Case Study on Dakot Office Supply
A Case Study on Dakota Office Supply Case: Dakota Office Products 1.
Background Information Dakota Office Products (DOP) is a regional office supply company with a strong reputation for customer service and quality supplies. Additionally, DOP is unafraid to adopt new services such as its desk top deliver option which delivers smaller orders directly to individual sites as well as its traditional commercial freight delivery.DOP has also introduced and Electronic Data Interchange (EDI) in order to ease data and payment transfer from and to customers as well as building a customer website that acts as an order and account interface for its customers. 2. 1 People/Key Players John MaloneGeneral Manager Melissa DunhillController Tim CunninghamDirector of Operations Wilbur SmithSite Manager Hazel NutleyData Entry Operator 2.
2 Chronology of Key Relevant Events John Malone, General Manager for Dakota Office Products was concerned about the financial results for 2000 since the company just suffered the first loss in company history.Recently, DOP has attracted new business by offering a desk top delivery option which delivers smaller orders directly to customer sites. Dakota charges a small mark up of 2% for this service. DOP has historically priced its products by using a traditional method of cost accounting by marking up purchased products by 15% to cover warehousing, freight, and distribution and then adding another markup to cover general and selling expense plus an allowance for profit.Dakota has also introduced electronic data exchange (EDI) and a new internet site which allowed customer orders to be placed so that clerks would not have to enter customer and order data manually.
Several customers have switched to this method for the convenience but Dakota’s costs have continued to rise. John sent Melissa and Tim into the field to get a clearer picture of the company’s activities and costs. Melissa and Tim met with Wilbur and Hazel at a local DOP site and gathered information concerning all of Dakota’s operating activities and, time to perform activities and costs associated with those activities. . 3 Key Facts Dakota’s net income before taxes for 2000 was ($470,000).
We were also given the facts that Dakota processed 80,000 cartons (75,000 by commercial freight and 5,000 by desk top delivery), 2,000 desk top deliveries during the year, processed 16,000 manual orders, and validated 8,000 EDI orders. The 16,000 manual orders contained nearly 10 items per orders, or 150,000 order lines. 90% of the workers in the distribution center processed cartons while the remaining 10% were assigned to the desk top delivery service.The data entry team worked 10,000 hours in 2000 with 9,500 hours being devoted to setting up manual orders and entering individual order lines in an order. Additionally, we were given a profitability report and services provided comparison on Customer A and Customer B showing comparatively equal dollars of sales, gross margin and profitability between the two customers.
2. 4 Concepts Activity Based Costing (ABC) is an accounting method that allows an organization to determine actual costs associated with each product and/or service produced by the organization without regard to the organizational structure or other function.For Dakota Office Products, its existing traditional costing system is inadequate because it is incapable of accounting for all of the known costs such as the desk top delivery service. ABC is a tool for identifying, describing and assigning costs to an organization’s operation. ABC can also be utilized to identify opportunities to improve business effectiveness and efficiency by determining the true costs of a given product or service.
2. 5 Assumptions Dakota Office Products recently introduced a new delivery system and internet option for customer orders.It is assumed that these new systems are going to continue to be offered by the company. 2. 6 Point of View The point of view of this case comes from the management of Dakota Office Products and their front line employees in determining the cost drivers associated with the products and services of the company.
2. Problem Statement The existing traditional costing system is inadequate for Dakota Office Products because it is incapable of accounting for all of the known costs associated with its products and services. 3. Problem Causal AnalysisSince Dakota uses a traditional method of cost accounting they cannot identify areas of weakness or inefficiency in their pricing and how those inefficiencies translate to lower bottom line profits. 4.
Management Theory, Process, or Approach In implementing an activity-based costing program, Dakota will need to take steps to move away from their current cost accounting method. Ideally, a team of cost accountants and managers would work together to define and implement an ABC program (Latshaw ; Cortese-Danile, 2002).This would entail an analysis of all activities, cost gathering, associating cost with activities, base-lining outputs, and cost analysis to determine the true cost for each activity identified. 5. Recommendation My first recommendation would be to move as many customers as possible over to the internet based ordering and billing system. Approximately 9,500 labor hours can be removed from the current ordering process.
Additionally, the cost drivers of processing manual orders and the manual entry of item would be removed from the cost equation. These two cost drivers are $760,000 of the yearly budget.Considering DOP missed its earnings by ($470,000), this cost savings alone could return the company to profitability. Secondly, if the company plans to continue the desk top delivery option, there must be a higher premium charged for the service than the current 2%. Currently the desk top delivery service is costing nearly four times the amount of traditional commercial shipping.
Finally, the traditional cost accounting method used by DOP does not identify the hidden costs of the 10% DOP paid to maintain its working capital line of credit for accounts receivable.Customer B has maintained an average accounts receivable of $30,000 or nearly 30% of its sales. DOP need to push Customer B for more timely payment on sales. 6. Assessment I believe my recommendation is feasible and realistic for Dakota Office Products to implement immediately.
These recommendations could turn DOP back to a profitably business. Ignoring the costs and inefficiencies brought to light by applying activity-based costing would most likely result in several more years of negative earnings for Dakota. 7. ImplicationsBy implementing these recommendations (raising the premium for desk top delivery, demanding more timely payment of account receivables and working to migrate more customers to internet ordering and billing) Dakota may run the risk of losing some current customers. I believe though, that by running a more lean operation, understanding the cost associated with each activity and working with each customer to attain both a healthy customer relationship as well as a healthy bottom line for DOP, everyone can win. Case Study Questions 1.
Why was Dakota’s existing pricing system inadequate for its current operating environment?For Dakota Office Products, its existing costing system is inadequate because it is incapable of accounting for all of the known costs such as the desktop delivery service. 2. Develop an activity-based cost system for DOP based on Year 2000 data. Calculate the activity cost-driver rate for each DOP activity in 2000. See attached diagram of cost drivers and cost driver rates.
3. Using your answer to Question 2, calculate the profitability of Customer A and Customer B. See attached customer cost diagram. 4. What explains any differences in profitability between the two customers?The added cost of the desktop delivery service, as evidenced by the activity-based costing system as well as the cost of carrying a much larger average accounts receivable for Customer B makes Customer B much less profitable even though the amount of sales to both Customer A and Customer B were nearly identical.
5. What are the limitations, if any, to the estimates of profitability of the two customers? It could be argued that the goodwill created by the additional services (desktop delivery and carrying a larger accounts receivable) for Customer B will result in more customer loyalty, longer service and greater orders in the future. . Is there any additional information you would like to have to explain the relative profitability of the two customers? Perhaps more of an explanation of the average accounts receivable and whether Customer A has any plans to move more of their orders to the desktop delivery method. Are both customers located similar distances from DOP? Is Customer A too far from DOP to utilize desktop delivery? Are Customer B’s accounts receivables always three times the amount of Customer A or was the average skewed is some way? 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? This analysis could assist the managers in identifying areas of weakness in any customer’s profit to DOP’s bottom line. An example might be to migrate a customer from manual orders to internet based ordering which is much less expensive for Dakota. 8. Suppose that a major customer switched from placing all its orders manually to placing all its orders over the Internet site.How would this affect the activity cost driver rates calculated in Question 2? How would the switch affect Dakota’s profitability? As mentioned above, the cost of internet orders is nearly one-third of the cost of manual ordering and the verification of line items of manual orders. This cost savings would directly correlate to increased profitability to Dakota.
References Latshaw, C. A. , & Cortese-Danile, T. M. (2002). Activity-Based Costing: Usage and Pitfalls.
Review of Business, 23(1), 30. Retrieved from EBSCOhost.