ALLIED OFFICE PRODUCTS

Submitted by: Group-2 Mayank Pandey Nishant Kumar Savita Soni Varun Pai

Allied Business Forms Division

February 9, 2007

BACKGROUND
Annual

sales of $900 million Forms Manufacturing

Business forms Specialty paper

Business

Forms Inventory Management Services - Total Forms Control (TFC)

Warehousing Inventory financing Forms usage reporting Inventory control Distribution
(Pick pack & desktop delivery)

Allied Business Forms Division

February 9, 2007

BACKGROUND

TFC Inventory Storage

10 distribution centers

Pricing
Clients charged flat monthly fee on product cost plus 32.2%, regardless of level of service Covers warehousing, distribution, cost of capital for inventory & freight expense (based on 1990 aggregated financial data)

Profit Margin
Sales force charges average of 20% of product & services; individual accounts can vary from standard formula

Allied Business Forms Division

February 9, 2007

BACKGROUND
VALUE CHAIN CONCEPT - TFC
Industry Chain
Customer Purchasing Manager

Trees

Pulp Paper

Forms Mfg.

Forms Sales

TFC

Customer Receiving

Forms User

The TFC Chain

Storage & Inventory Financing Requisitioning Stock Selection & Pick Pack Order Entry & Billing Desk Top Delivery Freight

ISSUES FACED BY ALLIED

The Business Forms Division in 1988 earned a 20 percent Return on Investment (ROI). But returns have been dropping for several years. TFC is projected to earn an ROI of only 6 percent for 1992. TFC profitability was suffering in October 1992. It tells that Allied is not managing this business very well. It seems that the charge for services needs closer scrutiny Customer Profitability. Not all customers are profitable but very often without ABC, it is very difficult to know which ones are profitable. Pricing. Charges for services needed closer scrutiny. It is not fair for two clients who buy the same amount of

CURRENT COST ACCOUNTING SYSTEM

Forms manufacturing and TFC activities are separate profit centers. Transfer of product to TFC is at arms length with transfer price set at fair market value. Clients in forms management program keep an inventory of forms at one of Allieds 10 distribution centers. The forms are distributed to the client as needed. If a TFC client made use of any of the distribution services, they were supposed to be charged a price for the forms which was high enough to allow for an additional 32.2% of product cost to cover warehousing and distribution expenses. The cost of capital is tied up in inventory and freight expense.

CURRENT COST ACCOUNTING SYSTEM

DISTRIBUTION CENTER ACTIVITY ANALYSIS

Identified and reviewed six primary activities across five distribution centers
-Storage -Requisition handling -Basic warehouse stock selection -Pick-pack activity -Data entry -Desktop delivery

Interviews with key staff

Site Manager Warehouse Supervisor Data Entry Operator

Conducted activity cost analysis

Identify cost drivers

Q1. Using the information in the text and in Exhibit 2, calculate ABC based service costs for the TFC business.
Tim and John assigned costs to these below activities as follow for a sample of five of the distribution centers : Activity Cost $ Cost Driver

Storage Requisition Handling Basic Warehouse Stock Pick-Pack Activity Data Entry Desk top delivery
Total

$ 1,550 Number of Cartons $ 1,801 Number of Requisitions $ 761 Number of Requisition Lines $ 734 Number of Pick and Req. Lines $ 612 Number of Requisition Lines $ 250 Number of Desktop Deliveries
$ 5,708

Tim then estimated the following for 1992 based upon historical information and current trend for the sample of five warehouses : On average, these 5 distribution centers scattered across the country, will have combined inventories of approximately 350,000 cartons ( most cartons were of fairly standard size ) They will process about 310,000 requisitions for 1992 Each requisition will average 2.5 lines About 90% of the lines will require pick-pack activity ( as opposed to shipping an entire carton) Cost of capital in 1992 was probably about 13%

ANALYZE THE COST USING ACTIVITY BASED SYSTEM

TFC management called ABS based pricing system SBC ( Service Based Pricing ). An accounting method that identifies the activities that a firm performs, and then assigns indirect costs to products. An activity based costing (ABC) system recognizes the relationship between costs, activities and products, and through this relationship assigns indirect costs to products less arbitrarily than traditional methods.

