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Transcript of MOP
By: Yuan Zhang & Christine Habeeb
Processed 80,000 cartons – 75,000 Commercial Deliveries & 5,000 Desktop Deliveries. Midwest delivered 2,000, average delivery 2.5 cartons
Capacity 80,000 cartons for handling, processing & shipping using existing employees & space
$250,000 total compensation for truck drivers who worked 1,500 hours each per year
Employed (16) order entry operators who worked 1,750 hours each per year
Productive hours equaled 1,500 worked per yer per data entry operator
$840,000 all inclusive data entry operating expense
Manual Order - 9 minutes enter customer information & 4.5 minutes enter each line item on order
Electronic Order – 6 minutes verify information on order
Accounts Receivable – some paid within 30 days, remainder paid between 90 – 120 days
MOP has working capital loan to finance accounts receivable balance, at rate 1% per month
Regional distributor of office supplies to institutions and commercial businesses
Expansive product line offering： （1）Simple writing instruments – pens, pencils and fasteners； （2）Specialty Products – paper for high speed copiers & printers
Financial Results for 2003 – company suffered first profit loss in history
Excellent reputation - customer service & quality supplies
Case Study - 2
John Malone - General Manager
Melissa Dunhill - Controller
Tim Cunningham - Director of Operations
Wilbur Smith - Site Manager
Hazel Nutley - Data Entry Operator
Key Relevant Events MOP
Introduced Electronic Data Interchange (EDI) in 1999
Internet Site in 2000
Started accepting orders online via its new website.
Introduced Desktop Delivery – Offered direct delivery to individual locations at customer site
MOP - The financial results of calendar year showed that sales increased, yet company still suffered loss.
Introduced Desktop Delivery & Electronic Data Exchange, yet costs increased could not earn profit
Need to evaluate current business operations and make changes to ensure future company success.
MOP is challenged with pricing and costing issue for its products.
Using the traditional costing method to compute the cost of the product provided & delivered to customers
Adds markup to the selling price of the product.
Result – Not able to cost the products realistically, so led to mispricing of the products and company loss for 2003.
Unload truckloads shipments from variety manufacturers
Cartons moved to designated storage location until requested by customers
Orders filled on daily basis by warehouse personnel
Priced products to end use customers
16% markup for cost of warehousing, order processing & freight
5% markup cover general, selling & administrative expenses
Includes an allowance for profit
Markups determined at start fiscal year – based on prior year expenses & industry trends
Long term customers received pricing discount
Pricing independent of specific level of service required by customer
Products shipped to customers using commercial truckers
New service - Desktop Deliveries
Direct delivery to by MOP employees to customer site
Price Premium – 5% markup for convenience to customers
Leased four trucks & hired four drivers
Company believed that Desktop Delivery service would increase sales and create more loyal customers
Receive & Store -
Amount of warehouse space & number employees needed varies, based on number cartons required
Space & handling costs proportional to number cartons pass through distribution center
Enter Customer Orders –
Manual Orders –Validate customer information & requires each line item on order to be entered separately by data entry operator
Electronic Orders - Interface automatically thru EDI or website. Data entry operator validates order quickly, regardless of number items orders.
Distribute & Ship
Commercial - used for normal shipments, with cost based on volume
Desktop – Special service offered – average delivery 3 hours, no route planning currently in place
Based on the interviews and data in the case, we calculated the following information.
a) (1) The cost of processing cartons through the facility
The only two costs of processing cartons through the facility are i) warehouse costs, and ii) warehouse personnel costs. Both of these are proportional to the number of cartons. The total processing costs are therefore $54/carton.
(2) The cost of entering electronic and manual customer orders
Here, the cost is entirely based on personnel costs. Manual costs consist of both i) entering basic information, and ii) an additional cost for each line item. The electronic entry has a single cost.
(3) The cost of shipping cartons on commercial carriers
Freight cost per carton is simply the total freight cost divided by the number of cartons shipped by commercial freight.
Suggest: (i)MOP needs to develop an ABC that will cost each order separately. What if some orders are special handling, rush orders or orders for less than full cartons. (ii) EDI
Suggest: MOP needs different shipping arrangements ( such as special handling, rush orders or orders for less than full cartons) , then extra charges will apply, kind of like a Menu Based Pricing.
(4) The cost per hour for desktop deliveries
The cost per hour for desktop deliveries includes the cost of both the drivers and the trucks themselves (leasing, maintenance, etc.). There are four drivers working 1500 hours so the cost/hour is the total cost divided by 6000.
