Atkinson, Solution Manual t/a Management Accounting, 6E

Chapter 6
Measuring and
Managing Customer
Relationships
QUESTIONS
6-1 Nonfinancial measures such as customer satisfaction and customer loyalty are
important in managing relationships with customers, but an excessive focus on
improving customer performance with only these metrics can lead to
deteriorating financial performance. To balance the pressure to meet and exceed
customer expectations, companies should also be measuring the cost to serve
each customer and the profits earned, customer by customer.
6-2 Examples of differences between customers who have high and low costs-to-
serve may be drawn from the chapters Exhibit 6-, part of which appears
below.
High Cost-to-Serve Customers Low Cost-to-Serve Customers
! "rder custom products ! "rder standard products
! #mall order $uantities ! %arge order $uantities
! &ustomi'ed delivery ! #tandard delivery
! (anual processing) high order
error rates
! Electronic processing *E+,-
with 'ero defects
! %arge amounts of pre-sales
support *mar.eting, technical, and
sales resources-
! %ittle to no pre-sales support
*standard pricing and
ordering-
! %arge amounts of post-sales
support *installation, training,
warranty, field service-
! No post-sales support
! /ay slowly *have high accounts
receivable from customer-
! /ay on time *low accounts
receivable-
6-3 &ompanies should not necessarily avoid high cost-to-serve customers. The high
cost of serving such customers can be caused by their unpredictable order
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Atkinson, Solution Manual t/a Management Accounting, 6E
patterns, small order $uantities for customi'ed products, nonstandard logistics
and delivery re$uirements, and large demands on technical and sales personnel.
2ctivity-based pricing may be used to ensure that companies charge prices that
are high enough to cover the high costs of serving such customers. &ustomers
may, in response, change their behavior to become lower cost-to-serve
customers. &ompanies may also improve the process used to produce, sell,
deliver, and service customers in order to improve customer profitability.

6-4 The 34-54 rule as applied to sales revenues refers to the common finding that
when companies ran. products and customers from the highest sales volume to
the lowest, they generally find that their top-selling 546 of products or
customers generate about 346 of total sales.
6-5 The typical shape of a graph of cumulative profits versus percentage of
customers ran.ed from most profitable to least profitable is a 7whale curve,8 in
which the most profitable 546 of customers generate about 346 of total
profits) this is the pea., or hump of the whale above sea level. The middle 646
of customers approximately brea. even, and the least profitable 546 of
customers lose about 346 of total profits, leaving the company with its 446 of
total profits *7sea level8 in the whale curve represents the companys actual
reported profits-. The hump *or maximum height- of a cumulative profitability
curve generally hits 946 to 5946 of total profits, and this height is usually
achieved by the most profitable 546 to :46 of customers.
6-6 #ervice companies, even more so than manufacturing companies, must focus on
customer costs and profitability sales because the variation in demand for
organi'ational resources is much more customer driven than in manufacturing
organi'ations. 2 manufacturing company producing standard products can
calculate the cost of producing the products without regard to how their
customers use them. ,n this sense, the manufacturing costs are customer
independent. "f course, the costs of mar.eting, selling, order handling, delivery,
and service of the products might be customer specific. ;or service companies,
in contrast, customer behavior determines the $uantity of demands for
organi'ational resources that produce and deliver the service to customers.
6-7 &onsider customers who maintain chec.ing accounts at a ban.. "ne customer
may maintain a high cash balance in his chec.ing account) ma.e very few
deposits, withdrawals, balance in$uiries, or service re$uests) and use only
electronic channels *i.e., automatic teller machines and the ,nternet-. 2nother
customer may manage her chec.ing account balance very closely, .eeping only
the minimum amount on hand, and use her account heavily by ma.ing many
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Chapter 6 Measuring and Managing Customer !elationships
small withdrawals and deposits via manual transactions with ban. tellers. The
conse$uence of the customers very different use of the ban.s resources is that
the second customer is much more costly to serve than the first customer.
6-8 The four broad groups of actions that managers might use to transform
unprofitable customers into profitable ones are=
,mprove the processes used to produce, sell, deliver, and service the
customer.
+eploy menu-based pricing to allow the customer to select the features and
services it wishes to receive and pay for.
Enhance the customer relationship to improve margins and lower the cost
to serve that customer.
>se more discipline in granting discounts and allowances.
6-9 2 pricing waterfall chart depicts the multiple revenue lea.s from list price
caused by special allowances and discounts granted to obtain the order and build
customer loyalty.
6-10 #alespersons incentives or compensation plans that set minimum $uotas and
commissions based on sales revenue, and tie bonuses and rewards to achieving
sales revenues above a stretch target contribute to unprofitable customer
relationships. #uch arrangements encourage salespeople to close deals and
generate revenues without regard to the cost of fulfilling the special
arrangements negotiated in the deal and the impact of discounts and allowances
granted to close the deals.
6-11 %ife-cycle profitability analysis weighs the expected value of the stream of a
customers net margins against the cost of ac$uiring the customer. &ompanies
must understand variation of customer demands across multiple products and
services and the expected length of each customers relationship with the
company *given potentially costly retention efforts-, in order to calculate each
customers total life-cycle profitability. The analysis involves identifying
characteristics of profitable customers. &ompanies can then direct their
mar.eting efforts accordingly to specific segments that are most li.ely to yield
and retain profitable customers. 2c$uiring the information necessary for life-
cycle profitability analysis and using this information to calculate life-cycle
profitability thus provides insights about which customer groups are li.ely to be
profitable over the expected life of a customers relationship with the company.
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Atkinson, Solution Manual t/a Management Accounting, 6E
6-12 No. Experts now agree that it is a mista.e for a company to use the satisfaction
score as its only customer metric. 2 customers satisfaction is an attitude or
belief stemming from a feeling that the product or service has generally
delivered on the customers expectation of performance. ?ut having attitudes
and beliefs are not actions) a customers attitude toward a product or a
company does not readily translate into the desired behavior of repeated and
increased purchases of the product or service, or customer loyalty.
6-13 %oyal customers are valuable for several reasons. Three reasons are re$uired in
this $uestion) the chapter lists the following five reasons=
. %oyal customers have a greater li.elihood to repurchase, and the costs to
retain them are generally much lower than the cost to ac$uire an entirely
new customer.
5. %oyal customers can persuade others, through word of mouth, to become
new customers) they can become references for potential future customers.
@. %oyal customers are less li.ely to defect when a competitor offers a similar
product at the same or slightly lower price.
:. %oyal customers are often willing to pay a price premium to retain a .nown
and trusted relationship with a .ey supplier.
9. %oyal customers are willing to collaborate with the supplier to improve
performance and develop new products.
6-14 &ustomer retention rate, though a traditional customer loyalty metric, is a poor
indicator of a customers loyalty. This is because customers often remain with
their current supplier because of inertia, high switching costs, or the current
lac. of an alternative supplier.
6-15 The five stages of a hierarchy for categori'ing customer satisfaction and loyalty
are=
. #atisfied customers, as measured by how well a customers expectations
have been met or exceeded in an individual transaction or long-term
relationship.
5. %oyal customers, as measured the customer devoting an increasing 7share
of wallet8 for repeat purchases from the same supplier.
@. &ommitted customers, those who not only purchase fre$uently from the
supplier but also tell others about the suppliers great products and service.
:. 2postle customers, committed customers who have credibility and authority
when they recommend the supplier to friends, neighbors, and colleagues.
9. &ustomer 7owners,8 who ta.e responsibility for the continuing success of
the suppliers product or service.
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Chapter 6 Measuring and Managing Customer !elationships
2 company should strive to have more of its customers in categories @, :, and 9
above, since their willingness to recommend the company to others and to
collaborate with it to continually improve product features and service ma.es
them far more valuable, with a much higher customer lifetime value, than
customers who are merely satisfied with the most recent transaction.
&ompanies that offer personali'ed services to customers, such as by a
Nordstrom salesperson, or that offer rewards to loyal customers can generate
high customer loyalty. These loyal customers then recommend the companies to
others. "nline companies such as ama'on.com generate customer loyalty
because provide a good selection of desired products, competitive prices, easy
ordering, $uic. delivery, and reviewers comments on products. %oyal
customers, in turn, provide comments on products) helpful reviews in
conAunction with the other positive attributes of the company contribute to
continuing and growing customer loyalty.
