Dakota Office Products

Customer Profitability Analysis

Pricing of Products/Services
ABC in Service

What concerned John Malone?

1
 Why was Dakota’s Existing
pricing system inadequate for
its current operating
environment?

Develop an activity based

cost system for Dakota office
products based on year 2000
data. Calculate the activity
cost driver rate for each DOP
activity.

2
Lets Find Activities First and
Match With Costs

KEY ISSUE TO LEARN IN

THE CASE:
Approach used to get the
information for ABC
Frustration with the accuracy

3
 ?
Cost Pools Activity Allocation

Process
cartons in
and out
Desktop
Delivery
Order
handling
Data entry

Activities and Costs

Activities Drivers Costs
Ship Cartons # of Cartons Freight (commercial and own)
Process Cartons # of cartons Warehouse Costs (Rent,
Personnel and Distribution)
Delivery to # of deliveries Delivery Truck and
Desktop Warehouse Personnel
Process Manual Order Entry (Processing
Custom Order System and operators)
Enter Items # of Lines Order Entry
(ordered Manual) entered
Process EDI Per EDI order Order Entry (Quick Check )

4
What is profitability of Customer
A and B?

Spread Sheet

5
Customer Profitability Customer A Customer B
Sales $103,000 $104,000
Cost of items purchased 85,000 85,000
Gross margin $18,000 $19,000
Number of cartons ordered 200 10,400 200 10,400
Number of cartons shipped,
commercial freight 200 1,200 150 900
Number of desktop deliveries - - 25 5,500
Number of orders, manual 6 60 100 1,000
Number of line items, manual orders 60 240 180 720
Number of EDI orders 6 30 - -
Average Accounts Receivable $9,000 900 $30,000 3,000
Customer Contribution (Loss) $5,170 ($2,520)
6.10% –3.0%

What explains the difference in

profitability between two
customers?

6
What are the limitations if any to
the estimates of profitability of
the two customers?

Limitations
• Transactional drivers assume every carton processed and
shipped cost the same.
• Every desktop delivery costs the same could have used
duration drivers
• All customers are identical in the time taken to setup an
order
• All EDI orders require same degree of efforts for
validation
• ABC Depends on subjective estimates
• Ignores assignment of General and selling expenses

7
 Is there any additional
information you would like to
have to explain the relative
profitability of the two
customers?

• Ignored
– Large amount of General and selling expenses
– Customer relationship expenses
• Should have been allocated in the way
warehouse expenses are done

8
 Assume that Dakota applies
the analysis done (Customer
Profitability based of ABC) to
its entire customer base. How
could such information
Illuminate and Inspire the
Dakota managers increase
company profits?

• Charge special service such as desktop delivery

• Encourage customer to switch to EDI
• Charge interest on O/S
• Change its customer mix by focusing profits
• Process improvement opportunities
• Outsourcing
• Determine Minimum order size
• Improve operating efficiency and create unused
capacity

9
Suppose a major customer switched from
placing all its orders manually to placing
all its orders over the Internet site.

How should this affect the activity cost

driver rates calculated earlier in ABC
analysis?

How would the switch affect Dakota’s

profitability?

Happy Costing!

10