DANCEST 805 Lecture Notes - Lecture 25: Strategic Sourcing, Purchase Order, Indirect Costs
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Question 1
In order to compete effectively in todayâs increasingly globalised market, many companies have used features related to environmental sustainability to âwinâ new customers.
In relation to the company you work in or one that you are familiar with,
(a) Explain the term âsustainable business strategyâ and how this strategy relates to operations and supply chain management.
(8 marks)
(b) Identify an operations and supply chain-related "disruption" that impacted the company. What could the company have done to minimise the impact of this type of disruption prior to it occurring?
(7 marks)
(c) You have recently been appointed as the production manager of the company. To meet the demands of its global market, the company has set up production locations in two different countries. One is located in the USA while the other is located in a Southeast Asian country. You want to find out what is the productivity of the current operations at the two production locations. You have obtained the following results from the production supervisor (Table 1).
Table 1
*FC â Foreign Currency where $1 = FC 10
| USA | Southeast Asia | |
| Sales (units) | 100,000 | 20,000 |
| Labour (hours) | 20,000 | 15,000 |
| Raw materials (currency) | $20,00 | *FC 20,000 |
| Capital equipment (hours) | 60,00 | 5,000 |
(i) Calculate the multifactor productivity figures for labour and capital together. Do the results make sense?
(5 marks)
(ii) Calculate raw material productivity figures (units/$) and explain any differences in these figures.
(5 marks)
Question 2
(a) A Japanese fast food restaurant, OiShi is concerned about its ability to provide quality service as they continue to grow and attract more customers. Its management has collected data from Friday and Saturday nights, its busiest times of the week. During these nights, about 75 customers arrive per hour for service. Given the number of tables and chairs, and the typical time it takes to serve a customer, the restaurant can serve on average about 100 customers per hour.
Analyse the restaurant service process in these nights where the data are collected and comment on whether the services are in the zone of service, the critical zone, or the zone of non-service? (Refer to Figure 2 when providing your answers)
Figure 2: Relationship between the Rate of Service Utilisation (r) and service quality
(4 marks)
The management anticipates that the restaurantâs demand will double in one year as long as it can provide good service to its customers. How much will the restaurant have to increase its service capacity to stay out of the critical zone?
(4 marks)
(b) Describe the characteristics of service processes of a typical fast food restaurant based on your service encounters.
(10 marks)
(c) Examine the strategies to manage service encounters. You should provide details on any TWO (2) possible customer-introduced variability in the service processes and propose THREE (3) accommodating strategies to effectively address these variabilities.
(7 marks)
Question 3
(a) Consider your organisation or one that you are familiar with that plays a role in the global supply chain network. This organisation can be a supplier, manufacturer, distributor, logistics service provider or retailer in a particular industry (e.g. fast-moving consumer goods, electronics, oil and gas, and pharmaceuticals). In your answer, you should relate the concepts and strategies in operations and supply chain management to the work environment.
Explain how the aggregate operations plan can help match supply with demand and optimise operational costs in this organisation.
(4 marks)
Provide TWO (2) strategies that can be used to influence demand and TWO (2) strategies that can be used to adjust capacity to match demand.
(8 marks)
(b) The development of web-based tools has allowed companies to collaborate on a larger scale and perform its operations and supply chain activities with greater ease. Demonstrate how collaborative techniques can be used to forecast demand. You should provide details such as the various stages of activities that are involved.
(8 marks)
Discuss the risks of being too reliant on the internet as a collaboration tool in demand forecasting and management.
(5 marks)
Question 4
Kee Wah Store sells a variety of exquisite European cookies and candies to the consumer market. The demand for cookies and candies is volatile and varies from month to month. The store orders from its suppliers. The lead time is normally one month, mainly consisting of the sea freight transportation time from Europe to Singapore. The store keeps a certain level of inventory at its warehouse.
The total demand for chocolate cookies is estimated to be 7,200 packets a year. The chocolate cookie packet is sourced from the supplier at $5 per packet and is sold to the end consumer at $15 per packet. It costs $100 to place an order to the supplier, and costs 20% of unit cost to store a packet of chocolate cookies for one year.
(a) Give FOUR (4) reasons why Kee Wah Store needs to maintain some inventory at its warehouse.
(8 marks)
(b) Examine the inventory situation for Kee Wah Store by applying the EOQ model to solve for order quantity and reorder point. What is the annual ordering cost, annual holding cost and total annual cost?
(10 marks)
(c) One supplier, Nee Ann Import Inc., approaches Kee Wah Store and proposes that it could shorten the lead time from one month to one week using airfreight.
What are the factors that Kee Wah Store needs to consider before deciding to accept or reject Nee Ann Importâs offer?