6-16 The net promoter score is computed based on responses to the $uestion, 7Bow
li.ely is it that you would recommend C&ompany DE to a friend or colleagueF8
&ustomers respond on a scale from *extremely unli.ely- to 4 *extremely
li.ely-, with 9 representing a neutral point. The net promoter score is the
percentage of customers who are 7promoters8 *score of 1 or 4- less the
percentage who are 7detractors8 *scores of through 6-. The net promoter
score is recommended based on research that finds that a customers
willingness to recommend a company is strongly correlated with future growth
and profits. ,n contrast, a customer retention rate, a traditional customer loyalty
metric, can be a poor indicator of a customers loyalty. This is because
customers may remain with a supplier because there no alternatives or simply
because of inertia. Gesearch suggests that 7promoters8 are the only truly loyal
customers and 7detractors8 may harm the companys reputation and brand
value.
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Atkinson, Solution Manual t/a Management Accounting, 6E
EXERCISES
6-17 *a- 2shton ?rown
#ales H:@4,444 H@94,444
&ost of goods sold H554,444 H99,444
Iross margin H54,444 H19,444
(ar.eting, selling, distribution, and
administrative expenses= @@6 J sales H:,144 H9,944
"perating profit H63,44 H<1,944
"perating profitK#ales 9.3:6 55.<6
-
*b- #ales H:@4,444 H@94,444
&ost of goods sold H554,444 H99,444
Iross margin H54,444 H19,444
(ar.eting, selling, distribution, and
administrative expenses
#ales representative travel H1,444 H:5,444
#ervice customers 9,444 4,444
Bandle customer orders ,444 5,444
#hip to customers 5:,444 <5,444
Total activity expenses H:1,444 H5@6,444
"perating profit H6,444 0H:,444
"perating profitK#ales @<.::6 0.<6
*c- The activity-based costing method provides more accurate assignments
of mar.eting, selling, distribution, and administrative expenses by
identifying activities consumed by each customer and assigning costs to
customers based on their activity usage. ,n this example, ?rown places
smaller orders, orders more fre$uently, and re$uires more after-sales
support *travel and service support- than 2shton does.
6-18 *a- H3<@,644K54 operators L H:@,634 per operator
H:@,634K,964 productive hoursKoperator L H53.44 per hour
*b- *i- 4. M *4 J 4.45- L 4.@ hours
4.@ hours J H53Khour L H3.:4
*ii- 4.46 hours J H53Khour L H.63
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Chapter 6 Measuring and Managing Customer !elationships
6-19 *a- #tudents can refer to the ,n /ractice box on textboo. page 55:. The
following table shows the customer profits sorted from largest to
smallest, the cumulative profit after adding each customer, and the
cumulative profit percentages that were used to plot the whale curve
shown below. ,n addition, the first row *ran. 4- was included below so
that the graph begins at 4.
&ustomer
Number
#orted
/rofit
&umulative
/rofit
&umulative
/rofit 6
&umulative
/ercent of
&ustomers
/rofit
Gan.
4
H
4 H 4 46 46 4
@ 56:,444 56:,444 @6 :6
1 591,444 95@,444 66 36 5
5 5@@,444 <96,444 336 56 @
55,444 1<<,444 :6 66 :
: 5<,444 ,1:,444 @16 546 9
543,444 ,:45,444 6@6 5:6 6
< 4,444 ,94@,444 <96 536 <
4 16,444 ,911,444 366 @56 3
55 3<,444 ,636,444 1<6 @66 1
: 3@,444 ,<61,444 5466 :46 4
59 <9,444 ,3::,444 596 ::6
< 94,444 ,31:,444 556 :36 5
54 @4,444 ,15:,444 55:6 956 @
9 55,444 ,1:6,444 55<6 966 :
6 :,444 ,164,444 5536 646 9
6 1,444 ,161,444 5516 6:6 6
5 - 4,444 ,191,444 5536 636 <
5 - :4,444 ,11,444 55:6 <56 3
1 - 14,444 ,351,444 5@6 <66 1
5: -44,444 ,<51,444 5456 346 54
@ -:@,444 ,936,444 396 3:6 5
5@ -93,444 ,:53,444 666 336 55
9 -<1,444 ,5:1,444 :66 156 5@
3 -1,444 ,493,444 5@6 166 5:
3 -544,444 393,444 446 446 59
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Atkinson, Solution Manual t/a Management Accounting, 6E
*b- The most profitable 546 of the customers *i.e., the most profitable 9 out
of 59 customers- generated @16 of the profit, as shown in the table in
part *a-.
*c- The least profitable 546 of the customers *i.e., the least profitable 9
customers- lost *5456 0 446- L 456 of the profit.
6-20 *a- 2 company might transform its brea.even or loss customers into
profitable ones through process improvements that lower the costs of
serving customers. ;or example, if most customers are migrating to
smaller order si'es, companies should strive to reduce the costs of
processes such as setup and order handling so that customer preferences
can be accommodated without raising overall prices. "ne way to become
more efficient in handling orders is to encourage customers to access a
purchasing web page and place their orders over the ,nternet. This would
substantially lower the cost of processing large $uantities of small orders.
,f customers have a preference for suppliers offering high variety,
manufacturing companies can try to customi'e their products at the latest
possible stage, as well as use information technology to enhance the
lin.ages from design to manufacturing so that greater variety and
customi'ation can be offered without cost penalties.
*b- 2 company might also transform its brea.even or loss customers into
profitable ones by activity-based *menu-based- pricing. This approach
establishes a base price for producing and delivering a standard $uantity
for each standard product. ,n addition to this base price, the company
provides a menu of options, with associated prices, for any special
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Chapter 6 Measuring and Managing Customer !elationships
services re$uested by the customer. The prices for special services on the
menu can be set simply to recover the activity-based cost to serve,
allowing the customer to choose from the menu the features and services
it wishes while also allowing the company to recover its cost of
providing those features and services to that customer. 2lternatively, the
company may choose to earn a margin on special services by pricing
such services above the costs of providing the service. /ricing surcharges
could be imposed when designing and producing special variants for a
customers particular needs. +iscounts would be offered when a
customers ordering pattern lowers the companys cost of supplying it.
2ctivity-based pricing, therefore, prices orders, not products. Nhen
managers base prices on valid cost information, customers shift their
ordering, shipping, and distribution patterns in ways that lower total
supply chain costs to the benefit of both suppliers and customers
*c- (anaging customer relationships provides still another way for a
company to transform its brea.even or loss customers into profitable
ones. ;or example, companies can persuade their customers to use a
greater scope of the companys products and services. The margins from
increased purchases contribute to covering customer-related costs that do
not increase proportionately with volume, such as the cost of the
salesperson assigned to the account. &ompanies can establish minimum
order si'es from unprofitable customers, so that the margins from higher
volumes more than cover the costs of processing an order and setting up
a production run for the customer.
*d- ;inally, companies might transform their brea.even or loss customers
into profitable ones by using their activity-based costing systems to trace
all revenue deductions, as well promotional costs and allowances, to
individual orders and customers in order to calculate actual, reali'ed
profit or loss, customer by customer. This approach should lead to
disciplined discounts and allowances instead of a situation where
companies fail to see all of the revenue lea.s from list price because they
record the discounts and allowances in different systems and ma.e the
revenue deductions at different times of the year. Nithout a disciplined
approach to discounts and allowances, companies might find that various
functional areas *e.g., salespeople, the finance group, and mar.eting-
independently offer discounts or allowances during the year, leading to
brea.even or loss customers because of the large total deductions from
revenues.
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Atkinson, Solution Manual t/a Management Accounting, 6E
6-21 *a- ;irms may fail to see all of the revenue lea.s from list price on orders
because they record the discounts and allowances in different systems
and ma.e the revenue deductions at different times of the year. ;or
example, the prompt payment discount may be recorded by the finance
department in an aggregate income statement account *sales deductions-)
the finance department may lump all freight costs into a general financial
statement account labeled as transportation expenses. ,t does not lin.
either the purchase discount or the freight expense bac. to a customer or
an individual order. The volume discount may be refunded to the
customer only once it has accumulated sufficient volume to $ualify, and it
is not lin.ed bac. to the individual transactions that $ualified for the
volume discount. Nith discounts and allowances recorded into different
accounts and at different times, no manager sees the complete picture for
individual orders and conse$uently no one reali'es how much revenue
loss occurs with individual orders.