The calculation using ABS system : Storage Charge = $ 1.550.000 = $ 4,43 / carton 350.000
310.00

Requisition Handling Charge = $ 1.801.000 = $ 5.81 / requisition Basic warehouse = stock selection $ 761.000
310.000 * 2.5

= $ 0.91 / line

 Data Entry = $ 612.000 = $0.79 / line

310.000*2.5

Charge for pick-pack = $ 734.000

310.000*2.5*0.9

= $ 1.05

Charge for Desk Top Delivery = $ 250.000 = $ 29.41 8500 - Freight out is charged based on actual rates - Cost of inventory financing is 13% of average inventory balance - Inactive inventory will be charged 1.5% / month after 9 month

Q2. Using your new costing system, calculate distribution services costs for customer A & customer B

ACTIVITY BASED COST ANALYSIS

Cost Driver
Number of Cartons Number of Requisitions Number of Requisition Lines Number of Pick and Req. Lines Number of Requisition Lines Number of Desktop Deliveries
350 364 910 910 910 0

Activity
Storage Requisition Handling Basic Warehouse Stock Delivery Pick Pack Data Entry Desk Top Delivery

Customer A Customer B
700 790 2500 2500 2500 26

ACTIVITY BASED COST ANALYSIS

Activity
Storage*

Current

Activity Based Activity Based Customer A Customer B

$1,550.50 $3,101.00

Requisition Handling
Basic Warehouse Stock Delivery Pick Pack Data Entry Desk Top Delivery Subtotal ABC Freight Cost of Capital Total $10,250 $3,500 $2,350 $16,100

$2,114.84
$891.80 $955.50 $718.90 $0.00 $6,231.54 $2,250 $1,950 $10,432

$4,589.90
$790.00 $2,625.00 $1,975.00 $764.66 $13,845.56 $7,500 $6,500 $27,846

ACTIVITY BASED COST ANALYSIS

Activity
Sales Product Cost Distribution/Services (32.2%) ABC Return on Sales ($) Return on Sales (%)

Current
$79,320 $50,000 $16,100 ---$13,220 16.7%

Customer A
$79,320 $50,000 ---$10,432 $18,888 23.4%

Customer B
$79,320 $50,000 ---$27,846 $1,474 1.9%

*Storage for customer A is for 350 units of inventory while for customer B it is for 700 units of inventory. In case only storage charges and average inventory balance is given and no info for inventory charges. Thus only storage considered

Q3.WHAT INFERENCE DO YOU DRAW ABOUT THE PROFITABILITY OF THESE TWO CUSTOMERS?
Company A costs Allied less money to service, they are also a much smaller source of potential growth for the company. Company B on the other hand utilizes far more services and has the potential to earn Allied much greater revenue. With the information we have from the new ABC costing scheme we now know that Allied should be charging far more for the services rendered to company B, and less for the services used by company A. Current information shows that company B utilizes $11.746 more in service costs than we were previously charging them, while company A is utilizing ($5.668) less.

Q4 : SHOULD TFC IMPLEMENT THE SBP (SERVICE BASED PRICING) PRICING SYSTEM?
Yes TFC should implement SBP pricing system because its not fair amount for the customer who does not put too many thing in their inventory and constantly request small shipment with the customer who stock a lot of inventory and no constant shipments get charge the same service fees.

Implementing SBP system will cause resistance in the organization, especially from salespeople. We can persuade and give explanation about the purposes and benefits of implementing this new system. ABC system will help management to analyze the profitability of each customer, and hopefully it will restore the profitability of the company. We believe that TFC can significantly improving profit by concentrating on individual account management. This can be done with the help of Services Based Pricing (SBP) scheme in identifying service costs, and then calculating contribution for each account and then ranking the accounts in order to identify the profitable ones.

However, dont drop out the bottom 20 customers, because the total cost is still the same. Do not see the unit cost. The unit cost is unitized fixed cost. If TFC drop out the bottom 20 customers, unit cost will go up because the total cost is spread on the remaining customers. This will cause some of the remaining customers to look unprofitable. So, if TFC drop these customers, the unit cost will be higher. TFC should charge its customers based on their service usage. We suggest TFC used cost plus pricing strategy. It means that the customers should be charged based on the cost of products plus service charge (based on SBP schemes) plus mark-up. So, it will be fair for customers that have the same sales but different level of services to be charged differently, based on the services they used.

THANK YOU