----- END OF PAPER -----
(7 marks)
QUESTION 1
_____ refer to the forces of change whose direction and sometimes timing can be predicted.
| Uncertainties | ||
| Trends | ||
| Occurrences | ||
| Scenarios | ||
| Forecasts |
2 points
QUESTION 2
Management institutes, certification agencies, and headhunting firms are examples of specialized intermediaries for:
| financial markets. | ||
| markets for managerial talent. | ||
| markets for products. | ||
| auction markets. | ||
| labor market. |
2 points
QUESTION 3
_____ involves analyzing markets for their potential size, accessibility, cost of operations, and buyer needs and practices to aid the company in deciding whether to invest in entering that market.
| Search retargeting | ||
| Unique selling proposition | ||
| Rebranding | ||
| First-mover advantage | ||
| Market due diligence |
2 points
QUESTION 4
Consumer safari refers to the initiatives taken by Unilever executives to spend a day with consumers in their homes to:
| understand how they use products. | ||
| convince them to use more Unilever products. | ||
| train them to make multiple use of their products. | ||
| estimate how many products they use. | ||
| help them set up cottage industries for their products. |
2 points
QUESTION 5
_____ refer to the forces of change whose direction and pace is largely unknown.
| Uncertainties | ||
| Trends | ||
| Occurrences | ||
| Scenarios | ||
| Forecasts |
2 points
QUESTION 6
_____ are straight-line, one-factor projections from present to future.
| Estimates | ||
| Opportunities | ||
| Scenarios | ||
| Forecasts | ||
| Plans |
2 points
QUESTION 7
The United States is separated from Nigeria by 5,840 miles and the Atlantic Ocean. According to the CAGE framework this is a case of:
| emotional distance. | ||
| economic distance. | ||
| cultural distance. | ||
| geographic distance. | ||
| administrative distance. |
2 points
QUESTION 8
The GDP of France is 2.113 trillion USD whereas Sierra Leone's GDP is approximately 4.812 billion USD. According to the CAGE framework, this is a case of:
| emotional distance. | ||
| economic distance. | ||
| cultural distance. | ||
| geographic distance. | ||
| administrative distance. |
2 points
QUESTION 9
_____ occurs when a function is taken out of one's country of residence to be performed in another country, generally at a lower cost.
| Open sourcing | ||
| Offshoring | ||
| Exporting | ||
| Importing | ||
| Licensing |
2 points
QUESTION 10
Which of the following is true of acquisitions?
| The acquiring company will be eligible for any financial help from the company whose shares it is trying to acquire. | ||
| It affords the firm maximum control and has the most potential to provide above-average returns. | ||
| The acquiring company enters into an agreement with the target business to pursue a set of agreed-upon goals while remaining independent organizations. | ||
| The acquiring firm avoids the expense of establishing operations in the new country. | ||
| The acquiring company gains control of another firm by purchasing its stock. |
2 points
QUESTION 11
Which of the following statements holds true for the ISO 9001:2008 certification?
| Organizations which supply raw materials are barred from applying for the ISO 9001:2008 certification. | ||
| Companies which meet the criteria of a minimum financial turnover can apply for the ISO 9001:2008 certification. | ||
| The ISO 9001:2008 certification is a mark that a company's products and services have met quality standards. | ||
| Companies that had achieved ISO 9001:2000 certification were exempt from being recertified to meet ISO 9001:2008 standards. | ||
| ISO 9001:2008 certification specifically focuses on the environment. |
2 points
QUESTION 12
_____ refers to buying goods and services from foreign sources and bringing them back into the home country.
| Open sourcing | ||
| Offshoring | ||
| Exporting | ||
| Importing | ||
| Farmshoring |
2 points
QUESTION 13
The _____ is the contract between the exporter and the carrier, authorizing the carrier to transport the goods to the buyer's destination.
| letter of credit | ||
| bill of lading | ||
| customs invoice | ||
| export declaration | ||
| license |
2 points
QUESTION 14
_____ is the document by which the exporter tells the importer to pay a specified amount at a specified time.
| Letter of credit | ||
| Bill of lading | ||
| Customs invoice | ||
| Insurance certificate | ||
| Bill of exchange |
2 points
QUESTION 15
Which of the following can also function as collateral against loans?
| Certificate of origin | ||
| Export declaration | ||
| License | ||
| Customs invoice | ||
| Bill of lading |
2 points
QUESTION 16
_____ refers to the financing granted against collateral, which can be the imported/exported goods.
| Angel funding | ||
| Purchase Order Financing | ||
| Secured financing | ||
| Overdraft | ||
| Cash advance |
2 points
QUESTION 17
Which of the following is a contractual mode of entry into a foreign market?
| Greenfield ventures | ||
| Licensing | ||
| Joint ventures | ||
| Acquisition | ||
| Merger |
2 points
QUESTION 18
_____ refers to an organization that assists foreign companies in exporting their products to Japan by providing free-market entry information and business-partner matching as well as some subsidies.
| Japan Bank for International Cooperation | ||
| Japan External Trade Organization | ||
| Development Bank of Japan | ||
| Master Trust Bank of Japan | ||
| Japan Post Bank Company |
2 points
QUESTION 19
Which of the following statements holds true for a nonentity joint venture?