*b- "nce firms become aware of pricing waterfalls leading to undesirably
large sales discounts, they can use their activity-based costing systems to
trace all revenue deductions, as well promotional costs and allowances,
to individual orders and customers in order to calculate reali'ed profit or
loss by order or by customer. >sing this information, companies can
periodically *e.g., every $uarter- calculate an operating income statement
for every customer. ;urthermore, companies can use the activity-based
information on (#+2 costs to base salesperson incentives on order and
customer profits, not Aust sales.
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Chapter 6 Measuring and Managing Customer !elationships
6-22 *a- ,f #aunders reduced its sales discounts so that net revenues increased by
46, the net revenue would increase to H554,444 and operating profit
would increase by *H<4,444 O H94,444-KH94,444 L :46, as shown
below. Thus, a 46 increase in net sales revenue would result in a :46
increase in operating profit.
Nith 46
,nitial Gevenue ,ncrease
Net sales revenues H544,444 H554,444
Pariable costs 34,444 34,444
&ontribution margin 54,444 :4,444
;ixed costs <4,444 <4,444
"perating profit H94,444 H<4,444
6 change in operating profit :46
*b- ,f sales discounts increased by another 56, the net revenue would
decrease to H16,444 and operating profit would decrease by *H94,444 O
H:6,444-KH94,444 L 36, as shown below. Thus, a 56 decrease in net
sales revenue would result in an 36 decrease in operating profit.
Nith 56
,nitial
2dditional
+iscount
Net sales revenues H544,444 H16,444
Pariable costs 34,444 34,444
&ontribution margin 54,444 6,444
;ixed costs <4,444 <4,444
"perating profit H94,444 H:6,444
6 change in operating profit 36
*c- %et "6 L the percentage change in net sales revenue. >nder the
circumstances in this problem,
&hange in operating profit L *,nitial revenue J "6-
/ercentage change in operating profit L
*,nitial revenue J "6-K*,nitial operating profit- L
"6 J *,nitial revenue-K*,nitial operating profit-
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Atkinson, Solution Manual t/a Management Accounting, 6E
Thus, the higher the ratio of sales to operating profit, the larger the
change in operating profit in response to a change in "# E$uivalently, the
lower the ratio of operating profit to sales, the larger the change in
operating profit in response to a change in "# This implies that the higher
the ratio of operating profit to sales, the smaller the change in operating
profit in response to a change in "#
6-23 *a- ?ased on the information given, +onner is more profitable and &arlson is
unprofitable=
&arlson +onner
#ales H:94,444 H:44,444
&ost of goods sold 34,444 34,444
Iross margin 5<4,444 @54,444
(+#2 expenses @54,444 69,444
"perating profit HO94,444 H599,444
*b- The sum of the commissions is higher for the sales revenue scheme, and
this scheme will encourage salespersons efforts to sell to &arlson, which
is unprofitable. The profit scheme will encourage sales efforts to focus on
+onner, which the company prefers because +onner is profitable and
&arlson is not. (oreover, at the stated commission rates, the company
will pay less in commissions with the profit scheme than under the sales
revenue scheme.
&arlson +onner
&ost to
&ompany
#ales H:94,444 H:44,444
&ommission on sales revenue 56 56
Total commissions on revenue H1,444 H3,444 H<,444
"perating profit HO94,444 H599,444
&ommission on profit :6 :6
Total commissions on profit H4 H4,544 H4,544
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Chapter 6 Measuring and Managing Customer !elationships
6-24 The customer lifetime value, &%P, for &ustomer :5 is calculated by summing
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
, where i L the cost of capital, for t L , Q, 6 and
then subtracting the initial ac$uisition cost. ,n this problem, r
t
L 4.3 each year
and i L 4.. &alculations were performed in Excel and rounded, leading to the
slight discrepancy in the total below.
t M
t
c
t
*r
t
-
t O
* M i-
t
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
H594 H 64 .4 . H<5.<5<@
5 @44 94 4.3 .5 69.531@
@ @59 94 4.6: .@@ @5.5@:
: @94 94 4.95 .:6: 4:.141
9 @<9 :4 4.:416 .649 39.544@
6 :44 :4 4.@5<63 .<<96 66.933
H<56.1:<5
&%P L H<56.19 O H644 L H56.19.
6-25 The net promoter score is the percentage of customers who are promoters
*scores 1 or 4- less the percentage who are detractors *scores through 6-.
Thus, the net promoter score L 5.356 M 59.@46 O *5.36 M 4.3:6 M .566
M <.:6 M 1.366 M 4.166- L 9.336.
#core
Number of
Gesponses
/ercentage
of Total
4 6: 5.356
1 569 59.@46
3 59: 59.436
< 553 :.966
6 9:3 4.166
9 :1@ 1.366
: @9< <.:6
@ 6@ .566
5 :5 4.3:6
41 5.36
9,444
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Atkinson, Solution Manual t/a Management Accounting, 6E
PROBEMS
6-26 This $uestion is designed to generate discussion on what constitutes a desirable
customer. 2lthough a credit customer who charges a large dollar volume and pays
the balance in full on time each month is probably a good credit ris., the customer
is not the most profitable to the credit card issuer. *Bowever, some credit card
issuers may generate indirect additional revenue from such customers by wor.ing
with advertisers to selectively add advertising inserts to these customers.- 2ll credit
card purchases generate merchant fees) the credit card issuer hopes to generate
additional income through interest payments and late fees.
Type 6 is the least desirable type of customer because that type generates no
revenue but causes the issuer to incur costs to send statements. Type is
preferable to Type 6, but less preferable than all the remaining types because of
the short-term, low-interest arrangement. Type @ is preferable to type : because
of the late fees, and type : is preferred to type 9 because of the higher balances
on which interest is paid. Type 5 is probably less preferred than types @ and :,
and possibly type 9. The suggested complete ordering will depend on the
relative dollar magnitudes assumed. 2 reasonable ordering, from most preferred
to least preferred, is @, :, 5, 9, , 6.
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Chapter 6 Measuring and Managing Customer !elationships
6-27 *a- &ustomer
Type
&ustomer
Type 5
&ustomer
Type @
&ustomer
Type :
#ales H,444 H,444 H5,944 H@,444
%ess returns 4 544 944 ,944
Net sales H,444 H344 H5,444 H,944
&ost of goods sold,
<96 of sales <94 644 ,944 ,59
/rocessing mail orders,
H9 per nonphone order 4 @4 54 4
/rocess phone orders,
H34 per hour 54 4 4 34
/rocess returns,
H9 per item returned 4 54 4 54
/rocess overnight
delivery re$uests,
H: per re$uest
: 4 4 :3
(aintain customer
relations 94 94 94 94
/rofit H<6 H44 H:54 H<<
/rofit #ales
4.3 4.4 4.< 4.4@
*b- 2lthough customer type : has the highest sales, it has the highest dollar
returns and the lowest profit. &ustomer type @ is by far the most
profitable, even though its sales are less than customer type :s *but
customer type @s net sales exceed customer :s-. &ustomer types and
5 are more profitable than customer type : in total dollars and in percent
of sales. &ustomer type returns the highest profit as a percent of sales,
slightly above customer type @s ratio. &ost of goods sold represents
<96 of sales revenue, so the remaining costs as a percent of sales pertain
to each customers interaction with the company. &ustomer type : is the
most expensive to service because it orders fre$uently, places orders in a
costly manner *one hour on the phone-, returns many items, and re$uests
overnight deliveries. &ustomer type is fairly low-cost to serve in spite
of ordering by phone and re$uesting overnight delivery because this
customer type orders only once a year and does not return merchandise.
2side from returns, customer types 5 and @ are fairly low-cost to serve
because they order via mail and re$uest regular delivery rather than
overnight delivery.
