Dakota's existing pricing system was inadequate for its current operating environment for several reasons:
- Profits only came from large orders, not small ones
- Costs were determined subjectively based on past years' numbers rather than actual costs
- Prices did not reflect differences in online vs manual ordering costs
- The same markup was used regardless of delivery distance
Activity-based costing using cost drivers will provide more accurate product and activity costs. This shows Customer A is more profitable than B due to placing half of orders through lower-cost EDI and fewer manual orders entered, while B placed no EDI orders and 100 manual orders.
Dakota's existing pricing system was inadequate for its current operating environment for several reasons:
- Profits only came from large orders, not small ones
- Costs were determined subjectively based on past years' numbers rather than actual costs
- Prices did not reflect differences in online vs manual ordering costs
- The same markup was used regardless of delivery distance
Activity-based costing using cost drivers will provide more accurate product and activity costs. This shows Customer A is more profitable than B due to placing half of orders through lower-cost EDI and fewer manual orders entered, while B placed no EDI orders and 100 manual orders.
Dakota's existing pricing system was inadequate for its current operating environment for several reasons:
- Profits only came from large orders, not small ones
- Costs were determined subjectively based on past years' numbers rather than actual costs
- Prices did not reflect differences in online vs manual ordering costs
- The same markup was used regardless of delivery distance
Activity-based costing using cost drivers will provide more accurate product and activity costs. This shows Customer A is more profitable than B due to placing half of orders through lower-cost EDI and fewer manual orders entered, while B placed no EDI orders and 100 manual orders.
Dakota's existing pricing system was inadequate for its current operating environment for several reasons:
- Profits only came from large orders, not small ones
- Costs were determined subjectively based on past years' numbers rather than actual costs
- Prices did not reflect differences in online vs manual ordering costs
- The same markup was used regardless of delivery distance
Activity-based costing using cost drivers will provide more accurate product and activity costs. This shows Customer A is more profitable than B due to placing half of orders through lower-cost EDI and fewer manual orders entered, while B placed no EDI orders and 100 manual orders.
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1- Why was Dakota’s existing pricing system inadequate for its current
operating environment?
Some problems with the current operating environment include:
- Profits only when clients placed large orders for cartons - Significant drop of profit when many clients placed small orders - Wrong cost determination for individual customers (subjective and based on previous year’s numbers which were probably calculated equally is wrong) - Wrong cost determination for new services provided by DOP - No difference in prices to consumers whether order placed online or manually even though the cost to the company varies - Markup process - 15% for warehousing, distribution, and freight, then SG&A, then profit - Standard markup of 2% for desktop deliveries no matter the distance for delivery
2. Develop an ABC for Dakota based on year 2000 data. Calculate activity cost driver for each activity in 2000? Activity based costing is going to be the best option for the Dakota Office group. This will allow them to do accurate calculations of the cost of products & activities
Cost rate of processing cartons was determined by dispersing warehouse expense and warehouse personnel expense (weighted by 90% labor allocation) over total cartons shipped. Cost rate of freight was determined by distributing total freight expense over the number of cartons shipped via freight. Cost rate of desktop deliveries was determined by distributing delivery truck expenses and warehouse personnel expense (weighted by 10% labor allocation) over total cartons shipped via delivery. Cost rate of manual orders was determined by dispersing order entry expenses (weighted by 20% time allocation) over total number of manual orders processed. Cost rate of line items was determined by dispersing order entry expenses (weighted by 75% time allocation) over total number of line items processed. Cost rate of EDI orders was determined by dispersing order entry expenses (weighted by 5% time allocation) over total number of EDI orders processed.
3. Using answer to 2 above, calculate the profitability of Customer A and B
As seen from the from the table above, the primary large costs that differentiate Customer A from Customer B are related to desktop deliveries and the quantity of orders processed. Desktop deliveries represent an enormous cost rate expense primarily due to equipment costs and relatively utilization of warehouse labor, some 10%, disperse over a relatively small volume of cartons shipped, 2,000 or 2.5% of the total. Maintaining desktop deliveries at its current rate is unsustainable for a variety of reasons. The nature of direct delivery makes scaling economies difficult, more desktop delivery orders processed will require more delivery trucks and warehouse labor without a more elaborate warehousing structure. Because of this, the current 2% markup will need to be adjusted to accommodate $220 per carton cost rate.
The quantity of orders processed also poses a large threat to DOP, one that can mean the difference between a profitable and unprofitable customer. During the year 2000, Customer A processed some 12 total orders while Customer B processed 100, resulting in a cost differential nearing $1,500. Manual ordering takes twice as much time per order relative to computer ordering from the numbers provided, costing twice as much. Gradually phasing out manual ordering and moving to EDI ordering will likely reduce overall expenses. EDI cost rates will go up as a resultant of this because time-resource allocation weights were used in the total cost rate; yet the ability for technological advantage presents itself using computer based ordering, potentially it could be structured so entering line items becomes an activity of the past.
4- What explains any difference in profitability between the two customers?
After developing the ABC model it is easy to notice that the difference in profitability between the two customers comes from the different services that they used. Customer A is more profitable as they placed half of the orders through the EDI service which is twice as cheaper as the manual one. Furthermore, using EDI decreased the cost of the line items entered compared to Customer B who placed no orders through the electronic system. As it was mentioned previously, using the ABC system minimizes the cross-subsidization of the services offered and in the case of DOP shows an accurate indication of which customer is more profitable.
