978-0137024971 Chapter 6 Part 3

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retain Customer 4 in years 1 and 2 provides net benefits and helps

(c) Assuming that n is very large and the numbers in the table remain about

Acquisition

Customer

(M − c)/(i + [1 − r])

Cost

CLV

1

$2,750

$1,000

$1,750

2

3,000

1,000

2,000

3

1,375

1,000

375

(d) Companies can use the information gathered to calculate customers’

are

 Initial acquisition cost

 Profits or losses earned year

Some companies have highly sophisticated analytic systems that allow

them to estimate these parameters based on the demographic

characteristics of a potential or newly-acquired customer. The analytics

help guide the companies’ promotion strategies and campaigns to

1 V. G. Narayanan, “Customer Profitability and Customer Relationship Management at RBC

Financial Group,” HBS Case # 102-043.

Atkinson, Solution Manual t/a Management Accounting, 6E

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6-31 The net promoter score is likely to have the greatest predictive power for repeat

purchases and growth in business-to–customer settings where customers have

X?”

CASES

6-32 The responses below are based on “Survival Strategies: After Cost Cutting,

Street Journal (September 18, 2002, p. A1).

(a) Jergens’ president based the price on what he determined to be the cost

of producing the order of 10 odd-sized fasteners from scratch. The cost

included setup for the odd size and overtime labor. The company

(b) Goodyear had been rewarding its sales force based on volume,

providing an incentive for the sales force to deeply discount prices to

large distributors. The discounts were so substantial that the large

distributors could resell the tires to smaller distributors (even with

a “revenue per tire” metric.

(c) Emerson discovered that customers were willing to pay about 20%

more than Emerson’s initially proposed cost-based price of $2,650 for a

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unit-level drivers. An activity-based costing system more accurately

assigns costs based on resource usage.

purchasing the lite version, they were informed of the benefits of the

original version, and most of these customers bought the original

version. An accurate costing system, such as a good activity-based

costing system that includes both manufacturing and nonmanufacturing

(e) Union Pacific introduced a minimum price that was higher than a third

of its customers paid. The company was not concerned if it lost these

customers because customers who were paying higher prices would fill

up the newly free space. Dropping unprofitable customers will not lead

profitable use.

6-33 Midwest Office Products2 (HBS Case 9-104–073)

Midwest is a revised version of Dakota Office Products (HBS Case No.

School Teaching Note 5-105-084. This teaching note was prepared by Professor Robert S.

Kaplan as an aid to instructors in the classroom use of the “Midwest Office Products” case,

Atkinson, Solution Manual t/a Management Accounting, 6E

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discuss with the class how to extend the model to capture more complex and

realistic situations. The costing of five representative orders gives students

The case is simple enough that it can be used as a first activity-based

costing case. Given that the time-driven approach is both simpler and more

Teaching Objectives

customers into profitable ones.

Assignment (for the standalone case)

Read

“Time-Driven Activity-Based Costing” Harvard Business Review reprint

#R0411J

“Activity–Based Costing and Capacity” HBS No. 105-059

The Kaplan–Anderson Harvard Business Review article on Time-Driven

ABC (#R0411) should be sufficient to introduce students to ABC even if they

have not previously studied the subject. Should instructors want a more

comprehensive introduction to “original” ABC, they can consider: R.S.

(Boston: Harvard Business School Publishing, 1997).

The technical note on ABC and capacity can be optional or background

reading. It helps students understand why ABC cost driver rates should be

based on practical capacity, not actual utilization. This may shorten discussion

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Textbook Assignment Questions (adapted from the original case questions):

(a) Based on the interviews and data in the case, estimate:

(b) Using this capacity cost rate information, calculate the cost and profitability

(c) On the basis of your analysis, what actions should John Malone take to

customer profitability.

(d) Suppose that currently, Midwest processes 40,000 manual orders per year,

i. How much unused practical capacity does the company have?

iii. Returning to the original information in (d), if the company’s process

improvement efforts result in a 20% reduction in time to perform each

Discussion

Introductory Remarks

If this is the students or executives’ first exposure to activity-based costing, I

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discussion with the senior executive team about whether to adopt activity-based

costing. In reading the company’s annual report, I saw the 10-year summary,

which I have excerpted in TN Exhibit 6-1. During the past ten years, the

company was fortunate to have had a sales increase of nearly 135%, as sales had

percentage of sales, as it would have to if any fixed costs existed—actually

increased as a percentage of sales. So not only were CGS not fixed, they were

costs rising faster than sales. An ABC model helps a company identify when it

has not recovered all the incremental costs associated with an order that has

Analysis

top of the board:

Process

Receive and Store Enter Customer

Orders

Distribute

or Ship

Process

Variety

none manual or electronic commercial or desktop

Receive and Store Enter Customer

Orders

Distribute

or Ship

Process

Variety

none manual or electronic commercial or desktop

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take to pay.

I then describe how to build an ABC model for the three processes performed by

Midwest:

Step 1: Assign costs to processes

I start with the warehouse process to receive and store a carton:

(a) (1)

Q: What does it cost to process a carton through the distribution center?

The cost of the warehouse personnel is calculated by subtracting the cost of the

operating the warehouse.

1. Cost of process: $2,320,000 + 2,000,000 = $4,320,000

You should ask what assumption is made by this calculation. The answer, of

course, is that all cartons place the same demands on warehouse resources. The

of space

3. Cartons can require different quantities of time by warehouse personnel to

process; as a specific example, a customer order may ask for a less than

Atkinson, Solution Manual t/a Management Accounting, 6E

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All of these complexities can be handled by a slightly more complex ABC

model. The analyst could treat the warehousing function as consisting of two

sub-processes, one for supplying space (cost per cubic meter per day) and one for

supplying warehouse personnel time (cost per hour). In this way, products that

take up much space and stay in storage longer will have higher costs assigned to

them than products packaged in small cartons that turn over quickly in the

warehouse. Similarly, breakpack quantities will have more costs assigned to them

than standard, carton-sized quantities. To introduce such complexity into the case

Q: What else is missing from the calculation of warehousing cost?

We do not have enough information to assign some general and administrative

costs related to warehouse personnel. General and selling (G&S) costs are

reported as a single line item in the income statement, and the project team did

are not. I try to get the class to understand that using percentage markups to

allocate indirect and support costs is indefensible. The percentages bear no causal

relationship back to the cost incurrence. If instructors follow Midwest Office

The instructor has the option to give a little lecturette at this point, pointing out

that a more complete costing model would perform an ABC analysis for each

component of G&S expenses—such as human resources, finance, and

information technology costs—so that the costs of these departments can be more

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make on each of the corporate support departments. The instructor can go back to

(a) (2)

Customer Order Entry

Calculate cost per hour for the resources doing the order entry

1. Cost of resources performing order entry $840,000

2. Capacity of order entry resources: 16  1,500 hours = 24,000

4. Assign costs based on use of resources

Entering a manual customer order:0.150  35 = $5.25/manual order

Validating an EDI order 0.100  35 = 3.50/EDI order

As with the previous discussion (on warehousing costs), the instructor can ask

same amount of time to enter the basic information, independent of the

complexity of the order (other than the number of line items in a manual order).

3 H.T. Johnson and D.A. Loewe, “How Weyerhaeuser Manages Corporate Over head Cost,”

Management Accounting, August 1987, pp. 20–26.