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Atkinson, Solution Manual t/a Management Accounting, 6E
*c- Rronec.er can see. to reduce the service activity usage or improve
efficiency to reduce the cost of providing services. ;or example,
Rronec.er might as. customers the reason for returns, and follow up
with ways to reduce problems that caused the returns. The company
might also explore ways to ma.e phone ordering more efficient, to
reduce the time spent on the phone. Rronec.er may also charge fees to
handle overnight delivery re$uests.
6-28 Rey points in the essay should include the items below. Exercise 6-1 provides
a numerical example for developing a whale curve.
Exhibit 6-5 illustrates an 34-54 graph for sales revenues, with cumulative
percent of products or customers on the "-axis and cumulative percent of
revenue on the %-axis. To prepare such a graph for n products, ran. the
products from highest to lowest revenue in spreadsheet column ?. ,n column
2, enter the ran.s *integers from to n-. &ompute the cumulative percent of
products in column & by dividing each product ran. by n and displaying the
result in percent format. These percents will be plotted along the "-axis.
&ompute the cumulative revenues in column + and cumulative revenue
percentages *divide each entry in column + by the total of all revenues in
column +- in column E. ?eginning with the highest-revenue product, plot
the point indicating */roduct s percentage in column &, /roduct s
revenue percentage in column E-. &ontinuing with the second-highest-
revenue product, plot the point indicating */roduct 5s percentage in column
&, cumulative percent of revenue for products and 5 in column E-.
&ontinue to plot *cumulative percent of products, cumulative percent of
revenue- in this manner until points representing all the products have been
plotted, as in Exhibit 6-5. 2 graph for customers would be plotted similarly.
Typically, companies find that their top-selling 546 of products or
customers generate about 346 of total sales. The lowest volume :46 of
products or customers generates only 6 of total sales.
2lthough the 34054 law applies well to sales revenues, it does not apply to
profits.
The 7,n /ractice= ?uilding a Nhale &urve of &ustomer /rofitability8
describes in detail how to prepare a whale curve with a spreadsheet and
Excel. *2lso see Exercise 6-1, which describes adding a starting point of
4.- ?riefly, ran. the customers from most profitable to least profitable *or
most unprofitable-. ?eginning with the most profitable customer, plot the
point indicating *&ustomer s percentage, &ustomer s percent of total
profit-. &ontinuing with the next most profitable customer, plot the point
indicating *&ustomer 5s percentage, cumulative percent of total profit-.
&ontinue to plot *customer percentage, cumulative percent of profit in this
0 5 0
Chapter 6 Measuring and Managing Customer !elationships
manner until points representing all the customers have been plotted, as in
Exhibit 6-@.
Exhibit 6-@ provides a typical whale curve of cumulative customer
profitability. The most profitable 546 of customers generated about 346 of
total profits) this is the pea., or hump of the whale above sea level. The
middle 646 of customers approximately brea. even, and the least profitable
546 of customers lose 346 of total profits, leaving the company with its
446 of total profits *7sea level8 in the whale curve represents the
companys actual reported profits-. The hump *or maximum height- of a
cumulative profitability curve generally hits 946 to 5946 of total profits,
and this height is usually achieved by the most profitable 546 to :46 of
customers.
6-29 *a- &ustomer &ustomer 5
. Polume discount if 54 or more units are
ordered 56 56
5. /ay in full in 9 days @6
@. &ooperative advertising allowance for
featuring the companys products in its
advertisements :6 :6
:. Ta.e a large shipment before the end of
the $uarter in advance of an expected
seasonal increase in demand 96
9. "nline ordering discount 56 56
6. Gebate on sales during specific
promotional periods 56
<. ;ree freight @6
Total 56 36
*b- Gandolph &ompanys management may have been unaware of
the potentially large discounts offered to its customers because
the discounts and allowances arise from different sources and are
recorded in different systems. ,n addition, the revenue deductions
may occur at various times of the year. ;or example, the prompt
payment discount may be recorded by the finance department in
an aggregate income statement account *sales deductions-) the
finance department may lumps all freight costs into a general
financial statement account labeled as transportation expenses.
The mar.eting department may initiate the cooperative
advertising allowance, volume discount allowance, and rebates.
Nith discounts and allowances recorded into different accounts
0 55 0
Atkinson, Solution Manual t/a Management Accounting, 6E
and at different times, no manager sees the complete picture for
individual orders and conse$uently no one reali'es how much
revenue loss occurs with individual orders.
*c- "nce firms become aware of pricing waterfalls leading to undesirably
large sales discounts, they can use their activity-based costing systems to
trace all revenue deductions, as well promotional costs and allowances,
to individual orders and customers in order to calculate reali'ed profit or
loss by order or by customer. >sing this information, companies can
periodically *e.g., every $uarter- calculate an operating income statement
for every customer. ;urthermore, companies can use the activity-based
information on (#+2 costs to base salesperson incentives on order and
customer profits, not Aust sales. Gandolph &ompany can also evaluate
whether it wants to continue offering free freight to &ustomer .
6-30 *a- &ustomer &ustomer 5 &ustomer @ &ustomer :
&%P H:5.:< OH59@.1: OH51.: H5<.<@
#upporting calculations appear below. The customer lifetime value, &%P,
is calculated by summing C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
across each of the t
years retained, where i L the cost of capital, and then subtracting the
initial ac$uisition cost. ,n this problem, i L 4.. &alculations were
performed in Excel and rounded, leading to the slight discrepancy in the
total.
&ustomer =
t M
t
c
t
*r
t
-
t O
* M i-
t
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
H5<9 H4 . H 594.44
5 5<9 4 .5 55<.5<
@ 5<9 4 .@@ 546.6
: 5<9 4 .:6: 3<.3@
9 5<9 4 .649 <4.<9
H,4:5.:<
&%P L H,4:5.:<O H,444 L H:5.:<
&ustomer 5=
t M
t
c
t
*r
t
-
t O
* M i-
t
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
H@44 H4 . H5<5.<@
5 @44 4 .5 5:<.1@
@ @44 4 .@@ 559.@1
H<:6.46
0 5@ 0
Chapter 6 Measuring and Managing Customer !elationships
&%P L H<:6.46 O H,444 L OH59@.1:
&ustomer @=
t M
t
c
t
*r
t
-
t O
* M i-
t
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
H5<9 H4 .4 . H594.44
5 5<9 4 4.1 .5 54:.99
@ 5<9 4 4.3 .@@ 6<.@6
: 5<9 4 4.<51 .:6: @6.1@
9 5<9 4 4.696 .649 5.4@
H3<4.36
&%P L H3<4.36 O H,444 L OH51.:
&ustomer :=
t M
t
c
t
*r
t
-
t O
* M i-
t
C*M
t
$ c
t
- J *r
t
-
t O
EK* M i-
t
H5<9 H94 . H 54:.99
5 5<9 59 .5 546.6
@ @44 4 .@@ 559.@1
: @44 4 .:6: 54:.14
9 @44 4 .649 36.53
H,45<.<@
&%P L H,45<.<@ O H,444 L H5<.<@
*b- &omparing &ustomer to &ustomer 5, even though &ustomer s net
margins *margins minus costs to serve- per year are smaller, the longer
time period more than compensates for the smaller net margins, yielding
a larger &%P. &ontrasting &ustomer and &ustomer @, we see the
importance of retention. 2 slight decrease in the retention rate changes
the &%P from positive to negative. ,n comparing &ustomer : to
&ustomers and @, note that &ustomer : has same total *( O c- as
&ustomers and @. The additional cost to serve and retain &ustomer : in
years and 5 provides net benefits in the form of higher margins in later
periods, yielding a positive &%P that is only slightly lower than &ustomer
s. &ontrasting &ustomer @ and &ustomer : again illustrates the
importance of the retention rate. The additional cost to serve and retain
&ustomer : in years and 5 provides net benefits and helps create the
difference between a positive &%P for &ustomer : and a negative &%P
for &ustomer @.
*c- 2ssuming that n is very large and the numbers in the table remain about
the same each year, the infinite hori'on &%P is *M $ c-K*i M C O rE-
minus the ac$uisition cost.