| In a nonentity joint venture, the partner with the smaller capital investment loses control over the joint venture after a period of two months. | ||
| In a nonentity joint venture, each of the partners contributes capital and resources in exchange for an equity stake and share in any resulting profits. | ||
| In a nonentity joint venture, the control of the joint venture is in the hands of the party which makes the larger capital investment. | ||
| In a nonentity joint venture, there is no contribution of capital to form a new entity. | ||
| In a nonentity joint venture the benefit gained is in the form of collective profits rather than individual profits. |
2 points
QUESTION 20
The _____ is a legal document issued by a bank at the importer's (or buyer's) request wherein the importer promises to pay a specified amount of money when the bank receives documents about the shipment.
| export declaration | ||
| license | ||
| letter of credit | ||
| bill of lading | ||
| customs invoice |
2 points
QUESTION 21
_____ refers to the constellation of business, corporate, and international strategy elements, which managers must consider when making decisions.
| Five Forces Analysis | ||
| Cluster model | ||
| Strategy diamond | ||
| Porter's four corners model | ||
| Strategic grouping |
2 points
QUESTION 22
Strategy implementation is the process of:
| deciding which strategies to follow in order to diversify. | ||
| performing all the activities necessary to do what has been planned. | ||
| deciding the businesses in which an organization would compete. | ||
| addressing the issue of the kind of strategies an organization would follow. | ||
| devising plans to add value to the existing line of business. |
2 points
QUESTION 23
The _____ function requires monitoring performance so that it meets the performance standards established by the organization.
| controlling | ||
| leading | ||
| planning | ||
| organizing | ||
| job design |
2 points
QUESTION 24
_____ refers to the sequence of activities that include the various steps of the supply chain as well as additional activities, such as marketing, sales, and service.
| Value chain | ||
| Differentiation | ||
| Cost leadership | ||
| Scope | ||
| Homesourcing |
2 points
QUESTION 25
Outsourcing involves:
| diversifying into a new business. | ||
| the sale of products or services in one country that are sourced in another country. | ||
| the company delegating an entire process to the outsource vendor. | ||
| guiding the choice of markets that a firm competes in. | ||
| performing a service by staff from within an organization and also by an external service provider. |
2 points
QUESTION 26
The U.S. fast-food chain Sonic will only open new outlets in states that are adjacent to states where it already has stores. This is an example of:
| differentiation. | ||
| increasing vertical scope. | ||
| diversification. | ||
| offshoring. | ||
| increasing geographic scope. |
2 points
QUESTION 27
_____, which are a part of the SWOT analysis, assess the external attractive factors that represent the reason for a business to exist and prosper.
| Strengths | ||
| Weaknesses | ||
| Threats | ||
| Opportunities | ||
| Strategies |
2 points
QUESTION 28
_____ refers to the number of different topographical markets in which an organization participates.
| Geographic scope | ||
| Value chain | ||
| Differentiation | ||
| Cost leadership | ||
| Offshoring |
2 points
QUESTION 29
The first step in the planning process is:
| establishing organizational objectives. | ||
| formulating and ensuring the effective implementation of plans. | ||
| the SWOT analysis. | ||
| identifying multiple ways of achieving organizational objectives. | ||
| monitoring the progress and evaluating the success of the plans. |
2 points
QUESTION 30
In Holland, KFC makes a potato-and-onion croquette, while in France it sells pastries alongside chicken. KFC:
| has centralized its business processes to enable it to provide the services mentioned. | ||
| assumes that consumer needs and desires vary by country. | ||
| assumes that the world is flat. | ||
| sells the same products in the same way in every country. | ||
| is following the cost-leadership strategy. |
2 points
QUESTION 31
An automobile giant headquartered in the United States sells high-end bikes across the world. It wants to enter an emerging market. Customers in the market cannot afford the types of accessories used in the bikes. Thus the regional branch of the organization makes an autonomous decision to remove the accessories and to offer a toned-down version of the bikes to compete in the emerging market. This decision is accepted by the headquarters on the principle that the man on the ground is the best judge of local conditions. The above serves as an example of a(n):
| decentralized organizational structure. | ||
| reverse engineering. | ||
| centralized organizational structure. | ||
| reverse innovation. | ||
| open sourcing. |
2 points
QUESTION 32
Nike products are manufactured in factories in countries such as China, Vietnam, Indonesia, and Mexico. Wholesalers, retailers, agents, and brokers are intermediaries who help in bringing the products to the consumer. These intermediaries bring the products from the factories to the consumers. They serve as an example of:
| product branding. | ||
| market positioning. | ||
| market segmentation. | ||
| channel of distribution. | ||
| social marketing. |
2 points
QUESTION 33
Which of the following statements holds true for a global brand?
