D. Now consider the alternate customer profitability system that Jamestown is contemplating. How does the alternate system differ (e.g., underlying assumptions, categorization and treatment of various costs) from the initial system?
ISSUES IN ACCOUNTING EDUCATION Vol. 23, No. 2 261-271 Jamestown Electric Supply Companv: Assessing Customer Profitability Lester E. Heitger and Dan L. Heitger ABSTRACT: Customers increasingly demand that companies offer a wide variety of products and services. As a result, industries collectively spend well into the billions of dollars on customer profitability analyses. Accordingly, customer profitability analysis often is listed as one of the recent major developments in managerial accounting Customer profitability analysis refers to the practice of estimating the profitability of individual customers and identifying both customers that create value for the company and, just as importantly, those customers that destroy value. Effective customer profitability analysis provides the company with a strong competitive advantage by improving key strategic and operating decisions involving customer selection and retention. For example, managers at Kraft Foods used data analytics and customer profitability analysis to identify Velveeta super-consumers who represented only 10% of buyers but accounted for 30-40% of revenue and more than 50% of profits (Yoon et al 2014) This case reflects the experiences of several international companies in the automotive supply industry and provides you with an opportunity to enhance your knowledge about customer profitability. First, the case demonstrates the importance of customer profitability analysis. Second, the case enhances your ability to perform customer profitability analysis. Third, it helps you improve your critical thinking and analytical reasoning skills. Finally, the case enables you to integrate business knowledge across functional boundaries Keywords: customer profitability analysis; business processes; activity cost analysis incentives; performance measurement; management control systems. THE AUTOMOTIVE ELECTRONICS INDUSTRY amestown Electric Supply Company has been designing, manufacturing, and supplying electrical supplies in various forms to a wide variety of businesses over the past 45 years One of Jamestown's main customer groups is the automotive industry. The worldwide market for semiconductors in the automotive electronics industry exceeds $10 billion. In addition, telematics-or wireless data delivery-currently is estimated to be a $20 billion industry, and experts predict that soon 50 percent of all new cars and 90 percent of higher-end models will possess telematic-capable devices. Also, many experts estimate that 30 to 40 percent of the production value of all automobiles consists of electrical products. Jamestown Lester E. Heitger is the BKD Distinguished Professor of Accounting at Missouri State University and Dan L. Heitger is the Deloitte Professor and Isaac & Oxley Center for Business Leadership Co-Director at Miami University The authors are grateful for helpful comments and suggestions from three anonymous reviewers, Sue Ravenscroft, and Pekin Ogan. In addition, the authors are grateful to the company presidents, vice-presidents, corporate controllers, plant managers, operating personnel, and numerous other executives at Tomkins, Plc., as well as the graduate and undergraduate students at Indiana University, Miami University, and Auburn University who have participated and provided extensive feedback regarding this case. 262 Jamestown Electric Supply Company: Assexsing Customer Profitahility 263 Heitger and Heitger 261 historically has invested heavily in researching and developing automotive electronic technology in order to provide customers with state-of-the-art functionality, safety, and performance. Jamestown continues its heavy investment in this research and development arena because the resulting product features quickly devolve from being "cutting edge" features that create a competitive advantage to commodities that customers regard as standard features on all automobiles. EXHIBIT 1 Jamestown Income Statements for 20X3 to 20X7 20X4 20x6 20x7 20X3 20X5 Jamestown started supplying headlight systems, and a variety of other electrical parts and components over 30 years ago. The company has continued to upgrade its rescarch and development and manufacturing abilities to keep pace with changing technologies. For instance, Jamestown designs, produces, and installs a direct measurement tire pressure sensor and monitoring system for many of its automotive clients. Demand for this system has grown tremendously, as Jamestown has gone from producing 3,000 tire pressure sensor devices per week to 250,000 per week. Jamestown has found such growth challenging to manage from both cost control and cost forecasting various automotive customers with wiring ab $200,000 S210,000 S212,000 $220,000 $230,000 042.040 Sales Cost ofgoods sold Gross profit W&s G&A Net Income (130,000) 70,000 (138.600) 71,400 (14,500) (15,200) 3750 39.400) (l49.600) 70,400 (15.785) 17,220) 0.58.700) 71,300 (18,305) 69,960 (39335(3998O 41495 $ 18,000 S 16,800 S 14,840 13,200 11,500 Other uses for clectronics and microclectromcchanical systems include "smart airbags," carbon monoxide sensors, angular rate sensors, Global Positioning System-based navigation systems, and rollover-sensing modules that measure vehicle lateral and angular rotations; these modules are useful in automatic countermeasure deployment mechanisms that stabilize vehicles during rollovers. Amounts are shown in thousands ($000). Exhibit 2 contains financial data for specific customers (1.c., Alanson, Boyne, and Conway). W&S (Warehousing and Shipping) G&A (General and Administrative) FINANCIAL CHALLENGES FOR JAMESTOWN The automotive industry has been a mainstay of Jamestown's business. During 20X7, the automobile segment provided 55 percent ofthe firm's gross sales. Growing, and even maintaining, sales volume in this crucial business segment is one of Jamestown's core strategic goals, but achieving this goal has not been easy. Competition for business has been fierce from both domestic and international competitors Jamestown has developed its market position