0 5: 0
Atkinson, Solution Manual t/a Management Accounting, 6E
2c$uisition
&ustomer *M $ c-K*i M C O rE- &ost &%P

H5,<94 H,444 H,<94

5
@,444 ,444 5,444
@
,@<9 ,444 @<9
*d- &ompanies can use the information gathered to calculate customers
estimated lifetime value to target customers with high expected lifetime
value. The critical parameters for calculating lifetime customer value are
,nitial ac$uisition cost
/rofits or losses earned year
2ny additional costs incurred to retain the customer each year
The duration of the relationship
#ome companies have highly sophisticated analytic systems that allow
them to estimate these parameters based on the demographic
characteristics of a potential or newly-ac$uired customer. The analytics
help guide the companies promotion strategies and campaigns to attract
customers with the highest expected lifetime value. ;or example, G?&
;inancial Iroup in &anada uses an analytic model of a customers future
profitability based on age, tenure with the ban., number of products and
services already used at the ban., and the customers potential to
purchase additional products and services, grow account balances, and
generate fee-based income.

The ban. assigns a personal account

representative to its estimated high lifetime value customers, ensures that
their phone calls get pic.ed up $uic.ly, and provides them with ready
access to credit at attractive terms.
6-31 The net promoter score is li.ely to have the greatest predictive power for repeat
purchases and growth in business-to-customer settings where customers have
fre$uent interactions with companies. The score is li.ely to have the least predictive
power in business-to-business settings where purchasing decisions are made by
highly sophisticated professionals. ,n this case, it is better to as., 7Bow li.ely is it
that you will continue to purchases products or services from &ompany DF8
C!SES

P. I. Narayanan, 7&ustomer /rofitability and &ustomer Gelationship (anagement at G?&

;inancial Iroup,8 B?# &ase S 45-4:@.
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Chapter 6 Measuring and Managing Customer !elationships
6-32 The responses below are based on 7#urvival #trategies= 2fter &ost &utting,
&ompanies Turn Toward /rice ,ncreases,8 by Timothy 2eppel, &he 'all Street
(ournal *#eptember 3, 5445, p. 2-.
*a- Tergens president based the price on what he determined to be the cost
of producing the order of 4 odd-si'ed fasteners from scratch. The cost
included setup for the odd si'e and overtime labor. The company actually
produced the odd-si'ed fasteners by producing full-si'e fasteners and
then shortening 4. This method was less costly than setting up the
e$uipment to run a small batch of the re$uired odd si'e.
*b- Ioodyear had been rewarding its sales force based on volume, providing
an incentive for the sales force to deeply discount prices to large
distributors. The discounts were so substantial that the large distributors
could resell the tires to smaller distributors *even with transportation
costs to other regions-, reducing Ioodyears sales at higher prices to
smaller distributors. Ioodyear responded by cutting the discounts to
large distributors, removing discount approval authority from the sales
force and transferring it to a 7tactical pricing group8 that determines
whether Ioodyear can profitably match a competitors prices. Ioodyear
also modified its sales force bonus scheme to include a 7revenue per tire8
metric.
*c- Emerson discovered that customers were willing to pay about 546 more
than Emersons initially proposed cost-based price of H5,694 for a new
compact sensor. Emerson priced the sensor at H@,94. Note that the
article does not provide information on how Emerson determined product
costs that it used as a basis for its mar.ups. 2 traditional cost system is
more li.ely to undercost a low-volume or customi'ed product because it
allocates manufacturing support costs to products based on unit-level
drivers. 2n activity-based costing system more accurately assigns costs
based on resource usage.
*d- Nildec., 7a ma.er of metal guard rails, me''anines and material lifts for
factories and warehouses,8 promoted pac.ages that included installing its
products. The installations bring higher profit than parts catalog sales.
Nildec. responded to a competitors lower-priced storage-rac. protector
by developing its own 7lite8 version and pricing it much lower than the
competitors price. Nhen customers called about purchasing the lite
version, they were informed of the benefits of the original version, and
most of these customers bought the original version. 2n accurate costing
0 56 0
Atkinson, Solution Manual t/a Management Accounting, 6E
system, such as a good activity-based costing system that includes both
manufacturing and nonmanufacturing costs of providing goods and
services to customers, provides reasonably precise information to
managers for ma.ing decisions about the mix of products and services to
offer to customers and prices to charge in order to generate the desired
level of profitability.
*e- >nion /acific introduced a minimum price that was higher than a third of
its customers paid. The company was not concerned if it lost these
customers because customers who were paying higher prices would fill
up the newly free space. +ropping unprofitable customers will not lead
to an immediate increase in profit if the associated capacity-related costs
are committed costs and the resources cannot be put to other profitable
use.
6-33 (idwest "ffice /roducts
5
*B?# &ase 9-104-073-
(idwest is a revised version of +a.ota "ffice /roducts *B?# &ase No. 45-
45-, designed to introduce students to time-driven activity-based costing.
(idwest is a constructed example, but one based on the actual experiences of
several medical distribution and office products companies. ,t simplifies many
of the complex processes that would arise in an actual application, but the
simplification enables students to construct a time-driven 2?& model for
(idwest in a relatively short amount of time. ,nstructors can discuss with the
class how to extend the model to capture more complex and realistic situations.
The costing of five representative orders gives students insights about the
power and management implications of the approach.
The case is simple enough that it can be used as a first activity-based costing
case. Iiven that the time-driven approach is both simpler and more powerful
than original 2?&, , now prefer to introduce students directly to this approach,
rather than introduce 2?& in its original form, and then migrate them to the
time-driven approach.
Teaching Objectives
2
&opyright U 5449 by the /resident and ;ellows of Barvard &ollege. Barvard ?usiness
#chool Teaching Note 9-49-43:. This teaching note was prepared by /rofessor Gobert #.
Raplan as an aid to instructors in the classroom use of the 7(idwest "ffice /roducts8 case,
B?# No. 4:-4<@. Geprinted by permission of Barvard ?usiness #chool. The teaching notes
have been adapted for use with the textboo..
0 5< 0
Chapter 6 Measuring and Managing Customer !elationships
,ntroduce students to time-driven activity-based costing through a simplified
numerical exercise based on actual company situations. Enable students to
propose actions that would transform unprofitable orders and customers into
profitable ones.
Assignment (fo the stan!a"one case#
$ea!
7Time-+riven 2ctivity-?ased &osting8 Harvard )usiness !eview reprint
SG4:T
72ctivity-?ased &osting and &apacity8 B?# No. 49-491
"ptional= 2?& /en ;actory Tutorial B?# No. 4@-<4:
The Raplan02nderson Harvard )usiness !eview article on Time-+riven
2?& *SG4:- should be sufficient to introduce students to 2?& even if they
have not previously studied the subAect. #hould instructors want a more
comprehensive introduction to 7original8 2?&, they can consider= G.#. Raplan,
7,ntroduction to 2ctivity-?ased &osting,8 B?# Note No. 1<-4<6 *?oston=
Barvard ?usiness #chool /ublishing, 11<-.
The technical note on 2?& and capacity can be optional or bac.ground
reading. ,t helps students understand why 2?& cost driver rates should be
based on practical capacity, not actual utili'ation. This may shorten discussion
that otherwise arises in class about what happens to cost driver rates after order
mix changes and process efficiencies reduce the demand on organi'ational
resources. The 2?& /en ;actory Tutorial provides an on-line demonstration of
why companies can benefit from 2?&. ,t shows how 2?& captures cost
behavior better than traditional, volume-based costing.
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Atkinson, Solution Manual t/a Management Accounting, 6E
Te%tboo& Assignment '(estions (a!a)te! fom the oigina" case *(estions#+
*a-?ased on the interviews and data in the case, estimate=
*- The cost of processing cartons through the facility
*5- The cost of entering electronic and manual customer orders
*@- The cost of shipping cartons on commercial carriers
*:- The cost per hour for des.top deliveries
(b)>sing this capacity cost rate information, calculate the cost and profitability of
the five orders in Exhibit 6-4. Nhat explains the variation in profitability
across the five ordersF
(c)"n the basis of your analysis, what actions should Tohn (alone ta.e to
improve (idwests profitabilityF ,nclude suggestions for managing customer
profitability.
