics. December 1999.

                                Hillstrom, Northern Lights

                                 updated by Magee, ECDI