with automobile companics by offering a variety of services that facilitate clients' production activities. These services include overnight delivery of electrical compont products, just-in time (JIT) inventory deliveries to clients' plants, warehousing of client parts, special part support services, and many other customer services designed to gain and maintain clients. Jamestown's management believes that support for customer sales is critical to building and maintaining market share and customer satisfaction. Therefore, key warehousing, shipping, and customer service personnel also receive bonuses based on the volume of sales. A second bonus pool, cqual to 10 percent of net income, comprises the bonus pool for all other key PART IASSESSING CUSTOMER PROFITABILITY An Initlal Customer Profitability System In an effort to determine why profits have continued to shrink during a period of rising sales, Jamestown's executive team tried carly in 20X7 to evaluate production, marketing, distribution, and customer support. In particular, many of Jamestown's top managers were concerned about which customers provide profits and which customers do not. Therefore, they Jamestown has hundreds of different contracts with many different divisions and plants of cach of the major automobile manufacturers. Most of these contracts show reasonably sound gross profit margins on sales. However, because of the different commitments that Jamestown sales personnel have promised, it is not clear which contracts (customers) provide acceptable bottom-line profits (or any profits at ). Although Jamestown's total sales-including sales in the automotive segment have continued to rise, total profits as a percentage of sales have not kept pace. Exhibit 1 shows summarized income statements from 20X3 through 20X7 decided to implement a customer profitability system This customer profitability system included an "internal charging" system for Jamestown customers. Besides cost of goods sold (COGS), Jamestown has two major cost categories: warehousing and shipping (W&S) costs, and general and administrative costs (G&A). With the help of accounting personnel, the marketing department developed a method of internally charging customers for W&S services. For internal analysis purposes, customers are charged a user fee, which is based on the volume (i.e., COGS) of each customer's purchases. The service rate used for this customer service charge is determined at the beginning of the year by dividing the estimated total W&S costs for the coming year by the estimated total COGS for the coming year. In order to help Jamestown managers evaluate whether the customer is an attractive client, this service rate is then used for assigning W&S costs to customers. During 20X7, the cstimate of W&S cost was $18.2 million, and the estimated cost of goods sold was $155 million, resulting in a customer service charge for internal analysis purposes of 11.75 percent. In other At first, Jamestown's top managers believed that as long as sales growth remained positive, any problems with profits would surely work themselves out. Unfortunately, that has not happened: even though sales have risen, profits have fallen. Selling expense has averaged about 10 percent of sales. Half of this amount tends to be sales salaries and commissions. Because Jamestown's incentive plans relate primarily to sales and market growth, marketing personnel are paid a base salary plus commissions based on dollar volume of sales; most marketing employees generate about 80 percent of their earnings through sales commissions. suey in ccowting Education Issues in Accounting Education Heitger and Heitger Jamestown Electric Supply Company: Assexsing Customer Profitahility words, a customer purchasing products with a COGS amount of $100 would be assigned an internal W&S charge of S11.75 Jamestown's customer profitability model also uses retail sales volume to assign G&A costs to customers. Budgeted retail sales for 20X7 were S225 million, and budgeted G&A costs (excluding W&S) were $42 million. Therefore, the allocation rate for G&A is 18.67 percent. Jamestown management tested this initial customer profitability system by applying it to three key customers: Alanson, Boyne, and Conway. If the results appear to be informative and useful, then it will be applied to all customers. Alanson is a large automobile industry client; Boyne is a medium-sized, non-automobile industry client: and Conway is a small automobile industry client. Exhibit 2 displays the estimated profits Jamestown makes through sales to Alanson, Boyne, and Conway EXHIBIT 3 Jamestown 20X7 Sales Mix (by Sales Volume and Industry) Custoner Industry Automotive Non-Automotive $41,400 S41,400 S20,700 $103.500 Total $117,300 $79,350 $75,900 Large Mediumm Sales Volume $12,650 $126,500 Exhibit 3 describes the mix of sales to Jamestown's customers in the aggregate, classifying customers by industry type (automotive versus non-automotive) and by volume of sales to that customer (small, medium, and large S230,000 Total Amounts are shown in thousands Results from the Initial Customer Profitability System There is no shortage of opinions about the potential reasons for falling profits. Marketing managers still believe that more sales will solve the problem. Warchousing and shipping (W&S) management thinks that customer services are out of control and causing significant cost increases for the company. Both W&S and production management do not find the current customer profitability system helpful in determining the cause of the large increase in costs to service customer demands. While the bonuses of most managers are decreasing, marketing managers are actually getting larger bonuses because of the rising commission and bonus pools caused incrcascd tensions among the various Jamestown managers and made the January 3, 20X8, Board of Directors meeting quite After using the initial customer profitability system for a year (20X7), Jamestown management hoped to better understand costs and, therefore, he able to improve company profits. Instead of improved profits, however, the company's profits declined yet again, this time by 13 pervent, as sales continued to rise. EXHIBIT 2 20X7 Customer Data: Initial Customer Profitabillty