*d-#uppose that currently, (idwest processes :4,444 manual orders per year,
with a total of 544,444 line items to enter, and processes @4,444 electronic
orders.
i. Bow much unused practical capacity does the company haveF
ii. ,f the companys efforts to encourage customers who order manually to
change to electronic ordering results in 54,444 manual orders per year,
44,444 line items to enter, and 94,444 electronic orders, how many order
entry operators will the company re$uireF ,f order entry resource costs
can be reduced in proportion to the number of employees, what will be
the cost savings from the changesF
iii. Geturning to the original information in *d-, if the companys process
improvement efforts result in a 546 reduction in time to perform each of
the three order entry activities, how many order entry operators will the
company re$uireF ,f order entry resource costs can be reduced in
proportion to the number of employees, what will be the cost savings
from the process improvementsF
,isc(ssion
*ntroductor% !emarks
,f this is the students or executives first exposure to activity-based costing, ,
often start with the data in T- .%hibit 6-1, ta.en from a company , consulted
with in 119. Nhile flying to the company, , thought about how to motivate the
discussion with the senior executive team about whether to adopt activity-based
0 51 0
Chapter 6 Measuring and Managing Customer !elationships
costing. ,n reading the companys annual report, , saw the 4-year summary,
which , have excerpted in T- .%hibit 6-1. +uring the past ten years, the
company was fortunate to have had a sales increase of nearly @96, as sales had
increased from H5.43 billion to H:.31 billion. &onventional cost accounting
thin.ing focuses on distinguishing between fixed and variable costs. ,f this
company had any significant fixed costs during a period when sales increased by
@96, the companys main problem would be the fre$uency with which it would
have to deposit cash into its ban. accounts. ?ut as the study of cost of goods sold
and gross margin revealed, the &I#Vrather than decreasing as a percentage of
sales, as it would have to if any fixed costs existedVactually increased as a
percentage of sales. #o not only were &I# not fixed, they were not even variable
*that would have produced a constant gross margin percentage-. ,n fact, the &I#
were super-variable costs, rising faster than sales.
2 similar result was found in 7below the gross margin line8 costsVselling,
general, and administrative costs. +espite many accountants treating these as
7fixed costs,8 these #IW2 costs were also super-variable, increasing faster than
sales. These finding set the stage for the 2?& cost model, trying to understand
why companies, operating with a traditional volume-based cost system, typically
increase their sales by offering more variety, features, and service, leading to costs
rising faster than sales. 2n 2?& model helps a company identify when it has not
recovered all the incremental costs associated with an order that has special
features, such as small order $uantities, expedited ordering, and customi'ed
delivery options.
Anal%sis
'+ /hat ae the o)eating )ocesses at 0i!1est Office 2o!(cts3
, try to get the students help me get the simple process flow model below on the
top of the board=
Process
#tudents may also comment on the differential lengths of time that customers ta.e
to pay.
0 554 0
Atkinson, Solution Manual t/a Management Accounting, 6E
, then describe how to build an 2?& model for the three processes performed by
(idwest=
#tep = 2ssign costs to processes
#tep 5= &alculate practical capacity of processes
#tep @= &alculate cost rate of supplying capacity
#tep := 2ssign costs to orders or products based on their use of capacity
, start with the warehouse process to receive and store a carton=
*a- *-
'+ /hat !oes it cost to )ocess a caton tho(gh the !istib(tion cente3
The cost of the warehouse personnel is calculated by subtracting the cost of the
delivery personnel *not involved with warehouse operations- from the total
distribution center personnel cost. To this cost must be added the cost of operating
the warehouse.
. &ost of process= H5,@54,444 M 5,444,444 L
H:,@54,444
5. /ractical capacity 34,444 cartons
@. &ost rate for supplying capacity L H9: per carton
Xou should as. what assumption is made by this calculation. The answer, of
course, is that all cartons place the same demands on warehouse resources. The
follow up $uestion, therefore, is when would this assumption be violatedF The
hoped-for responses are=
. &artons can be of varying si'e, and therefore occupy differential amounts of
space
5. &artons can stay in storage for varying amounts of time, consuming
differential $uantities of days of cubic storage space
@. &artons can re$uire different $uantities of time by warehouse personnel to
process) as a specific example, a customer order may as. for a less than
carton $uantity to be shipped. ,n this case, a warehouse person has to brea.
open the carton, pic. the desired $uantity of materials, and then pac.age
them up to be shipped to the customer. #uch brea.pac. $uantities are far
more expensive to process per unit than carton-si'ed $uantities.
0 55 0
Chapter 6 Measuring and Managing Customer !elationships
2ll of these complexities can be handled by a slightly more complex 2?&
model. The analyst could treat the warehousing function as consisting of two sub-
processes, one for supplying space *cost per cubic meter per day- and one for
supplying warehouse personnel time *cost per hour-. ,n this way, products that ta.e
up much space and stay in storage longer will have higher costs assigned to them
than products pac.aged in small cartons that turn over $uic.ly in the warehouse.
#imilarly, brea.pac. $uantities will have more costs assigned to them than
standard, carton-si'ed $uantities. To introduce such complexity into the case would
lead to students *and the instructor- spending more time building the model, which
is why , did not incorporate them. ?ut the instructor should point out how the cost
model could be easily expanded to incorporate these more realistic situations, as
long as the company had data on carton si'e, product-specific turnover rates, and
actual $uantities orderedVas it almost always would.
'+ /hat e"se is missing fom the ca"c("ation of 1aeho(sing cost3
Ne do not have enough information to assign some general and administrative
costs related to warehouse personnel. Ieneral and selling *IW#- costs are
reported as a single line item in the income statement, and the proAect team did not
collect information about how these might be traced to order handling costs. This
was a deliberate omission in the case. #ome students will allocate these costs as a
percentage mar.up over the H9: per carton warehouse processing costs. , then
$uestion the rationale for such a procedure, as.ing them what assumption this
allocation method ma.es. The answer is an assumption that IW# costs are
proportional to warehouse processing costs, which they almost surely are not. , try
to get the class to understand that using percentage mar.ups to allocate indirect
and support costs is indefensible. The percentages bear no causal relationship bac.
to the cost incurrence. ,f instructors follow (idwest "ffice /roducts with a case on
customer profitability, they can point out that some IW# costs relate to customers
not to processing orders, and that this cost assignment will be discussed in a
subse$uent case.
The instructor has the option to give a little lecturette at this point, pointing out
that a more complete costing model would perform an 2?& analysis for each
component of IW# expensesVsuch as human resources, finance, and information
technology costsVso that the costs of these departments can be more accurately
driven directly to processes based on the demands that the processes ma.e on each
of the corporate support departments. The instructor can go bac. to an example
reported by Tom Tohnson of how Neyerhaeuser assigned its corporate support
departments to its business units using cost drivers, not percentages.
@
@
B.T. Tohnson and +.2. %oewe, 7Bow Neyerhaeuser (anages &orporate "ver head &ost,8
Management Accounting, 2ugust 13<, pp. 54056.
0 555 0
Atkinson, Solution Manual t/a Management Accounting, 6E
*a- *5-
Customer +rder Entr%
Baving explored approaches for driving warehousing costs to orders, the
instructor can now turn to estimating order entry costs. 2gain the four-part
numerical se$uence should be straightforward to elicit from the class=
&alculate cost per hour for the resources doing the order entry
. &ost of resources performing order entry H3:4,444
5. &apacity of order entry resources= 6 ,944 hours L 5:,444
@. &ost of order entry process H@9Khour *or H4.93@Kminute-
:. 2ssign costs based on use of resources
Entering a manual customer order= 4.94 @9 L H9.59Kmanual order
Entering a line item on order 4.4<9 @9 L 5.659Kline item
Palidating an E+, order 4.44 @9 L @.94KE+, order
2s with the previous discussion *on warehousing costs-, the instructor can as.
the class about what assumptions are being made by the above calculation. 2gain,
IW# costs are excluded because we dont have sufficient information to assign
them analytically. The core assumption is that all electronic orders ta.e the same
amount of time to validate or verify, and all manual orders ta.e the same amount of
time to enter the basic information, independent of the complexity of the order
*other than the number of line items in a manual order-. (ore realistically, some
orders may be more complex to handle= expedited orders, orders re$uiring special
pac.aging or delivery instructions, and, in general *beyond the (idwest case
example-, international orders, orders of fragile items, etc. This is a good time to
review the concept of time e$uations, discussed in &hapter 9 and the Raplan-
2nderson H)! article, as an easy and effective tool for handling order complexity.
