Facts• Paper Products Corp. founded in San

Francisco in the 1800’s• ‘92 flat growth & hard to maintain profit

margins• Introduced TFC in ‘92 by ‘94 $60 million in

sales• Price 32.2% of cost for TFC + 20% markup for

fees

Can anyone talk about Western States’ organizational setup?

TFC & Strategy

• TFC offered competitive differentiation• Value Added Service • Innovative• Customer Retention • Higher Profit Margins + Growth Potential• Customer Service

Existing Accounting System

• 32.2% Service Fee based on Product Cost– Warehousing 20.5%– Financing 4.7%– Trucking 7%

• 20% Mark-up based on Product Cost + Service Fee

Did this system fit their needs?

• No because…– Distribution charges were not appropriate

because their costing system was not accurate– Under the current system customers where

charged the same no matter how many services they used.

So they decided to design a new activity-based system…

Design of New System

• Talked to people in different areas to figure out what activities affected what costs– 85% of facility costs related to storage– 15% of costs used to handle admin of requisition

processing

Labor’s Effect on New System

• Processing of finding and selecting times took 50% of their time

• 40% of time used to deal with pick-pack• 10% of time was used to prepare/handle desk

top delivery shipments

Cost Pools

• Storage• Requisition Handling• Basic Warehouse Stock

Selection Pick-Pack Activity Desk Top Delivery

Activity Based Costing Rates

ABC BASIS COST PER UNIT    

Annual Usage Total

Annual Exp. Cost Per Unit

Requisition handling / Requisitions 310,000 $ 6.93

"Pick-Pack" / “Pick-Pack” lines 700,000 $ 1.11

Storage / Cartons in inventory 350,000 $ 4.64

Interest assume 8% prime rate plus 2% N/A  

Desk Top delivery / Desk Top deliveries 8500 $ 22.82

Basic Warehouse Stock Selection / Carton lines 775,000 $ 1.25

ABC Based Service Cost Per Unit.Cost Per Activity (Per Unit Costing) Customer A Customer B

Requisitions $ 2,521 $ 5,471

Total Lines (All Pick Pack) $ 1,006 $ 2,764

Stored at Warehouse (Cartons) $ 1,625 $ 3,250

Average Monthly Balance $ 1,500 $ 5,000

Desk Top Delivery requests per year $ - $ 593

Annual Shipping Costs $ 2,250 $ 7,500

Total Expenses $ 8,902 $ 24,579

Inferences on Profitability

• Both customers are profitable under the model but customer A nets nearly $15,000 more income than B.

• Customer A is $7,198 more profitable than the initial assumption.

• Customer B is $8,479 less profitable than the initial assumption.

ABC Income Statement

Price Per Unit Income Statement Customer A Customer B

Net Sales $ 79,320 $ 79,320

Product Costs $ 50,000 $ 50,000

Service Cost $ 5,152 $ 12,079

Inventory Financing $ 1,500 $ 5,000

Trucking $ 2,250 $ 7,500

Total Service Cost: $ 8,902 $ 24,579

Gross Profit $ 20,418 $ 4,741

Gross Profit % 26% 6%

Analysis of Customer Profitability

• The top 55 accounts contribute a significant portion of the overall operating income. – Specifically the top 5% contribute 80% of the income.

• The next 145 customers are still profitable and contribute the other 20% of the income.

• The bottom 50% of accounts actually incur expenses to service which reduces income.

Manager Suggestions

• Each customer should be reviewed based on the new pricing model to adjust their profitability.

• Shipping costs should be better tracked per mile and billed to the customer utilizing the new computer system.

• The bottom 50% of accounts which are not generating income should be reviewed and pricing adjusted with the new model to ensure profitability.

Pros of Service Based Pricing

• Accurate depiction of costs• Costs traceable & visible • a la carte services• Customer profitability visible• Sales reps’ profitability and productivity visible• Will make WS more efficient• Requirement to differentiate business • Customer cut back on services may help profitability

Cons of Service Based Pricing

• Customer push back • Sales force push back• Requires education for sales force & customers• Customers may feel they overpaid prior to this• Excellent service becomes more critical• May lose some customers• May need to drop some services (pick-pack)

Suggestions to improve efficiency• Price services based on costs • Use EOQ for raw materials • Warehouse organization, flow-thru racking• Monitor inventory turns, maintain min/max stock levels • Set up separate re-pack line for most frequent items • Computerize and automate • Incentivize customers to order specific day/time• Evaluate w/h productivity, may be able to combine and reduce

from 10 (flex leasing)• Develop delivery charges based on minimum # of cases, mileage,

frequency. Establish delivery windows• Investigate fuel efficient fleet, develop delivery costs • Align sales reps’ compensation with new SBP costing