| It refers to the brand name of a product that has worldwide recognition. | ||
| It refers to the marketing strategy in which a firm marketing a product with a well-developed image uses the same brand name in a different product category. | ||
| It refers to products that make the world less flat because of lack of recognition across countries. | ||
| It refers to the product that is distributed nationally under a brand name owned by the producer or distributor. | ||
| It refers to the changing the identity of a product, relative to the identity of competing products, in the collective minds of the target market. |
2 points
QUESTION 34
An organization that manufactures readymade cotton shirts sources the raw material from all over the world. It does this as a precaution against the failure of one or more companies to deliver the raw materials. The above serves as an example of:
| open-sourcing. | ||
| multisourcing. | ||
| sole-sourcing. | ||
| home sourcing. | ||
| outsourcing. |
2 points
QUESTION 35
Which of the following holds true for product adaptation?
| It refers to the company strategy of modifying an existing product in a way that makes it better fit local needs. | ||
| It refers to the total composite of products offered by a particular organization. | ||
| It refers to the strategy of taking the company's current products and selling them in other countries without making changes to the product. | ||
| It refers to the creation of a new name, term, symbol, design, or a combination of them for an established brand with the intention of developing a differentiated position in the mind of stakeholders and competitors. | ||
| It refers to the strategy of creating an entirely new product for a given local market. |
2 points
QUESTION 36
In marketing, market segmentation refers to the:
| process of dividing a larger market into smaller markets that share a common characteristic, such as age, gender, income level, or lifestyle. | ||
| combination of the four Ps of marketing that can be customized for different countries. | ||
| commerce areas where because of price differences across countries, consumers are able to cross international borders to legally purchase products at lower prices than in their home country. | ||
| commerce areas where vendors purposely deceive buyers by altering products and then selling them as branded products at a bargain cost. | ||
| set of expectations, memories, stories and relationships that-taken together-account for a consumer's decision to choose one product or service over another. |
2 points
QUESTION 37
In marketing, which of the following holds true for counterfeit markets?
| It refers to the process of dividing a larger market into smaller markets that share a common characteristic, such as age, gender, income level, or lifestyle. | ||
| It refers to the trade of goods and services that are illegal in themselves and/or distributed through illegal channels. | ||
| It refers to the commerce areas where, because of price differences across countries, consumers are able to cross international borders to legally purchase products at lower prices than in their home country. | ||
| It refers to the commerce areas where vendors purposely deceive buyers by altering products and then sell them as branded products at a bargain cost. | ||
| It refers to the secretive, unregulated (though often technically legal) trading in commodity futures. |
2 points
QUESTION 38
_____ refers to buying raw materials, components, or services from one supplier exclusively, rather than buying from two or more suppliers.
| Open-sourcing | ||
| Multisourcing | ||
| Sole-sourcing | ||
| Home-sourcing | ||
| Outsourcing |
2 points
QUESTION 39
_____ refers to a situation which means that there is no more stock of the company's product.
| Stock of record | ||
| Stock-check | ||
| Safety stock | ||
| Stock call | ||
| Stock-out |
2 points
QUESTION 40
Which of the following statements holds true for the indirect channel of distribution?
| It refers to the shortest channel of distribution, consisting of just the producer and the end consumer. | ||
| It refers to the combination of the four Ps of marketing that can be customized for different countries. | ||
| It refers to a channel of distribution which contains one or more intermediaries between the consumer and the producer. | ||
| It refers to a channel of distribution where the customer is the first and not the last link in the distribution chain. | ||
| It refers to the channel of distribution where the company sells its products to the consumers in other countries via the internet without using local retailers. |
Please answer only "Discussion Question" at theend.
Western States Stationery Case
Western States Stationery was founded in the late 1800s in theSan Francisco area as a one-man operation producing notepaper andcards for sale in the cityâs general stores. By 2004 it had grownto a large paper products corporation with sales more than $2billion.
One division of the company produces specialty paper products,such as writing paper, envelopes, note cards and greeting cards.Another division manufactures and prints business forms. By 2002 itwas one of the top 5 firms in the business forms industry.
For some period, the companyâs sales growth had been relativelyflat and profit margins had been difficult to maintain. Competitionamong suppliers was much more intense than in prior years. In 2002management decided it would venture into business forms inventorymanagement services. This was an area that management thoughtoffered several advantages. These services were thought to beâvalue addedâ allowing the firm to differentiate itself fromothers. Differentiation implied higher margins and the potential tofurther bind customers to Western, reducing the threat they mightswitch to an alternative supplier. Finally, the concept wasrelatively new, with little competition from large firms, therebyoffering high sales growth potential. Western embarked on acampaign to enroll its corporate clients in a program it calledTotal Forms Control (TFC).
By 2004, sales from TFC were about $60 million. Western hadestablished TFC as a separate operation within the business formsdivision. The services provided under TFC included warehousing anddistribution of forms (including inventory financing) as well asinventory control and forms usage reporting. TFC used asophisticated computer system network, which enabled them tomonitor a clientâs forms inventory, forms usage and orderingactivity.