T- .%hibit 6-2 shows a slide that can be used to illustrate time e$uations.
Emphasi'e with the class that this type of complexity was suppressed in the
(idwest case to reduce class preparation time. The other important point to be
made about time e$uations is that the information on order characteristics is
generally available from the companys EG/ or automated order entry system, so
that each order can be individually costed based on its specific characteristics. This
feature enables time-driven 2?& to incorporate far more process complexity and
0 55@ 0
Chapter 6 Measuring and Managing Customer !elationships
diversity than original 2?&, which would re$uire separate activity pools to be set
up to handle each maAor variation in order diversity and complexity.
,f time permits the instructor can also wor. with the class to learn how to update
the time-driven 2?& model= This material is optional to cover, especially in a <9-
minute class.
'+ /hat ca(ses a cost ate (45ho(# o (nit time estimate to change3
#uppose through a business process improvement *such as TY(, or 6 sigma-,
(idwest improves the process so that manual customer orders can be handled
546 faster. ,t can then Aust reduce the unit time estimate by 546 putting 4.9 J *
O.54- L 4.5 into the 2?& program or Excel spreadsheet.
,f (idwest grants its order entry cler.s a 66 raise, modify the resource cost and
re-estimate the cost per hour *from H@9Khour to H@<.4Khour-. #imilarly, if (idwest
grants them an extra holiday or vacation day, reduce the practical capacity of these
resources, and recalculate the cost per available hour. #tudents should see how
simple it is to .eep a time-driven 2?& model current, by modifying hourly cost
and unit time estimates based on .nown shifts in the process.
The class can now turn to costing the third maAor process, distributing orders to
customers. The instructor can as.=
*a- *@-
'+ /hat !oes it cost to shi) a caton (sing commecia" !e"ive63
The four-step calculation is simple to perform=
1.&ost of resources for commercial shipments H:94,444
2.Yuantity of cartons shipped <9,444
@. and :. &alculate shipping cost per carton L H 6Kcarton
(idwest has outsourced its standard shipping arrangements *rather than
performing this process with internal resources-. Therefore, the unit cost does not
involve calculating a cost of supplying capacity to perform this process.
The case example was simplified to assume an identical cost for each carton
shipped. ,n general you could direct charge the actual shipping expense to each
order without much difficulty by lin.ing the shipping invoice to the order. ,f you
had different shipping arrangementsVexpedite, prepare for overseas shipment,
special handlingVyou would again estimate specific times using time e$uations.
0 55: 0
Atkinson, Solution Manual t/a Management Accounting, 6E
Baving calculated the unit cost for commercial shipments, the class can now
perform the final cost estimate, for distributing cartons directly to the customers
location.
*a- *:-
'+ 7o1 m(ch !oes a !es&to) !e"ive6 cost3
. &ost of des.top delivery resources= H544,444 M 594,444 L H:94,444
5. Number of hours available for ++ L : J ,944 6,444
@. &ost rate for des.top delivery L H<9Khour
#tudents may propose two alternative methods for calculating the cost of
des.top deliveries. "ne option, based on an original 2?& calculation, assumes an
identical cost per carton for des.top delivery=
H:94,444K5,444 ++s L H559 per ++
The error in this calculation is that it doesnt allow for variation in des.top
deliveries, some may be close others may be far away. 2lso, some cartons may be
part of a large order delivered to a customer location, while others may be for a
sole delivery of a carton. The actual delivery cost varies by number of deliveries,
not the number of cartons in a delivery. Thus the original 2?& calculation above
contains two sources of error.
The other method estimates a standard cost per delivery. This allows number of
deliveries rather than number of cartons to be the cost driver. Nith 5,444
deliveries, the standard cost is H559 per delivery. Nhile this calculation avoids the
second problem above, it still assumes that all deliveries are e$ually costly, thereby
suppressing the different costs associated with delivering to nearby versus distant
customers. The preferred procedure, which is both accurate and simple to
implement, is to use the H<9 per hour costing rate, and calculate the time re$uired
for each delivery. Xou can point out that todays technology and information
systems *such as I/# to trac. truc.s in real time and hand-held computers that
truc. drivers can use to log in upon arrival and departure at a customers location-
enable (idwest to use cost drivers that are more specific and accurate for
individual customers, rather than averagesZ ,n general, (idwest could even trac.
the time used at the customers site if it had to deliver to multiple locations.
2t Remps, the dairy company described in the sidebar of the assigned B?G
article, drivers have computer entry device in their truc.s. They record when
leaving a companys warehouse, when they arrive at the next site, and when they
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Chapter 6 Measuring and Managing Customer !elationships
leave that site. The data are automatically uploaded to Remps EG/ and costing
system.
;or des.top deliveries, orders are costed only for the capacity they use. #uppose
the same H:94,444 of resources for des.top delivery were supplied during the year
but only ,944 des.top deliveries were made. Then the traditional cost per ++
would have been calculated at H@44 per direct delivery, not the H559 previously
calculated. #o the cost assigned fluctuates with capacity utili'ation, which is not a
good idea. Nith the time-driven approach, the cost rate automatically stays at
H<9Khour and orders are charged only for the hours they use. The cost of unused
capacity is reported each monthVfor management attention. This is subAect of the
technical note, which can be assigned as optional reading for the class.
2t this point, the instructor can step bac. from the calculation details to get the
class focused on the big picture, about when and why companies benefit from
having a more accurate costing system.
'+ /hen is it 1oth tac&ing this m(ch !etai" to c(stome o!es (the cost of
)ocesses an! the (nit times (se! on the )ocess b6 vaio(s o!es o
!e"iveies#3
1.&he 'illie Sutton rule=
:
%oo. for areas with large expenses in
indirect and support resources, especially where such expenses
have been growing over time. "perations where almost all
expenses are direct labor and direct materials, which can already
be directly traced to individual products by traditional costing
systems, may have less need for 2?& systems.
2.High ,iversit% rule= %oo. for a situation in which large variety
exists in products, customers, or processes. ;or example,
consider a facility that produces mature and newly introduced
products, standard and custom products, and high-volume and
low-volume products. ;or mar.eting and selling expenses,
companies may have a mixture of customers who order high-
volume, standard products with few special demands as well as
:
Nillie #utton was a successful ban. robber in the >nited #tates during the 194s. Nillie, who was
eventually captured at his home not far from a local police station, was as.ed during his initial
interrogation, 7Nhy do you rob ban.sF8 Nillie replied, with the wisdom that had made him
successful for many years, 7Thats where the money isZ8 Nhen developing 2?& systems, we should
follow Nillies sage advice *but not his particular application of the insight- to focus on high cost
areas where improvements in visibility and action could produce maAor benefits to the organi'ation.
2pplying an 2?& analysis to a set of resource expenses that are below 6 of total spending will not
lead to high payoffs to the organi'ation.
0 556 0
Atkinson, Solution Manual t/a Management Accounting, 6E
customers who order in small volumes, special products, and
re$uire large $uantities of pre-sales and post-sales technical
support.
*b- and *c-
Ne are finally ready to cost the five orders. , recommend having a student
estimate the cost for "rder and "rder 5 and then hand out T- .%hibit 6-3,
which contains the proposed solution, based on the model cost estimates
"rder and "rder 5 seem identical, except that the price for "rder 5 is :6
higher because it involves direct delivery. Thus "rder 5s gross margin is
substantially higher than for "rder . &ompanies operating with a traditional or
contribution margin costing system will celebrate the success of their direct
delivery option. ?ut the 2?& analysis reveals that "rder 5 re$uires far more
resources to fulfill, involving H@44 of delivery resources, H:.@3 more in order entry
resources *because of manual order entry-, and nearly H54 more in finance charges
because of its long collection period. #o rather than being the more profitable
order, "rder 5 has a profit margin of minus :46, compared to the attractive
positive 6.66 net margin from "rder .
"ne can go into more detail by showing that the customer has willingly paid
H5: extra for the direct delivery option, but (idwest has incurred H51: in higher
delivery costs to offer this option. +irect delivery is part of (idwests
differentiating strategy, to develop more sales and higher customer loyalty by
offering additional features and service that the customer values *and is willing to
pay more for-. ?ut a differentiation strategy is only successful if the value created
by the differentiation *the H5: price premium- exceeds the companys cost *H@44-
for providing the differentiating service. ,n this case, the differentiation strategy is a
$uite spectacular failure, at least for single carton deliveries.
