Indian Institute of Management Ahmedabad

IIMA/QM0008(A)

Kamdhenu Dairy(A)
"Why do you maintain that FA milk is more profitable than any of your other products?" Professor Puranik asked Mr Mathias, General Manager of Kamdhenu Dairy. Mathias replied, "This is so because we incur very little overheads for this product as compared to others: for instance, we have no advertising or other promotional expenditure for this product. The production process is very simple and the product has an assured market. However, you can study our costs for all our products and satisfy yourself about the validity of my statement. I am sure you will come to the same conclusion as I have after many years of experience in the industry." This was the discussion that took place between Mathias and two professors of a leading management institute. The two professors had visited the dairy in April 1964 to study the problem it was facing with the supply of FA milk to the government of a large state in western India.Kamdhenu Dairy was located in Sanand, a small town on the railway line connecting leading cities in western India. The dairy had been started mainly for providing better marketing facilities to farmers for marketing the milk they produced. In 1945 the state government of a western state had started a milk scheme for supply of milk in a major city in the state. According to this scheme, milk was to be collected from Kheda district, in which Sanand was located, and supplied to consumers in the city. During the initial stages of the scheme collection of milk was left to collectors and private dairies, with the result that very little of the increase in price offered by the state government was received by the farmers. In order to get the benefit of the increased prices, the farmers decided to start a union of milk producers and a central processing unit at Sanand. It was decided that this union would collect milk from the farmers, pasteurize it, and sell it to the state government. A building and some old machinery belonging to the government of India was leased by the union to start a pasteurizing unit at Sanand. This marked the beginning of Kamdhenu Dairy. From June 1948, the dairy started pasteurizing about 250 litres of milk a day. The cooperative movement amongst milk producers became very popular, and the organization grew at a very rapid rate. In 1953 it was found that the state milk scheme could not accept all the milk collected by the union in winter months. This was because the state scheme required that the state be supplied with a more or less constant quantity of milk, while production varied widely between summer and winter seasons. In winter production was 250 per cent of summer production. This left Kamdhenu Dairy with two alternatives: restrict drastically the collection of milk during winter months find alternative ways of consuming the surplus milk collected in winter months.

Prepared by Professors D.K. Desai and V.L. Mote Cases of the Indian Institute of Management, Ahmedabad, are prepared as a basis for class discussion. Cases are not designed to present illustrations of either correct or incorrect handling of administrative problems. Copyright 1964 by the Indian Institute of Management, Ahmedabad.

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The first alternative was not satisfactory, as the farmers wanted to be assured of a year-round market for all the surplus milk they desired to sell. In order to assure the farmers a year-round market, the management of Kamdhenu Dairy decided to construct a dairy plant to convert milk into milk products. It obtained assistance from UNICEF and the government of New Zealand and, with an investment of Rs. 50 lakh, a plant was put into operation in October 1955. The opening of the new dairy gave a great incentive to milk production in Kheda district and the union was able to procure more and more milk each year. The progress of the union after the new factory was built is illustrated in Exhibit 1. Milk collected by Kamdhenu Dairy was converted into the following main products: 1. FA milk for the state milk scheme 3. Ghee 5. Baby food 2. Butter 4. Skim milk powder 6. Cheese

Exhibit 2 gives the production processes for these products and the quantities produced during the financial year 1963-64. In early 1964, Mr Shrivastava, Assistant General Manager of Kamdhenu Dairy, attended a management development programme organized by the management institute mentioned before. During this programme he discussed with a senior professor of the institute the problem he faced in deciding the quantity of FA milk the dairy should commit itself to supply to the state milk scheme. The difficulty had arisen because of the variation and the uncertainty involved in the procurement of raw milk. The professor asked him to contact Professors S. Puranik and D.K. Mehta who were interested in problems of this nature. In April 1964 the two professors visited Kamdhenu Dairy and met Mathias and Shrivastava to understand the problem. Shrivastava explained: Milk supply from our societies is at its minimum in the month of June and reaches its maximum in December-January. Though this variation is known, it is possible to predict with certainty the quantity of milk we will be able to procure in the lean and peak periods. Ideally we would like to vary our supply of FA milk to the state milk scheme according to the variation of our milk procurement. Unfortunately our contract terms do not permit us to do so. According to the contract we have to supply them a more or less uniform quantity of FA milk throughout the year. In case we fail to supply the requisite quantity we have to pay a penalty at the rate of 8 paise for every litre that is falling short of the contracted quantity. You must remember that FA milk is our most profitable product. In case we contract too small a quantity with the state because of the fear of not being able to supply it in summer, we lose profit. On the other hand, if we contract too large a quantity we have to pay a penalty. In view of this, I would like to know what is the optimum quantity that I should settle for. It was at this point that Professor Puranik asked Mathias the question stated at the beginning of the case. As the question of profitability of various products was very important in this problem, the two professors decided to examine the cost structure of various products and ascertain the profitability of each product. Mathias suggested that Shrivastava, Ramaswamy (the accountant), and the two professors get together so that Ramaswamy could explain the cost structure of various products. At a

