Reference no: EM131370727

Assignment: Carson Beverage Inc.

Case Summary

Johnny Carson, owner of Carson Beverage, Inc. (CBI), has just received notice that one of his largest and most loyal customers may want to negotiate a lower price for its product purchases. Data compiled by Carson's accountant suggest that the profit margin on the customer is too low to withstand a price decrease. The accountant allocated all customer service costs to customers as a percentage of revenue.
Student Assignment

CBI has asked you to design an activity-based system to allocate the company's customer service costs, and to use this system to estimate customer profitability for its four major customers. As part of this report, you are also asked to comment on the strategic implications of your analysis, and make recommendations to the management of CBI.

Format of Report

The report should be no longer than four written pages, double spaced, with an additional three pages of appendices permitted. Appendices may be done in Excel.

The report is to be typewritten. Reports may be sent in via email prior to the deadline. No reports will be accepted after the due date.

The format of the report should follow the following structure:

(1) Cover page, identifying the case, date, your name and student number.

(2) Introduction: This should be one paragraph introducing the report, and outlining the major highlights of what is to be addressed the report (no executive summary is required in this case).

(3) Issue Identification: This should be one-two paragraphs outlining the situation that the company is facing.

(4) Analysis of situation: This should comprise most of your written report. Your calculations should appear in the appendices, not in the body of the report. You should summarize your analysis - do not make recommendations at this time! Simply present your findings.

(5) Recommendations: This should summarize your analysis, and make a clear recommendation on what course of action is best.

(6) Conclusion: This paragraph should summarize the major issues and recommendations. The conclusion should provide closure to a report.

CARSON BEVERAGE, INC.

As president of Carson Beverage Inc. (CBI), Johnny Carson was beginning to realize that retaining long-term customers was becoming a challenge. During a delivery run yesterday, driver Jake Matthews had noticed a competitor's sales manager talking with the general manager of Big Grocery, one of CBI's largest customers. Then, that morning, Carson's sales manager, Mary King, had mentioned that during her visit with the general manager of Big Grocery on Wednesday, he insisted that he wanted to negotiate a lower price. This could be a problem, because this customer had been one of CBI's largest and most loyal customers for years.

Carson decided to address this issue head-on, and scheduled a meeting with Matthews, King, and several others for later that day.

Company Background

CBI distributes beverages to retail customers. The company has been in business for 20 years, and has become a preferred distributor among several retail outlets in the local area. CBI primarily distributes bottled sports drinks made by small specialty beverage companies, and its business has grown steadily with the popularity of sports drinks over the years.

Last year, CBI's revenues totaled $12 million. The company has about 20 customers whose beverage purchases totaled anywhere from $100,000 to over $1 million annually. CBI's list price is $15.20 per case of 24 bottles. The full cost (excluding customer service costs) is $13.10 per case. The company offers discounts to some of its customers, depending on volume, future potential for sales, and negotiations by the sales manager.

The Meeting

Carson opened the meeting by summarizing what he had learned over the past days. "It looks like we've got some competition for one of our best customers, Big Grocery. I'm not very surprised. They are a big customer".

"This isn't the first time it has happened," said King. "This same competitor approached Big Grocery last year. We were able to keep the business by offering a bit more of a discount. I think we have to do this again, if we are going to keep this customer."

Carson replied, "We cannot get into a price war. I know this is a big customer, and a loyal one too, but it certainly is not one of our most profitable customers. I had Rick put some numbers together on several of our accounts. Big Grocery is one of our lowest-margin customers." Rick Jones, in accounting, who was also at the meeting, had prepared a report (Exhibit 1), for the group.

Jones explained how the numbers had been compiled:

"For each customer, we just pulled the revenues right out of the accounting system. We know what they ordered and what we shipped, and we know what price we charge each customer, so that part is easy. We know that the cost per case, excluding customer service costs, is $13.10. So, we multiply $13.10 per case by the number of cases we shipped to get our cost of goods. Then we subtracted our cost of goods from revenue for each customer to get a gross margin. We have always had a problem tracing our customer service costs to any particular customer. Our customer service costs run about $1.2 million per year, approximately 10% of revenue. To make things easy, we allocate those costs to each customer based on its share of the company's total revenue. For example, if a customer accounts for 5% of our revenues, we allocate it 5% of our customer service costs. Then we calculate a customer margin for each customer.

Carson looked at the numbers and said,

"I don't think we can lower our price to Big Grocery much more and make any money on this one. And if we offer them a larger discount, then our other customers will want the same thing."

Josh Roberts, the operations manager for CBI was listening carefully. He said, "You know, I am not surprised to hear this. Big Grocery is a great customer. They buy lots of beverages, and they are easy to deal with. They place their orders on a regular basis and almost never ask for anything special. I don't remember the last time we had to run around in the warehouse pulling together a rush order for them. Who wouldn't want their business?"

