Chapter 5

Activity-Based Costing and Management

Teaching Notes for Cases

5-1 Blue Ridge Manufacturing (Activity-Based Costing for Marketing Channels)

Case Description:

Blue Ridge Manufacturing produces and sells towels for the U.S. “sport towel” market. A “sport towel” is a towel that has the promotion of an event or a log printed on it. Most often they are used in connection with major sporting events such as the Super Bowl.

Case Writers: Paul E. Juras and Paul A. Dierks, Wake Forest University; written for the IMA 1994 Student Case Competition

Teaching Objectives:

The main teaching objective of the case is to illustrate, with an extensive numerical exercise, the use of value chain analysis for profitability analysis. The analysis follows an ABC model, in which selling and administrative costs are allocated to customer groups for the purpose of analyzing customer profitability.

Main Points:

Activity-Based Costing

Value Chain Analysis

Customer profitability analysis

Discussion Questions:

1. What is Blue Ridge’s competitive strategy?

The current strategy appears to be a combination of focus (on the southeast states) and cost leadership. The manufacturing is in a modern plant with upgraded facilities, including the use of ABC costing for manufacturing costs and the commitment to introducing advanced manufacturing techniques. This suggests a commitment to efficiency and large volume production, which is characteristic of cost leadership firms. Because the product is much like a commodity, unless Blue Ridge has exclusive rights from the sports teams, it is unlikely they are competing on differentiation.

However, with the introduction of new ink that is non-toxic and won’t wash out, the firm appears to be moving to a differentiation strategy. Further evidence of this is the firm is “going national,” it will focus more on quality, and is interested in identifying the least profitable customers. All this suggests efforts to differentiate the firm from its competitors.

The case does not provide sufficient information for a thorough strategic analysis. However, the student’s should be expected to identify strategic issues, as noted above, and also:

a) Is the new ink patented? How soon are competitors expected to meet this new innovation?

b) Are Blue Ridge’s licenses with the sports teams of unique value, or do competitors have the same access as Blue Ridge?

c) How strong are Blue Ridge’s ties to its customers, especially the large customers? Are these ties sufficiently strong to protect against competition for the next few years?

d) Has Blue Ridge integrated the marketing and manufacturing strategies, so that they are consistent? Given the changes in both manufacturing (new ink) and marketing (going national, seeking more profitable customers), the integration of these functions is important.

2. What type of cost system does Blue Ridge use, and is it consistent with their strategy?

The ABC costing system in use is consistent with the cost leadership strategy. It will also assist the firm in identifying the most profitable customers, as the firm moves to a differentiation strategy based on quality and innovation.

3. What is Blue Ridge likely to gain from a value chain analysis? What are some of the opportunities for cost reduction and for value added for the customers?

The value chain analysis can help Blue Ridge better understand its competitive advantage and to identify opportunities for improving its competitive position.

Blue Ridge occupies the second, third and fourth value activities of a five-activity chain - knitting, ink-dye-embroidery, and marketing-distribution:

A study of the value chain raises issues for possible cost reduction and value added.

Cost reduction:

- Can Blue Ridge obtain better terms or prices from its suppliers? Materials cost represents a large share of total manufacturing cost.

- Use profitability analysis (as illustrated in the computer exercise below) to determine the “full” costs of each product line and customer group as a basis for identifying and focusing on the most profitable product lines and customers.

- Further analyses to identify the cost drivers in manufacturing, marketing and distribution:

- Customer service requirements

- Order frequency

- Delivery frequency

- Geographic location

- Technical support requirements

(Does Blue Ridge do design or other service for any of the customers, and if so are they properly charged to the customer?)

Value Added for Customers

- Develop service links with the larger customers, as in the case of Proctor and Gamble and Wal-Mart; where the retailer and manufacturer share data so that the manufacturer knows when, where and what to restock at the retailer’s various locations

- Faster delivery, better coordination with all customers, especially the largest ones

- Identify new ways to improve customer satisfaction

- Identify new ways to boost demand at the retail level

Computer Assignment:

Develop a spreadsheet analysis, which can be used to assess the profitability of the three customer groups of Blue Ridge -- large, medium and small customer account size. Use the information in Tables 1-4 to trace and allocate the costs necessary for the analysis.

The solution is shown on the attached spreadsheet. The solution process involves three stages:

Stage 1: Allocate SG & A Costs to SG & A Activities.

1.  Collect all SG & A costs incurred in each function (Shipping, Sales, Marketing) as showed in Table 4A of the case.

2.  For each function, collect usage % for each activity (Entering P.O., Commissions, Shipping, Invoicing, Making Sales Calls, Checking Credit, Samples & Catalog Information, Special Handling, Distribution Management, Marketing by Customer Type, Advertising & Promotion, Marketing, Administrative Office Support, and Licenses & Fees) as shown in 4A.