Suggest: Midwest needs to use this $75 cost and calculate the cost required for each delivery. A GPS or Navigation System will allow drivers to log arrival and departure time at each customer site. This will provide more accurate costing at the customer level.
b) Using this capacity cost rate information, calculate the cost and profitability of the five orders. & What explains the variation in profitability across the five orders?
Orders 1 & 2 look similar, except the second order includes a surcharge. Thus Order 2’s gross margin is higher than for Order 1.
Orders 3 & 4 are the same as Orders 1 & 2 except they are scaled by a factor of 10. Order 4 has a positive profit contribution and it break even on its direct delivery service.
Order 5 explains the impact of the hidden costs due to manual order entry and long payment terms. It is the same as Order 3, except for manual vs electronic ordering and payment in 120 days vs 30 days.
Action needed to improve Profitability:
(1) Customer Orders/Relationship
Desktop deliveries - limit distance will travel to take orders. This will reduce truck expense and gas usage.
Standardize Packaging and delivery
Establish minimum customer order size
(2) Improve process
Route planning need to be improved - manage multiple deliveries in more efficient way.
Push EDI or new Internet site to new and existing customers
Improve efficiency of warehouse operations
Offer discounts for customers who place order on EDI
Separate cost of service and product pricing
c) On the basis of your analysis, what actions should John Malone take to improve Midwest’s profitability? Include suggestions for managing customer profitability
d) Suppose that currently, Midwest processes 40,000 manual orders per year, with a total of 200,000 line items entered, and 30,000 electronic orders.
(i) How much unused practical capacity does the company have?
Using the order entry times stated in part 1(a), MOP requires (40,000 × 0.15) + (200,000 × 0.075) + (30,000 × 0.1) = 24,000 hrs/year,
and the current practical capacity is 16 × 1500 = 24,000 hrs/year.
Therefore, the company needs all 16 operators and there is no unused capacity.
(ii) If the company’s efforts to encourage customers who order manually to change to electronic ordering results in 20,000 manual orders per year (100,000 line items entered) and 50,000 electronic orders, how many order entry operators will the company require? If order entry resource costs can be reduced in proportion to the number of employees, what will be the cost savings from the changes?
MOP requires (20,000 × 0.15) + (100,000 × 0.075) + (50,000 × 0.1) = 15,500 hrs/year.
Requires (15,500/1500=) 10.33 operators.
The cost per operator is 840,000/16 = $52,500.
The cost savings are 52,500 × (16 −10.33) = $297,500.
If MOP only hires full-time employees, it will need 11 operators Then, the cost savings are 52,500 × (16 −11) = $262,500.
(iii) Returning to the original information in part d, if the company’s process improvement efforts result in a 20% reduction in time to perform each of the three order entry activities, how many order entry operators will the company require? IF order entry resource costs can be reduced in proportion to the number of employees, what will be the cost savings form the process improvements?
MOP requires (40,000 × 0.12) + (200,000 × 0.06) + (30,000 × 0.08) = 19,200 hrs/year.
Requires (19,200/1500=) 12.8 operators.
The cost savings are 52,500 × (16 − 12.8) = $168,000.
If MOP only hires full-time employees, it will need 13 operators Then, the cost savings are 52,500 × (16 −13) = $157,500 (or 168,000-0.2×52,500 = $157,500).
(i) Comment on the application of ABC, particularly Time-based ABC in the case. Are there additional aspects that Mid-West could have considered?
Lack of commitment and support from upper management.
Other priorities take precedence to the ABC project.
Limited resources for the project members.
Considered to be time-consuming and costly.
Inadequate training of managers and users.
Resistance to change in organizational culture.
(ii) How do firms consider channel profitability in addition to customer profitability using ABC? What is the additional value to this form of ABC analysis?
Management should apply the ABC system to determine the activities, costs, and profit, which are associated with serving particular customer, and assign the costs more accurately.
ABC provides management with the ability to change its pricing structure to compete more effectively in the office products industry
ABC provides management with insight so can make more-informed decisions about customer service.
ABC provides insight of which customers:
High cost to serve
Low cost to serve
ABC- More widely implemented as provides a more accurate picture of the profits and costs of doing business than traditional cost accounting.
Provides better understanding of the the real product profitability & customer profitability
THANKS FOR YOUR TIME!!
Cost of processing: $2,320,000 + 2,000,000 = $4,320,000
Practical capacity /80,000 cartons
Cost rate for supplying capacity = $54 per carton
Total entry operating expense $840,000
Capacity of order entry resources: 16×1,500 hours = 24,000
Cost of order entry process is 840k/24k =$35/h
Assign costs based on use of resources
Manual customer order: 0.150×35 = $5.25/manual order
A line item on order 0.075×35 = 2.625/line item
Validating an EDI order 0.1×35 = 3.50/EDI order