First, go through the case carefully to understand how they are coming up with the ABC cost rates in exhibit 8. This case describes the flow of costs in more detail relative to the cases we covered in class. (Real world systems are another order-of-magnitude more complex. In particular, we have to deal with support departments such as maintenance, accounting, IT and payroll that are integral to the functioning of the firm, but do not touch the product directly. We touched upon such a service department allocation in Lakeside Hospitals. We also might have 3- or 4-stage allocation systems.)
Second, crunch some numbers using the excel worksheet provided to you.
- Look at variations in profitability, by order size (without distinguishing across products or customers.). For these computations, begin with the contribution by order size etc., and knock off overhead costs (e.g., customer service, selling support etc.) to arrive at the profit. You might have to make some informed guesses as to how to split each activity up across order sizes.
- Figure out the interaction between products and order size. Prepare a table that replicates the table in (1) above, except that the data focus on just two products – jackets (which are high CM) and tops (which are low CM).
- Figure out the interaction between customers and order size. Again, prepare a table that calculates the profitability of various order sizes for two customers – Nordstrom (which is not profitable) and Dillard’s (which is profitable).
- You can round out the analysis by doing an analysis by customers and by products. Note that we have data only on the top 7 customers.
These data will help uncover patterns and provide evidence on the impact of order size on profitability. This is the ABC part, which is relatively mechanical, albeit data intensive.
The final part is what to do with the data. Here, you have to consider what actions might be taken to reconfigure operations and restore profitability. For example, should Sloan drop Nordstrom? Not take small orders? Avoid private label production? How do these actions square with their strategy and competitive niche? What is the cost impact (some educated guessing might have to occur here as there is not much in the form of solid numbers in the case)? This is the ABM part, which is where we take the data and use it from an operations perspective.
As you do the analysis, please keep the following in mind.
- SS is a distributor. This means that they get a 25-35% contribution on revenue (varies by product / order size and so on), after paying for the cloth and the sewing to the contract firms. The~$12.3MM in costs in SS (detailed in the case) are to be covered out of this contribution. These are the “capacity costs” or overhead that SS incurs ….they have outsourced, basically, all of their variable costs. So, for product analysis, begin with the CM described in exhibit 3; orders will begin with the data in exhibit 4.
- Exhibit 7 and 8 describe the ABC system in SS. Exhibit 7 lists their costs (by category) and how they are distributed to various activities. Exhibit 8 then allocates the costs to the various activities (the columns); this is stage 1 of the system.. At the bottom of each column, a driver rate is computed.
- There are some inconsistencies between note 4 in exhibit 7 and the actual allocations (in exhibit 8) of the associated costs. To ease matters, take the numbers in exhibit 8 as the correct allocation of costs to activities. Do not try to re-do exhibit 8 for the “correct” numbers. There is little value add from this exercise, and this rabbit hole will suck up lots of time.
- There also is rounding in some numbers, when calculating rates. In particular, the admin rate is 6.78% (= $3,263/$48,136), which has been rounded up to 7%. On a base of $48MM, this leads to a $100K differential in totals.Depending on your comfort with approximations, you might wish to use a rate that is more precise. The inferences do not change one bit.
- Three parts comprise the core of the assignment.
- Figuring out how a complex business process can be modeled with a few activities and the development of cost rates for activities. This is just understanding the case and the flow of the data. There is nothing due on this.
- The numerical part is to use the rates (in exhibit 8, refined for approximations if needed) to derive the profit from various product / customers / order sizes (relevant driver data is provided in earlier exhibits).
- The data from the above step provide a consistent message re what is dragging profit down. The Q then is what do we do? What other factors do we need to consider in this context? This part is largely devoid of numbers (it is possible to dummy up a projected income statement that incorporates changes. However, making such a statement requires new assumptions about how capacity costs will change…and is well beyond the scope of this assignment.)
A specific computation
Consider the OH allocated to order sizes less th