As part of its distribution services, TFC also offeredâpick-packâ services where workers opened full cartons to pick theexact number of forms requested by the clients. TFCâs operatingphilosophy was that a well-run warehousing and distribution networkwas vital to any forms management program ---âwe know what you need⦠the right product at the right place at theright time.â
For a small number of clients TFC also offered "desk topdelivery," where TFC personnel would distribute the forms toindividual offices within the customerâs company (otherwise formswere usually delivered only to a receiving dock area). As acomprehensive forms management provider, Western's product linealso had to be comprehensive. Their product line includedeverything from stock computer printout paper and fax paper tocustom designed forms tailored by Western's design consultants tomeet the exact business needs of the client.
TFC also had the ability to custom design its forms managementservices to meet the needs of each of its clients. TFC clientsranged from small businesses, which desired only basic inventorycontrol, to those who had comprehensive forms managementprograms.
CURRENT COST ACCOUNTING SYSTEM
Western operated its forms manufacturing and TFC activities asseparate profit centers. Western manufactured business forms in 13locations. The transfer of product from manufacturing operations toTFC was at arm's length with the transfer price set at fair marketvalue. Although the company encouraged internal sourcing forcustomer orders, TFC salespeople had the option of outsourcingproduct.
Clients who participated in the forms management program kept aninventory of forms at one of Western's 10 distribution centers. Theforms were distributed to the client as they were needed. Theclient was charged a service fee to cover the cost of warehousingand distribution based on a percentage of the cost of sales of theproduct for that month, regardless of the specific level of serviceprovided to that client. The standard charges were as follows:
⢠Warehousing/Distribution, 20.5% ofproduct cost
⢠Inventory financing, 4.7% of productcost
⢠Trucking to the customer, 7% ofproduct cost
If a TFC client made use of any of the distribution services,they were typically charged a price for the forms which was highenough to allow for an additional 20.5% of product cost to coverwarehousing and distribution expenses (everything from storage andrequisition handling up to and including desk top delivery), plus4.7% to cover the cost of capital tied up in inventory, and 7% tocover trucking costs. These percentages were determined based onactual 2002 financial data so that on an aggregate basis, in total,all expenses were covered (see Exhibit 1). Sales prices weregenerally determined by applying a 20% mark-up on the combined costof the product (business forms) and the 32.2% charge for TFCservices. To some degree, prices charged on customer accounts couldvary from the standard formula, based on what the sales departmentthought customers would pay.
UNDERSTANDING CUSTOMER PROFITABILITY
With TFC profitability suffering in October 2002, GeneralManager John Malone began to question the appropriateness of thedistribution charges: "The Business Forms Division used to earn a20% Return on Investment (ROI). But returns have been dropping forseveral years. TFC is projected to earn an ROI of only 6% for 2004.Something tells me that we are not managing this business verywell! It seems to me that the charges for services needs closerscrutiny."
John looked through his records and found two accounts ofsimilar size, accounts A and B, which were handled by differentsalespeople. Accounts A and B had essentially the same annual
sales of about $79,000 with the cost of the product being$50,000. Under the current system, these accounts carried the sameservice charges, but John noticed that these accounts were similaronly in the value of the product being sold; they were verydifferent on the level of service they required from Western.Malone double-checked his records and confirmed that the twoaccounts had indeed generated identical sales revenues (see Exhibit2).
In the past year, customer A had submitted 364 requisitions forproduct with a total of 910 lines (all of them "pick-pack") whilecustomer B had submitted 790 requisitions with a total of 2500lines (all of them "pick-pack"). Customer A kept an average of 350cartons of inventory at the distribution center while customer Bkept 700 on average. Customer B's average monthly inventory balancewas $50,000 ($7,000 of which had been sitting around for a wholeyear) while that of customer A was only $15,000. In addition,customer B had requested desk top delivery 26 times during the pastyear, while customer A did not request desk top delivery at all.John had support staff research the truck operating costsassociated with these customers. Mileage to and from each customerwas estimated and multiplied by an estimated cost per mile. Becauseof the greater activity on customer B's account, a shipment wentout three times a week at an annual trucking cost of $7,500 whileCustomer A required only one shipment a week at an annual truckingcost of $2,250.
With corporate breathing down his neck, John Malone turned toTFC Controller Melissa Dunhill and Director of Operations TimCunningham for help. As a first step, they could provide John withthe following information:
The total expenses for the distribution centers in 2002 wereestimated as follows (in 000's):
Rent | $1,504 |
Depreciation | $208 |
Utilities | $200 |
Salaried payroll | $945 |
Fringe benefitsâsalaried | $164 |
Taxes/Insurance | $110 |
Postage & supplies | $96 |
Hourly payroll â admin | $476 |
Fringes â hourly admin | $69 |
Variable warehouse payroll | $1,599 |
Warehouse fringes | $336 |
Total | $5,707 |
John said, "How am I going to use this information to solve myproblem?" "Well," Tim said, "if we can figure out, without goingoverboard of course, what exactly goes on in the distributioncenters, maybe we can take these financial numbers and assign themto the activities. If we can do that, we'll have a much better ideaof what it costs to serve our various clients." Tim knew that twoprimary activities took place in the distribution centers â thewarehousing of forms and the distribution of those forms inresponse to a customer requisition. He decided to talk to somepeople in the field to get more specific information.