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subsequent meeting, Ramaswamy presented the statement given in Exhibit 3 and made the following comments: Our contention that FA milk is the most profitable product is borne out by facts. You will notice that in other products, except for whole milk powder and FA milk, we are either breaking even or losing money. For example, consider cheese, Mr Shrivastava's favourite product. In estimating the profitability of this product, I have not accounted for the expenditure that we incurred on the development of this product; even so, we are losing heavily on cheese. I am wondering why we should not drop this product. As for baby food, we do not make any money; but, as Mr Mathias says, we are a cooperative society and must look to the welfare of the people in general, and should not concentrate merely on profit. For your information, this is our prestige product. However, I must say that the concept of defining alternatives as I have used in the statement was something which I learned from the discussions with the professors. Formerly we used to evaluate profitability of products individually, rather than by combinations, which is the correct way of looking at things from the technical as well as the accounting point of view. At this point Professor Puranik commented, "We are glad that you have started considering product combinations rather than individual products. However, we are not sure as to how far the cost you have worked out is relevant for deciding the cost profitable product mix." Shrivastava said, "Ramaswamy, the management boys always talk of relevant costs. At the management development programme they always used to tell us that while choosing amongst alternatives, one should consider only the costs that had to be incurred in future and not worry about the sunk costs. As they said, let bygones be bygones. I don't see how you could be wrong in your findings. You have not missed any relevant costs. However, let the professors scrutinize the cost statements and advise us." He continued, "I am interested in finding out the optimum product mix. Today we are enjoying a seller's market, and have not difficulty in selling all we produce. Our whole milk powder is purchased by the government of India for defence needs; our cheese has a good demand and I can hope to sell cheese at the rate of a thousand tonnes a year without any difficulty. In short, marketing is no problem at present and I think conditions will remain the same for some time to come. Our only constraints are the production capacities [listed in Exhibit 5], availability of raw milk, and contractual obligations of supplying FA milk to the state milk scheme at the rate of 75,000 litres a day. You may perhaps be aware that we have a big programme for expansion. We would like to know the direction in which we should expand." The professors were considering what they should do next.

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Exhibit 1 Kamdhenu Dairy Progress from 1955-56 to 1962-63 Number of Share farmer capital of the members of union the societies (Rs.) Position before the new dairy was built 1955-56 64 22828 217400 Position after the new dairy was built 1956-57 107 26795 361500 1957-58 130 29003 393900 1958-59 168 33068 473500 1959-60 167 40181 567100 1960-61 195 40500 741100 Position after the dairy was expanded for baby food and cheese 1961-62 219 46400 748700 1962-63 254 58400 819200 Year ending 31st March Number of societies

IIMA/QM0008(A)

Monetary value of milk collected (Rs.) 11136343 14164000 21156400 27557800 22927000 23513000 65398429 50417811

Cost of milk and products sold (Rs.) 7636000 8847000 13447000 21165000 18210000 19833000 31528820 45624311

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Exhibit 2 Kamdhenu Dairy 2.1

IIMA/QM0008(A)

Raw milk received daily from contributing farmers at weighing scales (1) goes into raw milk tanks (2). The milk is then conveyed to pasteurizers (3a) and (3b). A portion of the pasteurized milk is mixed with skim-milk stores in a milk condensing plant (14) and the mixture is conveyed to insulated railway milk tanks (5) as FA milk. The remaining quantity of pasteurized milk is stored in insulated milk tanks (4) to be processed into three main products, viz. butter, ghee, and skimmed milk powder, and the two by-products, viz. casein and lactose. Butter From the storage tanks (4) milk is conveyed to cream separators (6) to be separated into cream and skim milk. The separated cream is then conveyed to the vacreator (7) and the vacreated cream to the cream cooler (8). The cooled cream is conveyed to jacketted cream ripening vats (9) and then to the butter churn (10) where butter is made, and brought to the butter wrapping machine (11). The finished product is then stocked in the cold store (12) and is ready for the market. Ghee Butter, when it comes out of the butter churn (10), is conveyed to the ghee pan (13), stocked in the cold store (12) and is ready for the market. Skimmed Milk Powder The separated skim milk from the cream separators (6) is conveyed to the milk condensing plant (14). The condensed skim milk is conveyed;to the milk drying plant (15) and the dried skim milk powder is conveyed to the milk powder filling machine (16). The finished product is taken to the milk powder store (17) and is ready for the market.

