Dakota office Products

Executive Summary[pic 1]

Dakota Office Products (DOP) just suffered their first loss in loss in company history despite an increase in year-over-year sales. This unfortunate loss, was largely due to DOP’s new Desktop delivery method and a resistance to customers using their EDI ecommerce website to initiate orders. An ABC costing analysis is complete and referenced below to give more context regarding the loss.

Background[pic 2]

DOP supplies customers with a comprehensive product line as well as choices with regards to delivery and order submission.  In DOP’s traditional method of pricing, there is an incorrect cost determination for their customers as well as for the new services (Desktop Delivery and Online Ordering) as it wasn’t being allocated based on activity volume.  Since there are multiple products and services that consume different resources, using job-order costing can under cost the more ‘custom’ products or services that consume more resources.  This can lead to pricing that is not consistent with the actual cost and ultimately losses on the bottom line.

Activity Based Costing (ABC) is a better way to look at profitability for DOP as they will be able to understand the cost of products and services based on the actual activities that are completed and the resources that were used up in the process.  This will also help DOP to set up a better pricing structure that will charge their customers according to the resources that are used.  Furthermore, a proper profitability analysis will be able to help DOP make better decisions about their product and service mix.

ABC Costing         [pic 3]

Based on the information given for DOP, the following activities were identified as being key activity cost pools of the company: Process Cartons, Ship Cartons, Desktop Delivery, Processing Manual Orders, Entering Manual Orders and EDI Orders.  These activities were then grouped into the following cost drivers: Freight, Warehouse Expenses, Warehouse Personnel, Delivery Truck Expenses and Order Entry Expenses.  As shown in Exhibit 1, total overhead for these activities was $5,850,000.  This does not include General and Selling expenses as well as interest expense as these expenses are not directly tied to the products.

As we understand the total overhead and how much of that is allocated across the different activity cost pools and drivers, we can start to calculate profitability for individual customers. As shown in Exhibit 2, even though both Customer A and B delivered approximately the same amount of Sales and Gross Margin, after taking into account the appropriate overhead costs for the activities of the customer, Customer A is much more profitable.  The leading drivers that are affecting Customer B’s lack of profitability are: Desktop deliveries ($5,500 in total overhead) and manual orders ($1,000). Also worth mentioning, Customer B placed 100 orders vs. 12 orders from Customer A.  Small unit orders like Customer B can create a lot more overhead per delivery as you lose economies of scale quickly.  

There are however, some limitations to understanding the full profitability of these two customers.  Some of those key limitations are:

• Lack of information regarding the distance traveled for deliveries – if all distances are different, the ones that are the farthest are using more resources.  The other closer deliveries end up subsidizing the rest as there are different costs for delivery based on distance.
• Wages of all personnel.
• ABC Costing doesn’t account for the Accounts Receivables and the carrying cost of the outstanding balance and interest payments for Customer B.

Additionally, it would be beneficial to understand more information related to the number of hours spent on deliveries and how many employees are required for each job.  

Recommendations   [pic 4]

The ABC costing analysis and profitability exercise should be applied to the entire customer base as it will help DOP set proper prices for each customer by reflecting the true cost of the customer.  By doing this across the entire customer base, it will inform management where the wins (customers with high profitability) and opportunities (customers with low or negative profitability) are today.