Facts

Paper Products Corp. founded in San Francisco in the 1800 s 92 flat growth & hard to maintain profit margins Introduced TFC in 92 by 94 $60 million in sales Price 32.2% of cost for TFC + 20% markup for fees

Can anyone talk about Western States organizational setup?

TFC & Strategy

TFC offered competitive differentiation Value Added Service Innovative Customer Retention Higher Profit Margins + Growth Potential Customer Service

Existing Accounting System

32.2% Service Fee based on Product Cost
Warehousing 20.5% Financing 4.7% Trucking 7%

20% Mark-up based on Product Cost + Service Fee

Did this system fit their needs?

No because
Distribution charges were not appropriate because their costing system was not accurate Under the current system customers where charged the same no matter how many services they used. So they decided to design a new activity-based system

Design of New System

Talked to people in different areas to figure out what activities affected what costs
85% of facility costs related to storage 15% of costs used to handle admin of requisition processing

Labor s Effect on New System

Processing of finding and selecting times took 50% of their time 40% of time used to deal with pick-pack 10% of time was used to prepare/handle desk top delivery shipments

Cost Pools
Storage Requisition Handling Basic Warehouse Stock
 Selection  Pick-Pack Activity  Desk Top Delivery

Activity Based Costing Rates

ABC BASIS COST PER UNIT Annual Usage Requisition handling / Requisitions "Pick-Pack" / Pick-Pack lines Storage / Cartons in inventory Interest assume 8% prime rate plus 2% Desk Top delivery / Desk Top deliveries Basic Warehouse Stock Selection / Carton lines
Total Annual Exp.

Cost Per Unit $ $ $ 6.93 1.11 4.64

310,000 700,000 350,000 N/A 8500 775,000

$ $

22.82 1.25

ABC Based Service Cost Per Unit

.
Cost Per Activity (Per Unit Costing) Requisitions Total Lines (All Pick Pack) Stored at Warehouse (Cartons) Average Monthly Balance Desk Top Delivery requests per year Annual Shipping Costs Total Expenses Customer A $ $ $ $ $ $ $ 2,521 1,006 1,625 1,500 2,250 8,902 Customer B $ $ $ $ $ $ $ 5,471 2,764 3,250 5,000 593 7,500 24,579

Inferences on Profitability
Both customers are profitable under the model but customer A nets nearly $15,000 more income than B. Customer A is $7,198 more profitable than the initial assumption. Customer B is $8,479 less profitable than the initial assumption.

ABC Income Statement

Price Per Unit Income Statement Net Sales Product Costs Customer A $ $ 79,320 50,000 $ $ Customer B 79,320 50,000

Service Cost Inventory Financing Trucking Total Service Cost:

$ $ $ $

5,152 1,500 2,250 8,902

$ $ $ $

12,079 5,000 7,500 24,579

Gross Profit Gross Profit %

20,418 26%

4,741 6%

Analysis of Customer Profitability

The top 55 accounts contribute a significant portion of the overall operating income.
Specifically the top 5% contribute 80% of the income.

The next 145 customers are still profitable and contribute the other 20% of the income. The bottom 50% of accounts actually incur expenses to service which reduces income.

Manager Suggestions
Each customer should be reviewed based on the new pricing model to adjust their profitability. Shipping costs should be better tracked per mile and billed to the customer utilizing the new computer system. The bottom 50% of accounts which are not generating income should be reviewed and pricing adjusted with the new model to ensure profitability.

Pros of Service Based Pricing

Accurate depiction of costs Costs traceable & visible a la carte services Customer profitability visible Sales reps profitability and productivity visible Will make WS more efficient Requirement to differentiate business Customer cut back on services may help profitability

Cons of Service Based Pricing

Customer push back Sales force push back Requires education for sales force & customers Customers may feel they overpaid prior to this Excellent service becomes more critical May lose some customers May need to drop some services (pick-pack)

Suggestions to improve efficiency

Price services based on costs Use EOQ for raw materials Warehouse organization, flow-thru racking Monitor inventory turns, maintain min/max stock levels Set up separate re-pack line for most frequent items Computerize and automate Incentivize customers to order specific day/time Evaluate w/h productivity, may be able to combine and reduce from 10 (flex leasing) Develop delivery charges based on minimum # of cases, mileage, frequency. Establish delivery windows Investigate fuel efficient fleet, develop delivery costs Align sales reps compensation with new SBP costing