DISTRIBUTION CENTER: ACTIVITY ANALYSIS
John and Tim visited Western's Kansas City, MO distributionfacility. Site manager Wilbur Smith confirmed, "All we do is storethe cartons and process the requisitions. I'll tell you, the amountof warehouse space we need just depends on the number of cartons.If we got into some flexible lease programs and changed aisleconfigurations, we could probably adjust our space requirements ifthe number of cartons we stored was to change. The other thing thatbothers me is that we've got some inventory that's been sittinghere forever.
The team then interviewed warehouse supervisor, Rick Fosmire, "Idon't care if I get a hundred requisitions with one line each orone requisition with a hundred lines on it, my guys still have togo pick a hundred items off the shelves. And those darned"pick-pack" requests. Almost everything is "pick-pack" nowadays. Noone seems to order a whole carton of 500 items anymore. Do you knowhow much more labor it requires to pick through those cartons? Andon top of that, this desk top delivery is a time drain for my guys.It's not like my guys don't have enough to do."
John and Tim returned to Denver with a better idea of whathappens in a distribution center. From what they observed, theybroke the distribution center down into 5 primary value-addedactivities: storage, requisition handling, basic warehouse stockselection, "pick-pack" activity, and desk top delivery.
They turned to Melissa for help assigning costs to activities.Melissa spent considerable time talking to each of the sitemanagers and warehouse supervisors. A consistent picture emerged.The majority (85%) of facility costs related to storage of businessforms. The remainder (15%) was necessary to handle theadministration of requisition processing. Warehouse workers wereinterviewed to determine where they spent their time. The basicprocess of finding and selecting items required half of their time(50%) - this includes finding and selecting either full box ordersor âpick-packâ orders. If the order also required âpick-packâ thisnearly doubled the required time as the workers opened cartons,counted items, etc. Thus, workers estimated that they spent 40% oftheir time dealing with âpick-packâ over and above basic formsselection. Preparing and handling desk top delivery shipments tookup the rest of their time (10%). Based on the above information,Melissa assigned costs to these activities as follows ($'000's).(See Exhibit 3 for calculations):
Storage | $1,625 |
Requisition Handling | $2,147 |
Basic Warehouse Stock | |
Selection | $967 |
Pick-Pack Activity | $774 |
Desk Top Delivery | $194 |
Total | $5,707 |
Tim then estimated the following for 2004 based upon historicalinformation and current trends:
On average, the 10 distribution centers scattered across thecountry will have combined inventories of approximately 350,000cartons (most cartons were of standard size).
TFC will process about 310,000 requisitions for 2004.
Requisitions will average 2.5 lines of different stationerymaterial requested and pulled.
About 90% of the lines will require an additional "pick-pack"activity (as opposed to shipping an entire carton).
They were still uncomfortable with the way inventory financingand trucking costs were charged out. John checked with the financedepartment and learned that Western obtained financing at the primerate (currently 8%) plus 2%. He thought they could just pass thatalong. "Our new computer system is coming on line soon which willtrack mileage we log to deliver shipments to each customer," saidTim, "so, using a per mile cost we can just charge the client forwhat it actually costs us." They all agreed that this soundedfair.
They were almost finished. "What about desk top delivery?" Timsaid. I think we should charge extra for it, but I don't want thisto get too complicated."
John said, "How much extra time does it take your guys onaverage to prepare a desk top delivery and then run around thecustomerâs company?"
"I'd say about an hour and a half to two hours."
"Alright. At $12 per hour, that's about $24 each time.
"Sounds OK to me. That ties pretty well to the $194,000 overallassignment, since we will process somewhere around 8,500 'desk top'requests this year."
The above information was used to derive activity / cost drivers(See Exhibit 4).
The entire management team, including Doug Kingsley, FinanceDirector of the Business Forms Division, felt that there had to bea better way of charging out distribution services and that thesolution would help TFC become more profitable. They now had a muchbetter understanding of the drivers of costs involved indistribution services. As the four headed off in Doug's SUV for theBroncosâ first home game, they tried to figure out how to use thisinformation to find a workable alternative.
SERVICES BASED PRICING (SBP)
"It would not be easy getting the sales force on board with anactivityâbased pricing program," John said. "Some of them getpretty stuck in their ways and don't like change. Some accountswould see increases because of the additional distribution chargesunder a Services Based Pricing (SBP) scheme. These salespeoplewouldn't be very happy. On the other hand, some salespeople may seetheir margins increase." Overcoming these organizational problemswould be only the tip of the iceberg.