Matthews agreed. "You are right. I almost never have to change my delivery schedule for them. And they are right around the corner, so they are easy for us to get to."

Roberts continued:

"I think about some of our other customers. They seem to never anticipate when they are going to run out of stock. Then they call us and make it our problem to deal with. It seems like we have some customers that we work on all day, every day. Why can't the competitor go after those customers? It is hard for me to believe that some of those customers are more profitable than Big Grocery. Maybe we ought to add all the time we spend in the warehouse to those customers and then see who is the most profitable for us."

Carson thought Roberts might be on to something.

"Rick, what types of costs are included in those customer service costs?"

Jones replied,

"That number includes several things. It includes anything related to handling the beverages, like picking beverages from the warehouse shelves, moving the beverages to the loading dock, and loading them on the delivery truck. It includes costs of taking, coordinating, and administering the orders, like what we pay the people in the sales office who take phone orders from customers, the supervisory costs to administer the order, and similar things. It includes anything related to delivering the order, like the costs of delivery trucks, truck maintenance, and what we pay Jake and other drivers. It includes anything related to fulfilling rush orders, like overtime, extra scheduling, and stuff like that. And it includes what we pay Mary for what she does, like visiting customers to check on them."

Carson thought about this. "So, you are telling me that there are some customers that you are spending a lot more time on than others? And it is not Big Grocery?"

"That's right", Josh replied.

Carson continued, "But since our accounting system is allocating these customer service costs based on revenues, and Big Grocery is one of our biggest customers, it's allocating a large share of those costs to Big Grocery."

"Exactly", said Rick Jones.

Matthews, King, and Roberts all agreed to spend some time with Jones so he could summarize the amount of activity they devoted to each customer. They agreed to meet the following Friday to look at the analysis that Jones was to prepare.

Activity Analysis

Jones first pulled together some information about the customer service costs. He searched through the accounting system and determined how much of the $1.2 million of customer service costs was associated with each category (Table 1).

Table 1: Customer Service Costs during Prior Year by Area of Activity

Area of Activity	Total $
Product handling	$672,000
Taking orders from customers	100,000
Delivering the product	140,000
Expediting deliveries (other than automobile)	198,000
Sales visits to customers	90,000
Total	$1,200,000

Jones met with Matthews, King, and Roberts, and with their help, determined the primary driver of the costs in each of the customer service categories (Table 2).

Table 2: Cost Drivers by Area of Activity

Area of Activity	Cost Driver
Product handling	Number of cases sold
Taking orders from customers	Number of purchase orders
Delivering the product	Number of kilometres traveled
Expediting deliveries (other than automobile)	Number of expedited deliveries
Sales visits to customers	Number of sales visits

Jones determined from the accounting records that the company sold 800,000 cases of beverages, and processed 500 purchase orders the previous year. Matthews checked the travel records for the delivery vehicles and found that the vehicles had traveled a total of 44,800 kilometres. Roberts determined that the company made 4,480 deliveries, 2,500 of which were expedited deliveries. And finally, King determined she had made a total of 360 visits to customers last year.

Jones's next step was to determine how much of these cost drivers were attributable to each customer. Exhibit 2 presents this data for the four customers included in Jones's first report (Exhibit 1).

Exhibit 1

Carson Beverage Inc.

Customer Profitability Report for Last Year for Four Customers

	Big Grocery	Joe's Discount	Middle Supermarket	Uptown Convenience	Total
Net Revenues	$1,168,000	$1,192,000	$ 121,520	$ 454,500	$12,000,000
Cost of Goods	1,048,000	1,048,000	104,800	393,000	10,480,000
Gross Margin	120,000	144,000	16,720	61,500	1,520,000
Customer Service Costs	116,800	119,200	12,152	45,450	1,200,000
Customer Profit	3,200	24,800	4,568	16,050	320,000
Customer Profit (% of net revenues)	0.3%	2.1%	3.8%	3.5%	2.7%

Exhibit 2

Carson Beverage Inc.

Additional Information from Last Year for Four Customers

	Big Grocery	Joe's Discount	Middle Supermarket	Uptown Convenience	Total for CBI
Price per case	$14.60	$14.90	$15.19	$15.15	$15.00
Number of cases	80,000	80,000	8,000	30,000	800,000
Number of orders	16	40	20	30	500
Number of deliveries1	110	400	200	230	4,480
Kms traveled per delivery	5	19	11	4	10
No. of expedited deliveries	10	250	130	90	2,500
Number of sales visits	12	25	18	9	360

1 Includes both expedited and regular deliveries.