3.  Then, allocate function costs to activities by usage %.

Stage 2: Allocate activity costs to Customer Type (Large, Medium, Small).

1.  Identify cost drivers (as shown in Table 4) and their consumption statistics for each customer type (as shown in Table 1).

2.  Calculate cost driver consumption % for each customer type.

3.  Allocate activity costs to customer type.

Stage 3: Customer Profitability Analysis.

1.  Calculate revenues for each customer group (sales quantities from Table 1 and unit prices from Table 2).

2.  Calculate manufacturing cost (Regular, Mid-size, Hand, Special), customizing cost (Inking, Embroidery, Dyeing), SG & A cost and total costs for each customer group (using data from Tables 1 & 2).

3.  Calculate customer profits ($102,661, $49,742, -$4,828) and profit per customer ($12,833, $323, -$6) for each customer type.

Note that the analysis makes it clear the group of large customers provide most of the profits for Blue Ridge. Show how the cost of purchase orders, shipping, the medium and small customer groups predominantly cause credit checks, advertising, and marketing. The analysis shows clearly that these two groups, on a per customer basis, are marginally profitable. This analysis indicates that Blue Ridge should concentrate on its largest customers and/or determines how to make its smaller customers more profitable. This is especially important if the firm is planning to “go national” and this may bring in an even larger portion of medium and smaller customers.

