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1. Why was Dakotas existing pricing system inadequate for its current operating environment? profits
only when clients placed large orders for cartons real drop of profit if many clients place small orders
wrong cost determination for individual customers wrong cost determination for new services provided
by DOP (to small charges for the desktop delivery, then the actual cost of it)

2. Develop an activity-base cost system for Dakota Office Products based on Year 200 data. Calculate
the activity cost-driver rate for each DOP activity in 2000.

Activity cost-driver rates:


Activity One: process cartons in and out of the facility Rate=(90% of Warehouse Personnel Expense
+ Cost o Items Purchased)/cartons processed Rate=(90%*2,400,000+35,000,000)/80,000=464.5
$/per carton
Activity Two: the new desktop delivery service Rate=(10% of Warehouse Personnel Expense +
Delivery Truck Expenses)/desktop deliveries Rate=(10%*2,400,000+200,000)/2000=220 $/per carton
Activity Three: order handling Rate=( Warehouse Expenses + Freight)/ number of orders
Rate=(2,000,000+450,000)/(16,000+8,000)=102.08 $/per order
Activity Four: data entry Rate=Order entry expenses/Order lines Rate=800,000/150,000=5.3
orders/per line

3. Using your answer to question 2, calculate the profitability of Customer A and Customer B.

Activity One: process cartons in and out of the facility > Number of cartons ordered

Activity Two: the new desktop delivery service > Number of desktop deliveries

Activity Three: order handling > Number of orders (manual + EDI)

Activity Four: data entry > Number of line items Manufacturing Overheadcost-driver rates

Customer A Customer B Customer A* Customer B*

Activity One 464.5 200 200 92900 92900

Activity Two 220 0 25 0 5500

Activity Three 102.08 12 100 1224.96 102,08

Activity Four 5.3 60 180 318 954 94,442.96 109,562

sing your answer to question 2, calculate the profitability of Customer A and Customer B.

Activity One: process cartons in and out of the facility > Number of cartons ordered

Activity Two: the new desktop delivery service > Number of desktop deliveries

Activity Three: order handling > Number of orders (manual + EDI)

Activity Four: data entry > Number of line items Manufacturing Overhead cost-driver rates Customer
A Customer B Customer A* Customer B*