"rders @ and : are the same as "rders and 5 except that they are scaled by a
factor of 4. "rder : now ma.es a positive profit contribution and it is brea.ing
even on its direct delivery service) the incremental revenues of H5: per carton now
generate H5:4 of additional revenues, which e$uals the incremental costs of H5:4
*H@44 0 H64- for direct versus commercial delivery of the cartons. 2lso, by paying
in 54 days, rather than @4 days, its financing costs are nearly H544 higher than for
"rder @. ,n addition, manual ordering costs decrease profits. #o even with the
higher scale of operations, with a gross margin H5:4 higher than for "rder @, "rder
: has less than half the profit margin of "rder @.
"rder 9 illustrates the impact of the hidden costs associated with manual order
entry and long payment terms. ,t is the same as "rder @, except for manual versus
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Chapter 6 Measuring and Managing Customer !elationships
electronic ordering and payment in 54 rather than @4 days. These seemingly
innocuous changes reduce the profit margin by nearly 946, a very important issue
for companies with small operating margins.
'+ /hat !o 6o( s(ggest 0i!1est sho("! !o8 base! on its ne1 cost estimates3
, recommend grouping the recommendations under the three columns, shown
below, without necessarily labeling the columns as you accept suggestions from the
class.
2ocess 9m)ove 2icing
O!e
Acce)tance50o!if6
:(stome $e"ationshi)s
Goute optimi'ation #pecific charges for ++
based on number of
drop points, distance
*time- traveled
GeAect small orders)
establish minimum order
si'e
(igrate customers to
more efficient channels
*E+,-
+iscounts for E+,
orders
%imit distances for ++
,mprove efficiency of
warehouse operations,
and order entry process
(enu-based pricing #tandard delivery,
pac.aging
&ustomer pic.s up at
warehouse) price $uoted
;"?
0 553 0
Atkinson, Solution Manual t/a Management Accounting, 6E
'+ ;())ose c(stomes a"" s1itch to .,9 o!es< no )ice !isco(nts8 get same
*(antit6 an! mi% of o!es3 7o1 !oes this affect 0i!1est=s )ofits ne%t
6ea3
&ertainly, the cost of processing orders goes down, and many more orders will
be profitable. ?ut (idwest still loses the same H34,444 in the year. Bow can this
beF
/rocess efficiencies or shifting customers to lower cost channels, reduces the
demands made on the organi'ations resources, in this case 0 the order handling
people. ?ut until action is ta.en to redeploy or reduce the supply of these
resources, (idwest .eeps paying for themZ The actions in the table above will
create >N>#E+ &2/2&,TX. (anagement must act to exploit this unused
capacity.
'+ 2 similar $uestion to the one above is, >/hat if 0i!1est e"iminates 30? of
T6)e 2 o!es beca(se the6 ae (n)ofitab"e8 b(t !oesn=t get an6 ne1
o!es to e)"ace them@
The na[ve model, based on actual capacity utili'ation would re-calculate the
per carton warehouse processing cost as
Narehouse processing cost L H:,@54,444K94R L H36.:4Korder
The ris. to (idwest is it now starts to drop Type : and Type 9 orders
leading to a death spiral. This is why resources should be costed at practical
capacity, not actual utili'ation. ,t is better to .eep the warehousing cost rate
at H9: per carton and report @4R J H9: L H,654R as unused capacity.
Xou can close the class by pointing out the next steps in extending the 2?&
analysis beyond the accurate costing of individual orders=
2naly'e and assign general and selling costs
+rive selling and order costs to customer) calculate cost-to-serve
individual customers
&ustomer profitability= aggregate all orders by individual customers
*d-
i. >sing the order entry times stated in part *a- *5-, if (idwest processes
:4,444 manual orders per year, with a total of 544,444 line items to
enter, and processes @4,444 electronic orders, then (idwest re$uires
*:4,444 J 4.9- M *544,444 J 4.4<9- M *@4,444 J 4.- L 5:,444 hours
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Chapter 6 Measuring and Managing Customer !elationships
per year, which e$uals the current practical capacity. Therefore, the
company needs all 6 operators and there is no unused capacity.
ii. (idwest will re$uire *54,444 J 4.9- M *44,444 J 4.4<9- M *94,444 J
4.- L 9,944 hours per year, which re$uires 4.@@ operators. The cost
per operator is H3:4,444K6 L H95,944. ,f order entry costs can be
reduced in proportion to the number of employees, the cost savings will
be H95,944 J *6 O4.@@- L H51<,944. ,f (idwest only hires full-time
employees, it will need operators and the cost savings will be H95,944
J *6 O- L H565,944.
iii. (idwest will re$uire *:4,444 J 4.5- M *544,444 J 4.46- M *@4,444 J
4.43- L 1,544 hours per year, which re$uires 5.3 operators. ,f order
entry costs can be reduced in proportion to the number of employees, the
cost savings will be H95,944 J *6 O 5.3- L H63,444. ,f (idwest only
hires full-time employees, it will need @ operators and the cost savings
will be H95,944 J *6 O@- L H9<,944.
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Atkinson, Solution Manual t/a Management Accounting, 6E
T- .%hibit 6-1 #uper-Pariable &osts, /rofitability +eclines with Irowth
IG"NTB &"(/2NX #2%E# 2N+ /G";,T #>((2GX, 139011:
1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
#ales H:,331 H:,@33 H:,1@ H@,19 H@,:13 H@,55 H5,3<3 H5,:3@ H5,5@: H5,43@
Iross profit H194 H3<4 H33 H<5< H631 H656 H93: H943 H:9< H:@5
(argin 1.:6 1.36 1.96 3.66 1.<6 54.6 54.@6 54.96 54.96 54.<6
# W 2 expense H:1 H:9: H:5 H@6: H@5< H51@ H5< H551 H546 H16
# W 2 6 4.46 4.@6 1.36 1.@6 1.@6 1.:6 1.:6 1.56 1.56 1.:6
#ales *131 L 44- 9< : @: 59 5 44 15 34 <5 6<
#W2 expense
*131L44- 63 99 : 5: 5 44 15 <3 <4 6<
#ource= Gobert #. Raplan
T- .%hibit 6-2 Time-+riven 2?& ,ncorporates Pariety and &omplexity by >se of
Time E$uations
:(stome ;evice Time L 6 minutes
M @ minutes for special orders
M 9 minutes if credit memo re$uired
0 5 minutes if electronic order
M : minutes if &ustomer xy'
0 .9 minutes if &ustomer p$r
Q
Q


+ata about specific order characteristics for time e$uations
come automatically from companys EG/ and &G( systems.
#ource= Gobert #. Raplan
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Chapter 6 Measuring and Managing Customer !elationships
T- .%hibit 6-3 ;ive "rder /rofitability
1 2 3 4 5
#ales H64.44 H6@:.44 H6,44.44 H6,@:4.44 H6,44.44
&ost of items purchased 944 .44 944 .44 9,444 .44 9,444 .44 9,444 .44
Iross margin H4.44 H@:.44 H,44.44 H,@:4.44 H,44.44
/rocessing cartons 9:.44 9:.44 9:4.44 9:4.44 9:4.44
#hipping cartons, commercial 6.44 4.44 64.44 4.44 64.44
+es.top deliveries 4.44 @44.44 4.44 @44.44 4.44
/rocess manual order 4.44 9.59 4.44 9.59 9.59
/rocess line items, manual
orders
4.44 5.6@ 4.44 56.59 56.59
Palidate E+, order @.94 4.44 @.94 4.44 4.44
,nterest on receivable 6 .4 59 .@6 6 .44 59@ .64 5:: .44
Total processing costs H 61.64 H@3<.5: H 66:.94 H,59.4 H 3<9.94
"rder profitability H :4.:4 *H59@.5:- H :@9.94 H 5:.14 H 55:.94
Geturn on sales 6.66 -@1.16 <.6 @.:6 @.<6
#ource= Gobert #. Raplan
0 5@5 0