Blue Ridge Manufacturing
First Stage Allocation: Allocate SG&A Costs to SG&A Activities
First: SG&A Costs / Total
Assigned
Shipping / Sales / Marketing / Other / Source
Administration / 17,000 / 37,400 / 20,400 / 56,100 / 130,900 / Table 3
Selling / 15,500 / 117,800 / 9,300 / 12,400 / 155,000 / Table 3
$32,500 / $155,200 / $29,700 / $68,500 / $285,900
Percentage of...
Second: SG&A / Shipping / Sales / Marketing / Other
ACTIVITIES
Enter P.O. / 55% / 10% / Table 3
Commissions / 10% / "
Shipping / 65% / 15% / "
Invoicing / 20% / "
Sales Calls / 30% / 10% / "
Check Credit / 10% / "
Samples... / 5% / 10% / "
Sp Handling / 5% / 5% / "
Distribution / 10% / 10% / "
Marketing, Customer / 5% / "
Advertising / 30% / "
Marketing / 15% / 50% / 5% / "
Administrative / 20% / "
Licenses, fees / 0% / 5% / "
TOTAL / 100% / 100% / 100% / 100% / "
Third: Allocate Costs to Activities
Shipping / Sales / Marketing / Other / Total Assigned
ACTIVITIES
Enter P.O. / 0 / 85,360 / 0 / 6,850 / 92,210
Commissions / 0 / 15,520 / 0 / 0 / 15,520
Shipping / 21,125 / 0 / 0 / 10,275 / 31,400
Invoicing / 0 / 0 / 0 / 13,700 / 13,700
Sales Calls / 0 / 46,560 / 0 / 6,850 / 53,410
Check Credit / 0 / 0 / 0 / 6,850 / 6,850
Samples,... / 1,625 / 0 / 2,970 / 0 / 4,595
Sp Handling / 1,625 / 0 / 0 / 3,425 / 5,050
Distribution / 3,250 / 0 / 2,970 / 0 / 6,220
Marketing, Cust / 0 / 7,760 / 0 / 0 / 7,760
Advertising / 0 / 0 / 8,910 / 0 / 8,910
Marketing / 4,875 / 0 / 14,850 / 3,425 / 23,150
Administrative / 0 / 0 / 0 / 13,700 / 13,700
Licenses, fees / 0 / 0 / 0 / 3,425 / 3,425
TOTAL / $ 32,500 / $155,200 / $29,700 / $68,500 / $285,900 / Table 3
Second Stage Allocation: Allocates SA&A Activities to Customer Type (Large, Medium, Small)
First: Identify Cost Driver and Its Consumption Level or Amount
Customer Type...
COST DRIVER / Large / Medium / Small / Total
Units sold- w/o specials / 99,770 / 55,118 / 116,812 / 271,700
Units sold-Total / 100,250 / 58,544 / 117,406 / 276,200 / Table 1
Units embroidered / 5,959 / 6,490 / 29,394 / 41,843 / "
Units dyed / 20,536 / 9,935 / 12,328 / 42,799 / "
Orders / 133 / 845 / 5,130 / 6,108 / "
Shipments / 147 / 923 / 5,431 / 6,501 / "
Invoices / 112 / 754 / 4,737 / 5,603 / "
%>60days / 1 / 11 / 122 / 134 / "
Revenues (Sales Value) / $308,762 / $183,744 / $318,024 / $810,530 / "
Customers / 8 / 154 / 824 / 986 / "
Second: Calculate Cost Driver Percentage for Each Customer Type
Units sold (excl. Special) / 0.367 / 0.203 / 0.430 / 1.000 / From above
Orders / 0.022 / 0.138 / 0.840 / 1.000 / From above
Shipments / 0.023 / 0.142 / 0.835 / 1.000 / From above
Invoices / 0.020 / 0.135 / 0.845 / 1.000 / From above
%>60days / 0.007 / 0.082 / 0.910 / 1.000 / From above
Revenues / 0.381 / 0.227 / 0.392 / 1.000 / From above
Customers / 0.008 / 0.156 / 0.836 / 1.000 / From above
Third: Allocate Activity Costs to Customer Type / Cost Driver/ Allocation Base
ACTIVITIES / Total Cost / Large / Medium / Small / (Table 4)
Enter P.O. / 92,210 / 2,008 / 12,757 / 77,446 / Orders
Commissions / 15,520 / 15,520 / Revenues (Medium Customers only)
Shipping / 31,400 / 710 / 4,458 / 26,232 / Shipments
Invoicing / 13,700 / 274 / 1,844 / 11,583 / Invoices
Sales Calls / 53,410 / 53,410 / Revenues (Large
Customers only)
Check Credit / 6,850 / 51 / 562 / 6,237 / %>60days
Samples... / 4,595 / 1,750 / 1,042 / 1,803 / Revenues
Sp Handling / 5,050 / 1,010 / 4,040 / Estimate (20% M, 80% S)
Distribution / 6,220 / 2,369 / 1,410 / 2,441 / Revenues
Marketing, Cust / 7,760 / 2,956 / 1,759 / 3,045 / Revenues
Advertising / 8,910 / 2,228 / 6,682 / Estimate (25% M, 75% S)
Marketing / 23,150 / 8,501 / 4,696 / 9,953 / Units sold (Excluding Specials)
Administrative / 13,700 / 5,031 / 2,779 / 5,890 / Units sold (Excluding Specials)
Licenses, fees / 3,425 / 3,425 / Revenues (Medium Customers only)
TOTAL / 285,900 / 77,060 / 53,490 / 155,350 / AA
Third Stage: Customer Profitability Analysis
First: Get Revenues by Customer Group
Unit Sales / Large / Medium / Small
Regular / 27,250 / 16,600 / 10,550 / 54,400 / Table 1
Midsize / 36,640 / 18,552 / 10,308 / 65,500 / "
Hand / 35,880 / 19,966 / 95,954 / 151,800 / "
Special / 480 / 3,426 / 594 / 4,500 / "
Total / 100,250 / 58,544 / 117,406 / 276,200
Revenue / Price / Large / Medium / Small
Regular / $ 3.60 / 98,100 / 59,760 / 37,980 / 195,840 / Table 2
Midsize / $ 3.20 / 117,248 / 59,366 / 32,986 / 209,600 / "
Hand / $ 2.55 / 91,494 / 50,913 / 244,683 / 387,090 / "
Special / $ 4.00 / 1,920 / 13,704 / 2,376 / 18,000 / "
Total Revenue / $308,762 / $183,744 / $318,024 / $810,530 / BB
Second: Calculate Manufacturing Cost --
(1) Unit Cost
Regular / $ 1.19 / 32,428 / 19,754 / 12,554 / 64,736 / Table 2 x Table 1
Midsize / $ 1.03 / 37,739 / 19,109 / 10,617 / 67,465 / "
Hand / $ 0.89 / 31,933 / 17,770 / 85,399 / 135,102 / "
Special / $ 1.44 / 691 / 4,933 / 855 / 6,480 / "
Total / $102,791 / $61,566 / $109,426 / $273,783 / CC
Direct Cost of Customizing / Unit Cost
Inking (Units x 2) / $ 0.0817 / 16,381 / 9,566 / 19,184 / 45,131 / Table 2 x Table 1
Embroidery / $ 1.2770 / 7,610 / 8,288 / 37,536 / 53,434
Dyeing / $ 0.1100 / 2,259 / 1,093 / 1,356 / 4,708
$26,249 / $18,947 / $58,076 / $103,272 / DD
(2) Total Cost
Mfg Cost / $102,791 / $61,566 / $109,426 / $273,783 / From CC above
Customizing / $26,249 / $18,947 / $58,076 / $103,272 / From DD above
SG&A / 77,060 / 53,490 / 155,350 / $285,900 / From AA above
Total Cost / $206,101 / $134,002 / $322,853 / $662,955 / EE
Third: Calculate Customer Profit -- / $102,661 / $49,742 / $(4,828) / $147,575 / BBEE
(1) Total
(2) Per Customer / $12,833 / $323 / $(6) / $150


5-2 Blue Ridge Manufacturing (Using SAS Activity-Based Costing Software)