Activity One 464.5 200 200 92900 92900

Activity Two 220 0 25 0 5500

Activity Three 102.08 12 100 1224.96 102,08

Activity Four 5.3 60 180 318 954 94,442.96 109,562


Profitability: Contribution to general and selling expenses = number of cartons ordered * (general and
selling expenses + Interest expenses)/cartons processed Customer A Customer B Sales 103,000
104,000 Cost of Items Purchased 94,442.96 109,562 Contribution to general and selling expenses,
and profit 200*2,120,000/80,000= =5300 5300 Profit 3257.04 - (10,862) 4. What explains and
difference in profitability between the two customers? method of delivery (customer B chooses much
more expensive delivery for 50 cartons) - Number of orders made by different number of clients a)
Customer A had 12 customers placing an order for 200 cartons b) Customer B had 100 customers
placing an order for 200 cartons More different customers placing orders means much higher costs
(cost per order is $102.08). So Customer A spend $1224.96 and Customer B spend $102,08 which is
$8983.04 more money spent on Customer B. 5. What are the limitations, if any, to estimates of the
profitability of the two customers? - Lack of information about distance taken for desktop delivery, so
we cant compute Delivery per Labor Hour because each time there is different distance form the
warehouse which makes different cost per delivery. 6. Is there any additional information you would
like to have to explain the relative profitability of the two customers? - Hours spend on delivery which
means Delivery per Labor Hour - To now the wages or number of personnel - Number of personnel
working in each activity (for example if all orders going to be place thru EDI then we can know how
many employees we can fire. 7. Assume that Dakota applies the analysis done in question 3 to its
entire customer base. How could such information help the Dakota managers increase company
profits? - If they would apply to analysis from question 3 the managers would discover that delivery
cost is incorrect and the price for desktop delivery should be higher or abdicative to the distance
where the order is placed. Make higher prices and for the customers who are placing big orders there
should be a discount to eliminate high number of customer placing small orders. - Correct the cost of
whole process by determining direct labor hour. 8. Suppose that major customer switched form
placing all its orders manually to placing all its orders over the interest site. How should this affect the
activity cost driver rates calculated in question 2? How would the switch affect Dakotas profitability? It
would affect Activity One: process cartons in and out of the facility and the driver-cost rate would
change. Rate=EDI Orders/EDI Labor Hours Rate=8,000/500=16 orders/per hour So we would have
spend Total Orders/Orders per hour = 24,000/16=1500 hours of work and when we compare to
10,000 hours spend before we have worked 8,500 hour less so its 85% less money we spend on
wages. It also would affect the Activity Four: Data Entry because while using EDI costs would reduce
and so the same cost per line would decrees. The Profitability would be much higher because two out
of four allocation base activity cost would decline so each customer would improve the profit and also
number of customers placing small orders wouldnt affect that dramatically the profit. Also there
should be bather way of collecting bills from customers so that the interest rate from credit wouldnt
affect the yearly profit. Bibliography: 1. Dakota Office Products Study Case Harvard Business School
DAKOTA OFFICE PRODUCTS: A CASE STUDY Dakota Office Products, hereafter referred to as
DOP, is a regional distributor of office supplies to institutions and commercial businesses. DOP
operates several distribution centers where they store office supplies which are then delivered to the
customers when requested. Up until now, the bulk of DOP shipments have been made by commercial
truckers. Recently DOP added a new service called desk top option where they deliver packages
directly to individual locations at the customers site for which they charge a small premium of 2%.
DOP believes that the added premium could improve the margins of the company. In addition, in 1999
DOP implemented a system called electronic data interchange (EDI) followed by a new internet site in
2000. Use of EDI allowed for automated orders which saved data processing time. However, even
with the use of the updated internet site, use of EDI, and added business on the desk top orders,
DOPs costs continued to rise. As a result of continued rising costs, John Malone, the General
Manager, asked his controller and director of operations to help him evaluate the current business
operations and recommend future actions. ANALYSIS OF CURRENT SITUATION The controller and
the director of operations, Melissa Dunhill and Tim Cunningham, went into the field to determine the
cause behind continued rise in costs. First, they asked themselves why was Dakota's existing pricing
system inadequate for its current operating environment? They determined that Dakota only profited
when the clients placed large orders. They also determined that real drop in profit occurred if many
clients placed small orders. In addition, they believe they need a better structure for determining cost
on products since they are losing money while their cost of keeping staff, rent, delivery have gone up.
In particular, they determined that they need to look at re-structuring the cost of the new services such
as desktop delivery. While the desktop service attracts new customers, inadequate mark-up of up to
2% for delivery does not cover the costs of providing the service. Another possible area to change is
the cost determination for the individual customers. To test out the current pricing margins, they
looked at Activity Based Cost System to analyze the 2000 data. Then, utilize the Activity Based Cost
System to compute the allocation rates for each of the identified cost pool and associated cost drivers
for the activity. In doing so, they can determine what areas should assume greater allocation rates
and which areas should not get the additional allocation. DOP has four main activities that cause
overhead to be incurred. The activities are: driver rates to process carts in and out of facility, new desk
top delivery service, order handling, and data entry. Calculations are as follows: Activity 1: process
cartons in and out of facility (90% of warehouse personnel + cost of items purchased ) / cartons
purchased (90% x 2,400,000 + 35,000,000) / 80,000 = $464.5 per carton Activity 2: New desk top
delivery service (10% of warehouse personnel + Delivery Truck Expenses) / desktop deliveries (.10 x
2,400,000 + 200,000) / 2000 = $220 per carton Activity 3: order handling (warehouse expenses +
freight) / number of orders (2,000,000 + 450,000) / (16,000 + 8,000) = $102.08 per order Activity 4:
data entry: order entry expenses / order lines 800,000 / 150,000 = 5.3 order per line In order to
understand the customer profitability, they next looked through the customer accounts and found two
typical accounts of similar size and activity volume. Both customer A and B generated sales of slightly
over $100,000 with the identical cost of the products ordered of $85,000 (See Exhibit 3). Additionally,
they noted that customer A generally paid their bills within 30 days while customer B often took in
excess of 90 days or more. The profitability difference between Customer A and Customer B is the
cost of desktop deliveries, manual orders and manual entry of those orders. Company B utilizes
desktop delivery service at a cost of $220 per carton versus the commercial shipment at $52 per
carton. Customer B placed several small manual orders which places large amount of labor for
manual entry of those orders. Profitability calculated below show that customer A provided a profit of
$3,257.04 and customer B cost DOP $10,862. Activity 1: Process cartons in and out X number of
cartons Activity 2: New Desk top service X number of desk top deliveries Activity 3: Order handling X
number of orders Activity 4: Data Entry X number of line items Activity 1: Customer A Total Customer
B Total Customer Customer 464.5 x 200 92,900 464.5 x 200 92,900 A: 94,442.96 B: 109.562 Activity
2: 220 x 0 0 220 x 25 5,500 Activity 3: 102.08 x 12 1,224.96 102.08 x 100 10,208 Activity 4: 5.3 x 60
318 5.3 x 180 954 Profitability: General and selling expenses = number of cartons ordered x (general
selling expenses + interest expenses) / cartons processed Customer A Customer B Sales 103,000
104,000 Cost of items purchased (94,442.96) (109,562) General/Selling/Interest (5,300) (5,300) Total
Profit 3,257.04 (10,862) The difference in the profitability between customer A and customer B can be
explained by the method of the delivery where the customer B orders much more expensive delivery
method for 50 of their cartons and the number of orders made by different number of clients.
According to Exhibit 3, customer A had 12 orders for 200 cartons whereas customer B had 100
manual orders for 200 cartons. More customers placing orders drive much higher costs. Using cost
per order of $102.08, customer A cost is $102.08 x 12 and $102.08 x 100, customer A cost is
$1224.96 and customer B is $10,208, difference in cost of $8983.04. The calculations done for
customer A and customer B have built-in limitations in estimating the profitability of two customers.
Customer A did not have any desktop deliveries while customer B had 25 desktop deliveries. There is
no information regarding the distance taken for desktop deliveries from the warehouse, so delivery per
labor hour cannot be calculated. And since many of these deliveries for customer B is desktop
deliveries, there is no way to determine the cost per delivery. To further calculate the actual cost of the
deliveries, some additional data is desirable. They are: hours spent on delivery or delivery per labor
hour, wages and number of personnel working on each step in the order delivery or order processing,
and number of personnel working in each activity. If all orders were to go through EDI, it would enable
us to determine the number of employees that can be redeployed elsewhere. If profitability analysis
was performed on the entire customer base for DOP, the DOP managers can use the information to
help increase company profits. First, they would be able to discover that delivery cost needs to be
restructured to reflect the distance driven for the delivery. They could also consider giving price breaks
to customers ordering in larger quantities in smaller number of orders and possibly consider raising
the price structure to reflect the cost of processing on customers ordering large number of smaller
quantity orders. Additional analysis should be completed to determine the amount of cost savings if a
major customer switched how they placed orders, such as placing orders via the internet site rather
than manually. This will affect Activity 1, process cartons in and out of facility. Rate = EDI Orders/EDI
Labor Hours Rate = 8,000/500 = 16 orders/hour Total Orders/Orders per hour = 24,000/16 = 1500
hours. Total hours spent would decrease from 10,000 hours to 1,500 hours, a change of 8,500 hours
which translates into 85% less spent on salaries. The change to placing orders over the internet site
would also affect Activity 4, data entry. Using EDI would reduce the cost of data processing leading to
cost per line decrease. Overall, two out of four allocation base activity cost will decline, profitability will
increase. RECOMMENDATIONS It is our recommendation that Dakota Office Products utilize the
Activity Based Cost system for allocating costs. An approach of this type will allocate costs
appropriately across the cost pools and reduce the impact of desktop delivery on company profits.
Dakota Office Products should also campaign to encourage use of internet ordering system to better
utilize EDI which will decrease the order processing time and will help in ensuring less mistakes are
made when keying in manual entries. Dakota Office Products should also consider changing its
payment policies to collect accounts receivable balances in a timely manner. Possible consideration
may be change the policy to payments due net 30 days from the receipt of the order. This will help
increase the cash at hand at Dakota Office Products. If Dakota Office Products determine that they
will continue to provide desktop delivery service, they should base the cost on the Activity Based Cost
system. In addition, we also recommend that minimum order requirements be established for the
desktop delivery orders. Exhibit 1 Dakota Office Products: Income Statement CY2000 Sales
42,500,000 121.4% Cost of Items Purchased 35,000,000 100.0% Gross margin 7,500,000 21.4%
Warehouse Personnel Expense 2,400,000 6.9% Warehouse Expenses (excluding personnel)
2,000,000 5.7% Freight 450,000 1.3% Delivery Truck Expenses 200,000 0.6% Order entry expenses
800,000 2.3% General and selling expenses 2,000,000 5.7% Interest expense 120,000 0.3% Net
Income Before Taxes (470,000) -1.3% Exhibit 2 Customer Profitability Report (Current Method)
Customer A Customer B Sales 103,000 121.2% 104,000 122.4% Cost of Items Purchased 85,000
100.0% 85,000 100.0% Gross margin 18,000 21.2% 19,000 22.4% Warehousing, Distribution and
Order Entry 12,750 15.0% 12,750 15.0% Contribution to general and selling expenses, and profit
5,250 6.2% 6,250 7.4% Exhibit 3 Services Provided in Year 2000 to Customers A and B Customer A
Customer B Number of cartons ordered 200 200 Number of cartons shipped commercial freight 200
150 Number of desktop deliveries 25 Number of orders, manual 6 100 Number of line items, manual
60 180 Number of EDI orders 6 - Average accounts receivable $9,000 $30,000