Kingsley, as well as many of the senior managers at corporate,continued to be very concerned with TFC profitability. Whileeveryone thought TFC now had a better understanding of its costdrivers, they were not convinced that overall profitability wouldimprove without significant changes in marketing. They were stillwondering how to use their new activity based costing (ABC)analysis to improve the profitability of TFC. So they decided to doadditional analysis on their customer base.
The accounting department had maintained a database, whichshowed all activity against individual accounts and calculated acontribution from that account. Although TFC maintained 1100separate accounts, a large portion of the business came from veryfew accounts. The top 40 accounts represented 48% of the company'snet sales volume (see Exhibit 5).
As a way of understanding customer profitability, TFC managementreworked the information in the database as if the accounts hadbeen charged service fees based on actual usage, leaving net salesand product cost the same as before. They recalculated contributionbased on these figures. They ranked the accounts according toprofit contribution. Exhibit 6 shows the top 20 accounts for themonth of August and Exhibit 7 shows the bottom 20.
The team looked at all accounts where the revised contributionwas below 20% and determined that if these accounts were managed toa 20% contribution, the profit improvement would be $4.3 millionannually. Of those, the top 40 accounts (ranked by the contributionopportunity if improved to a 20% contribution) represented 70% ofthe $4.3 million opportunity.
Another way of summarizing the range of profitability across the1,100 customers is shown in Exhibit 8. This was a new way oflooking at account management which combined the effects of bothvolume and contribution margin. Since such a large piece of theopportunity rested with these few accounts, management determinedthat it might be possible to significantly improve profitability byconcentrating on individual account management. The team felt theywere on the right track for improving account profitability andwondered what should be the next step. They also wondered whatother issues might be important for improving the overallprofitability of TFC. Management called the ABC based pricingsystem SBP and was seriously considering adopting it for all TFCcustomers.
Case Questions to Consider
How did Total Forms Control (TFC) fit into Westernâs strategy?Was it performing up to expectations?
How did the existing accounting system handle the costs ofservices that TFC provided? Did this suit TFCâs needs?
Using the information in the case calculate ABC based servicescosts per unit of activity for the TFC business. Using these newactivity costs calculate distribution services and gross profit forcustomer A and customer B. What inferences do you draw about theprofitability of these two customers?
What does TFCâs analysis of individual customer accounts(exhibits 5-8) suggest about TFCâs overall customer profitability?What might managers do based on this information?
What are likely to be some of the issues in adopting ServiceBased Pricing (menu) pricing? Do you think that TFC shouldimplement the SBP pricing system?
Do you have any additional comments or recommendationsconcerning the Total Forms Control (TFC) business?
EXHIBIT 1 | |||
Calculation of Service Fee Charges | |||
(Current Method) | |||
('000's) | |||
2002 Product Sales at Cost | $24,059 | ||
2002 Warehousing/Distribution Expense | $4,932 | ||
...% of Product Cost | 20.5% | ||
2002 Average Inventory Balance | $10,873 | ||
2002 Average Cost of Capital | 10.40% | ||
Total Cost of Inventory Financing | $1,131 | ||
...% Product Cost | 4.70% | ||
2002 Total Truck Operating Costs | $1,684 | ||
...% Product Cost | 7.00% | ||
EXHIBIT 2 | |||
Actual Service Fee Charges | |||
(Current Method) | |||
Customer A | Customer B | ||
Product Cost | 50000 | 50000 | |
Warehousing/Distribution (20.5%) | 10250 | 10250 | |
Inventory Financing (4.7%) | 2350 | 2350 | |
Trucking (7%) | 3500 | 3500 | |
Total Service Fees | 16100 | 16100 | |
Markâup (20%) | 13220 | 13220 | |
Net Sales | 79320 | 79320 | |
EXHIBIT 3 | ||
Breakdown of Expenses by Activity | ||
('000's) | ||