2.2

Production of milk products in 1963-64 A. Total milk received from societies: 6,04,30,000 litres (see Exhibit 5) B. Production 1. FA milk 2. Standardized milk 3. Baby food 4. Butter 5. Whole milk powder 6. Skimmed milk powder 7. Ghee 8. Cheese (Rs. '000) 35,519 1,362 1,839 1,385 569 224 398 81

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Exhibit 3: Kamdhenu Dairy Statement Showing Profitability of Different Products Alternatives Qty.of raw milk used (in litres) Byproduct Butter Ghee Butter Ghee Butter Ghee Butter Ghee Butter Ghee Butter Ghee 10000 9874(L) 10000 9874(L) 10000 813(K) 10000 813(K) 10000 1179(K) 10000 1179(K) 10000 10000 10000 10000 10000 10000 1307(K) 1307(K) 1094(K) 1094(K) 8675(L) 8675(L) 62 48 992 756 606 448 696 529 560 426 681 519 6953 6953 6953 6953 6953 6953 6953 6953 6953 6953 6953 6953 500 551 1285 1301 2000 2000 4478 4494 3864 3983 1052 1060 130 130 699 699 598 598 988 988 6581 6581 427 427 Qty. of litres/ Kgs of main product Qty. in Kgs of byproduct Cost of milk* Processing Allocated & packing overhead cost* cost# Total Revenue From

IIMA/QM0008(A)

Net Profit

Main product 1 FA Milk 2 FA Milk 3 Skimmed Milk Powder 4 Skimmed Milk powder 5 Whole Milk Powder 6 Whole Milk Powder 7 Baby Food 8 Baby Food 9 Cheese 10 Cheese 11 Standardized milk 12 Standardized milk

Main ByProduct produc t 7583 7553 403 7634 7553 399 8937 2334 6448 8953 9551 9551 12419 12435 17398 17517 8432 8440 2334 5876 5876 7772 7772 9010 9010 4338 4338 6275 3987 3822 4524 4308 3640 3536 4426 4307

Total

Total

7956 7952 8782 8609 9863 9698

373 318 155 344 312 147

Per ltr. of raw milk 0.037 0.033 0.016 0.034 0.031 0.015 0.012 0.036 0.475 0.497 0.033 0.021

12296 123 12080 355 12650 4748 12546 4971 8764 332 8645 205

* Cost of milk is taken to be Re 0.6953 per litre ** Includes:(1) Cost of utilities in processing like cost of electricity steam etc. (2) Packaging cost and other material cost, e.g., of salt, sugar, colour, etc. Refer Table 2 Exhibit 4 for explanation

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Exhibit 4 Kamdhenu Dairy

IIMA/QM0008(A)

Table 1 Statement Showing Overhead Costs and Allocated Overhead Costs per Unit of Product for 1963-64
Milk products 1963-64 Production (Units '00000) Labour cost* (Rs. '00000) Depreciattion** (Rs. '00000) Advertising (Rs. '00000) Total (Rs. '00000) Allocated overhead cost per unit of production (6/2)

1 FA Milk Butter Baby Food Cheese S.M.P.

2 344(L) 13.9 18.4 Rs. 0.8 2.2 Kg

3 1 3 3 2

4 2.1 2.2 0.9 0.9

5 1.75 5.2 1.75

6 3.1 6.95 9.1 4.65

7 0.01 0.5 0.49 5.76

2.0

2.0

0.25

W.M.P. Total

5.7 9 8.1 8.7 25.8

*Total labour cost is distributed to the different products on the basis of labour used. The labour force and wage structure are not affected by change in product mix and hence labour costs are accounted as overhead costs. ** Allocated on the basis of the machine capacities used for manufacturing different products in the year 1963-64.

