Question

Kronecker Company, a growing mail-order clothing and accessory company, is concerned about its growing MSDA expenses. It, therefore, examined its customer ordering patterns for the past year and identified four types of customers, as illustrated in the following table. Kronecker sends catalogs and flyers to all its customers several times a year. Orders are taken by mail or over the phone. Kronecker maintains a toll-free number for customers to use when placing orders over the phone. Kronecker prides itself on the personal attention it provides shoppers who order over the phone. All purchases are paid for by check or credit card. Kronecker has a very generous return policy if customers are not satisfied with the merchandise received. Customers must pay return shipping charges, but their purchase price is then fully refunded.

	Customer Type 1	Customer Type 2	Customer Type 3	Customer Type 4
Initial sales	$1,000	$1,000	$2,500	$3,000
Number of items returned	0	4	2	24
Dollar value of items returned	0	$200	$500	$1,500
Number of orders per year	1	6	4	12
Number of phone orders per year	1	0	0	12
Time spent on phone placing orders	0.25 hour	0	0	1 hour
Number of overnight deliveries	1	0	0	12
Number of regular deliveries	0	6	4	0

Prices are set so that cost of goods sold averages about 75% of the sales price. Customers pay actual shipping charges, but extra processing is required for overnight deliveries. Kronecker has developed the following activity cost driver rates for its support costs:

Activity	Activity cost driver rate
Process mail orders	$5 per order
Process phone orders	$80 per hour
Process returns	$5 per item returned
Process overnight delivery requests	$4 per request
Maintain customer relations (Send catalogs and respond to customer comments or complaints)	$50 per year

(a) Using ABC, determine the yearly profit associated with each of the four customers described.

(b) Comment on which customers are most profitable and why.

(c) What advice do you have for Kronecker regarding managing customer relationships with the different types of customers represented?

Answer 1

Answer :

(a)

	Customer Type 1	Customer Type 2	Customer Type 3	Customer Type 4
Sales	$1,000	$1,000	$2,500	$3,000
Less returns	0	200	500	1,500
Net sales	$1,000	$800	$2,000	$1,500
Cost of goods sold,   75% of sales	750	600	1,500	1,125
Processing mail orders,   $5 per nonphone order	0	30	20	0
Process phone orders,   $80 per hour	20	0	0	80
Process returns,   $5 per item returned	0	20	10	120
Process overnight   delivery requests,   $4 per request	4	0	0	48
Maintain customer   relations	50	50	50	50
Profit	$176	$100	$420	$77
Profit ÷ Sales	0.18	0.10	0.17	0.03

(b)   

Although customer type 4 has the highest sales, it has the highest dollar returns and the lowest profit. Customer type 3 is by far the most profitable, even though its sales are less than customer type 4’s (but customer type 3’s net sales exceed customer 4’s). Customer types 1 and 2 are more profitable than customer type 4 in total dollars and in percent of sales. Customer type 1 returns the highest profit as a percent of sales, slightly above customer type 3’s ratio. Cost of goods sold represents 75% of sales revenue, so the remaining costs as a percent of sales pertain to each customer’s interaction with the company. Customer type 4 is the most expensive to service because it orders frequently, places orders in a costly manner (one hour on the phone), returns many items, and requests overnight deliveries. Customer type 1 is fairly low-cost to serve in spite of ordering by phone and requesting overnight delivery because this customer type orders only once a year and does not return merchandise. Aside from returns, customer types 2 and 3 are fairly low-cost to serve because they order via mail and request regular delivery rather than overnight delivery.

(c)   Kronecker can seek to reduce the service activity usage or improve efficiency to reduce the cost of providing services. For example, Kronecker might ask customers the reason for returns, and follow up with ways to reduce problems that caused the returns. The company might also explore ways to make phone ordering more efficient, to reduce the time spent on the phone. Kronecker may also charge fees to handle overnight delivery requests.