Total Expenses | Share of Expenses | |
Storage | ||
Rent | $1,504x 85% | $1,278 |
Depreciation | $208 x 85% | $177 |
Utilities | $200 x 85% | $170 |
Total | $1,625 | |
Requisition Handling | ||
Rent | $1,504 x 15% | $226 |
Depreciation | $208 x 15% | $31 |
Utilities | $200 x 15% | $30 |
Salaries + Fringes | $1,109 | $1,109 |
Taxes/Insurance | $110 | $110 |
Postage & supplies | $96 | $96 |
Hourly Payroll + Fringes | $545 | $545 |
Total | $2,147 | |
Warehouse Activities | ||
Variable Warehouse Pay + Fringes | $1,935 | $1,935 |
Basic Warehouse Stock Selection (50%) | $967 | |
"Pick-Pack" Activity (40%) | $774 | |
Desk Top Delivery (10%) | $194 | |
Total | $1,935 | |
EXHIBIT 4 | ||
TFC Activities and Cost Drivers | ||
Activities / Cost Driver | Cost Driver in units | |
Storage / Cartons in inventory | (cartons) | 350,000 |
Requisition handling / Requisitions | (requisitioning) | 310,000 |
Basic Warehouse Stock Selection / Carton lines | (carton lines) | 775,000 |
"Pick-Pack" / âPick-Packâ lines | (Pick-Pack" lines) | 700,000 |
Desk Top delivery / Desk Top deliveries | (Desk Top deliveries) | 8500 |
Inventory financing / Inventory value | Not available or given elsewhere | |
Trucking / Mileage | Not available or given elsewhere | |
EXHIBIT 5 | ||
TFC Net Sales, 2003 | ||
Annual | No. of | % of TFC |
Sales/Account | Accounts | Net Sales |
>$300,000 | 40 | 48% |
>$150,000 | 53 | 19% |
>$75,000 | 86 | 15% |
>$30,000 | 143 | 11% |
>$O | 778 | 7% |
Total | 1100 | 100% |
EXHIBIT 6 | |||||
Top 20 TFC Accounts for August, 2004 | |||||
(Ranked by Contribution $) | |||||
Account | Actual Net Sales | Product Cost | ABC Based Service Costs | Revised Contribution | |
1 | 76,904 | 49,620 | 2,862 | 24,422 | |
2 | 130,582 | 74,396 | 34,578 | 21,608 | |
3 | 72,956 | 48,216 | 3,456 | 21,284 | |
4 | 64,903 | 37,981 | 6,574 | 20,348 | |
5 | 45,088 | 26,098 | 1,309 | 17,681 | |
6 | 104,689 | 62,340 | 25,356 | 16,993 | |
7 | 52,890 | 32,083 | 4,386 | 16,421 | |
8 | 38,902 | 23,087 | 1,245 | 14,570 | |
9 | 87,130 | 54,923 | 17,685 | 14,522 | |
10 | 67,935 | 42,012 | 12,290 | 13,633 | |
11 | 58,290 | 32,074 | 12,834 | 13,382 | |
12 | 84,589 | 54,023 | 17,528 | 13,038 | |
13 | 36,587 | 22,657 | 1,345 | 12,585 | |
14 | 47,890 | 32,'545 | 3,657 | 11,688 | |
15 | 56,294 | 27,801 | 16,923 | 11,570 | |
16 | 61,056 | 38,924 | 11,034 | 11,098 | |
17 | 56,902 | 32,789 | 13,904 | 10,209 | |
18 | 45,893 | 29,570 | 6,904 | 9,419 | |
19 | 62,954 | 41,034 | 13,746 | 8,174 | |
20 | 26,699 | 16,830 | 2,236 | 7,633 | |
Total | 1,279,133 | 779,003 | 209,852 | 290,278 | |
EXHIBIT 7 | |||||
Bottom 20 TFC Accounts for August, 2004 | |||||
(Ranked by Contribution $) | |||||
Account | Actual Net Sales | Product Cost | ABC Based Service Costs | Revised Contribution | |
1081 | 3,657 | 2,356 | 2,325 | â1,024 | |
1082 | 38,467 | 26,301 | 13,740 | â1,574 | |
1083 | 5,926 | 3,840 | 4,214 | â2,128 | |
1084 | 163 | 89 | 2,390 | â2,316 | |
1085 | 3,256 | 2,006 | 3,590 | â2,340 | |
1086 | 82,086 | 61,224 | 23,756 | â2,894 | |
1087 | 29,320 | 20,647 | 11,843 | â3,170 | |
1088 | 467 | 302 | 4,086 | â3,921 | |
1089 | 17,935 | 11,087 | 10,872 | â4,024 | |
1090 | 17,649 | 12,903 | 8,903 | â4,157 | |
1091 | 638 | 420 | 5,109 | â4,891 | |
1092 | 16,104 | 9,102 | 12,134 | â5,132 | |
1093 | 289 | 178 | 5,698 | â5,587 | |
1094 | 23,965 | 17,345 | 16,523 | â9,903 | |
1095 | 38,065 | 23,391 | 27,623 | â12,949 | |
1096 | 32,898 | 23,054 | 22,985 | â13,141 | |
1097 | 129,367 | 73,128 | 69,527 | â13,288 | |
1098 | 74,569 | 50,745 | 45,698 | â21,874 | |
1099 | 88,345 | 64,930 | 53,867 | â30,452 | |
1100 | 113,976 | 82,987 | 72,589 | â41,600 | |
Total | 717,142 | 486,035 | 417,472 | â186,365 | |
Exhibit 8
Current Operation Profit for 2004
The most profitable 5% of customers (55) contribute 80%
The next most profitable 45% of customers (145) contribute 220%.Profit could be 300% of the current level if we dropped theremaining 50% of customers (550)!
48% of customers (528) reduce profit by 140%.
2% of customers (22) reduce profit by 60%.
DISCUSSION QUESTIONS:
Discuss the following concepts only in the context of thisproblem.
1. Alternative Cost Driver Classification Schemes
2. ABC Implementation Issues
3. ABC and Customer Profitability Analysis
4. Activity Based Management
