Question

Boston Depot sells office supplies to area corporations and organizations. Tom Delayne, founder and CEO, has been disappointed with the operating results and the profit margin for the last two years. Business forms are mostly a "commodity" business with low profit margins. To increase profit margins and gain competitive advantages, Delayne introduced "Desk-Top Delivery" service. The business seems to be as busy as ever. Yet, the operating income has been declining. To help identify the root cause of declining profits, he decided to analyze the profitability of two of the firm's major customers: Omega International (OI) and City of Albion (CA).
According to the customer profitability analysis that Boston Depot conducts regularly, Boston Depot has the same amount of total sales with both OI and CA. However, the firm earns a higher gross margin and gross margin ratio from CA than those from the sales to OI, as demonstrated here:

Boston Depot adds a flat 17.5 percent to all sales for expenses incurred in such activities as handling customers' requests, pick-packing, order delivery, warehousing, and data entry. However, not all customers require the same level of services. Operation Manager, Jamie Steel, points out that CA has been a much heavier service user than OI. She shows the following data to support her belief:

Controller Rod Jay has been investigating ways to determine the costs of performing various activities. He summarized his findings:

Steel points out that activities cost money. Two customers who request different service activities most likely are not costing the firm the same.
Required:
1. Using activity-based costing, compute the charges per unit of service activities.۬
2. Using activity-based costing, compute the total distribution costs for each of the customers.
3. Is the City of Albion a more profitable customer?
4. Is Omega International a better customer for Boston Depot?

Answer 1

. Service cost rate per unit of activity.

 

2. Service Cost

 

3. Customer profitability Analysis-Activity Based

 

The above profitability analysis indicates that, under activity-based costing, Omega International, Not City of Albion, is more profitable to Boston Depot. The apparent higher gross margin percentage of the City of Albion relative to the Omega International was the result of not recognizing differences in the service activities requested by different customers under the firm's existing costing system.

City of Albion is a much heavier user of services provided by Boston Depot. Although both customers had the same total sates, City of Albion made more desktop delivery requests in smaller quantities and maintained more inventory by Boston Depot.

 

4. The answer depends on the competitive strategy of the firm. The gross profit margin ratios show that Omega is the better customer of the two. Omega does not use much of the desktop delivery service Boston offers. Most likely Omega is a buyer of "commodity" items and does not need the convenience of desktop delivery. However, Boston's pricing is likely to have incorporated the average cost of desktop deliveries. If Omega realizes that it is paying for services not used, it may buy the commodity it needs elsewhere, unless Boston lowers the price to Omega. All custom-printed business forms by different suppliers are likely to be the same. Delayne wanted to "differentiate" its forms from those of competitors' by offering desktop delivery services. In the long-run, Omega is not likely to be a customer staying with Boston Depot. Boston Depot needs to be prepared to lower the price to Omega. If the firm desires to compete on a differentiation strategy it needs to price accordingly. Boston

 

 

Depot needs to raise prices to City of Albion. If City of Albion is willing to pay a higher price for the convenience of desktop delivery, it is the kind of customer that Delayne wants.