Dakota Office Products

Customer Profitability Analysis

Pricing of Products/Services
ABC in Service

What concerned John Malone?

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 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.

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 Lets Find Activities First and
Match With Costs

?
Cost Pools Activity Allocation

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 Activities and Costs
Activities Drivers Costs
Ship Cartons Freight
Process Cartons Warehouse Costs (
Personnel, Rent and Dist)
Delivery to Delivery Truck and
Desktop Warehouse Personnel
Process Manual Order Entry
Custom Order
Enter Items Order Entry
(ordered Manual)
Process EDI Order Entry

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 What is profitability of Customer
A and B?

Spread Sheet

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%

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What explains the difference in
profitability between two
customers?

What are the limitations if any to

the estimates of profitability of
the two customers?

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 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

Is there any additional

information you would like to
have to explain the relative
profitability of the two
customers?

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

Assume that Dakota applies

the analysis done (Customer
Profitability based of ABC) to
its entire customer base. How
could such information help
the Dakota managers
increase company profits?

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• 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

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?

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Sum Up

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