Table 2 Table Showing Allocation of Overhead Costs to the Alternatives in Exhibit 3

Main product Byproduct Qty. of main product Qty. of byproduct (in Rs) Allocated overhead cost per litre/Kg of main product (Rs) Allocated overhead cost per Kg of by-product (Rs) Allocated overhead cost (Rs)

1 1. FA Milk 2. FA Milk 3. S.M.P. 4. S.M.P. 5. W.M.P 6. W.M.P. 7. Baby Food 8. Baby Food 9. Cheese 10. Cheese 11. Standardized milk 12. Standardized milk

2 Butter Ghee Butter Ghee Butter Ghee Butter Ghee Butter Ghee Butter Ghee

3 9874 9874 813 813 1179 1179 1307 1307 1094 1094 8675 8675

4 62 48 992 756 606 448 696 529 560 426 681 519

5 0.01 0.01 0.25 0.25 0.25 0.25 0.49 0.49 5.76 5.76 0.01 0.01

6 0.5 0.66 0.5 0.66 0.5 0.66 0.5 0.66 0.5 0.66 0.5 0.66

7 130 130 699 702 598 590 988 990 6581 6583 427 429

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Exhibit 5 Kamdhenu Dairy Table 1 Production Capacities of Different Milk Products Sr. No. Product Production capacity per day 10000 Kg** 2500 Kg 6000 Kg* 7000 Kg 2000 Kg

IIMA/QM0008(A)

1 Butter 2 Ghee 3 Milk Powder 4 Baby Food 5 Cheese *Powder-drying capacity ** All the butter required for making ghee must come from the butter churns.

Table 2 Monthwise Collection of Milk for the year 1963-64 Year Month Actual milk collection in '00000 litres 48.1 40.5 31.3 32.8 41.8 46.3 53.0 60.7 67.7 65.0 58.3 59.1 604.3

1963 1963 1963 1963 1963 1963 1963 1963 1963 1964 1964 1964

April May June July August September October November December January February March Total

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IIMA/QM0008(A)
Exhibit 5 (contd)

Table 3 Contractual Obligations FA milk to be supplied to the state milk scheme at the rate of 75,000 litres per day Supplement to the Case: Kamdhenu Dairy The discussion of the case "Kamdhenu Dairy" will be facilitated a great deal if there is some uniformity in the computations. In order to achieve this uniformity it is suggested that we define as follows the units for various products. With the help of Exhibit 3 it can be seen that 10,000 litres of raw milk would be required for producing each of the following 12 alternatives:

Alternatives

1. FA milk + Butter 2. FA milk + Ghee 3. S.M.P. + Butter 4. S.M.P. + Ghee 5. W.M.P. + Butter 6. W.M.P. + Ghee 7. Baby Food + Butter 8. Baby Food + Ghee 9. Cheese + Butter 10.Cheese + Ghee 11. Standardized Milk + Butter 12. Standardized Milk + Ghee

Corresponding to 10,000 litres of raw milk Qty. of main Qty. of byproduct product 9,874(L) 62 9,874(L) 48 813(K) 992 813(K) 756 1,179(K) 606 1,179(K) 448 1,307(K) 696 1,307(K) 529 1,094(K) 560 1,094(K) 426 8,675(L) 681 8,675(L) 519

Let us Define 1. 2. 3. 4. 5. 6. 7. 8. 9. 10,000 litres of raw milk 1,000 Kg of butter 1,000 Kg of ghee 9,874 litres of FA milk 813 Kg of S.M.P. 1,179 Kg of W.M.P. 1,307 Kg of baby food 1,094 Kg of Cheese 8,675 litres of standardized milk 1 unit of raw milk 1 unit of butter 1 unit of ghee 1 unit of FA milk 1 unit of S.M.P. 1 unit of W.M.P. 1 unit of baby food 1 unit of cheese 1 unit of standardized milk

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For example, in these units, one unit of raw milk yields one unit of cheese and 0.56 unit of butter. In terms of these units, the capacity restraints can be defined as under:

Butter Ghee Milk Powder Baby food Cheese

Production capacity per day 10,000 kg 2,500 kg 6,000 kg 7,000 kg 2,000 kg

Units

10 2.5 7.38 of S.M.P. or 5.09 of W.M.P. 5.36 1.83 of cheese

The following questions would help us in the analysis of this case. However, the discussion need not be confined only to these questions. 1. Should cheese be dropped from the product line as suggested by Mr. Ramaswamy? 2. Let us assume that the dairy will be able to procure raw milk as under: Units per day 11.9 19.0

May to August September to April

In view of this supply position what should be the production programme for the dairy if: a) b) c) It had no contractual obligations to supply FA milk to the state milk scheme. In case you were negotiating a contract with the state, what quantity of FA milk would you commit to supply? In case the dairy was planning to expand its butter churning and powder drying capacity, how much money should it invest in this expansion?