System resulting from the rising sales. These di lanson Conway $1,800,000 1260,000 540,0000 In addition, mounting shareholder frustration over declining profitability raised significant pressure on the Board of Directors to take appropriate action. As a result, the customer profitability system was an important issuc on the agenda at the 20X8 Board of Directors meeting. Sales Cost of goods sold Ciross Prolit W&S service charge $14,500,000 55,600,000 3,892,000 1,708,Dx) 457,310 045.520 205,170 10,150,000 350.010 1,192,625 2,707.150 S450,225 336,060 The Search for Better Profitability Measures: An Alternate Customer Profitability System The Annual Board Meeting Customer Profitahility Alanson is a large aulomobile clienl: Boyne is a small mon aukomolive client: Conway is a small aulumobile At the annual Board of Directors meeting on January 3, 20X8, the CEO, board members, and other top management decided that the customer profitahility system implemented in 20X7 had done little to help identify profitable versus unprofitable customers. The customer profitability analysis indicated that high-volume customers provide the most profit for client Exhibit 1 contains apgrepated annual tinancial data for all cstomens W&s (Warchousing and Shipping) costs are allocated at a rate of 11.75 pea of COGS dG&A General and Administrative) costs are allocated using a rate of 18.6 percent ot sales. Jamestown, while low-volume customers provide the least profit. In hopes of finding ways to obtain more useful information about the relationship of customer mix to profits, the company held a series of management meetings. At one such recent meeting, key company executives discussed issues possibly contributing to the decline in profits. One board member asked John Myers, the head of manufacturing, about the rising cost of direct labor for Jamestown's electrical component products. John responded that his peers at other manufacturing companies claim that their labor costs are decreasing. John then firmly stated, "Perhaps labor costs would go down at Jamestown, too, if it were not for the ever increasing demand by marketing for rush orders that have unrealistic promised delivery times, based on Jamestown's normal production planning and scheduling system." Janice Brody, director of corporate marketing, quickly defended the importance of her markcting department and its programs by saying, "I would like to point out that rapid responsc Issues in Acconing Education Issues in Accounring Education leitger and IJeitger Jamestown Electric Supply Company: Assessing Customer Profitability to customer demand is a corporate goal, and it is essential to attract new clients and to retain current clients! She also noted that the need for rapid response is particularly strong in the automobile segment of the fim's business. John wasted no time in responding to Janice's point, bluntly stating, "That may be true, but these rush orders are costing us a lot of money." EXHIBIT 4 Costs in the Key Activity Areas within the Warehousing and Shipping Process Frank Albert (the Chairman of the Board) questioned Fred Hanson, head of warchousing and shipping (W&S) operations, regarding the growing costs within his business process: "Warehousing costs are going up faster than sales revenue. Surely you can lay off some people or cut some other costs, can't you?" Fred, upset that his W&S operations were mentioned as a source of the waning profits, quickly defended his department: "My operation bends over backward to meet all of the demands put on us! Everyone always wants us to do more for customers, but no one ever thinks it will cost us more to accomplish it." As a result, Fred explained, the company now has what are, in effect, mini-warehouses in which inventory is stored for many larger customers, so Jamestown can ship it at a moment's notice. He further explained that his department also takes the time to prepare, repackage, and ship special electrical components to save time for many of Jamestown's larger customers. In addition, amestown offers customers an "Emergency Hot Line," so that customers can prevent production downtime by getting virtually instant shipments of Jamestown parts. Fred complained to the other managers, people's time the Hot Line and special repackaging activities really take." He concluded by noting that one analysis conducted last summer indicated it takes significantly more labor time per dollar of shipment to accommodate all of the extra requirements of special service ordeTs than it does to pick and package regular orders. Facility Costs Lease cost $1,400 $1,400 3.100 720 $1.400 tilities Total facility costs Inventory Storage and Handling Costs T00 taxes $470 320 "I don't think most of you have any idea how much of my Utilities/fucl Salaries and benefits Wages and benefits Communications lincs Office and miscellaneous expenses Tolal storage and handling costs 950 600 65 To get a better idea of the possible financial impact of customer mix on profitability Jamestown managers discussed at the meeting. The results of the internal auditors' analysis follovw 815 decided to have the internal audit staff look into some of the issucs Pulling and Shipping Costs Equipmenl depreciation/lease Utilities/fuel Salaries and benefits Wages and bencfits Temporary employee wages 1,410 $1,380 $1,450 The Warehousing and Shipping Process 850 800 2.700 200 Exhibit 4 summarizes the results of the study of the costs of major activities performed in the W&S process during the last three years (20X5-20X7). Discussions with W&S personnel suggested that significant differences exist among the amounts of services demanded by various customers. For example, personnel performing pulling and shipping activities believe that their costs associated with pulling, packaging, and repackaging products are heavily driven by the amount of time they spend providing special services for customers. During 20X7, the pulling and shipping activity arca used 250,000 hours for non-supervisory personnel. Of this amount, 200,000 hours were used primarily for special product handling (i.e., pulling and repackaging) services for some customers. Exhibit 5 displays historical data that the internal auditors accumulatedin an effort to document some of the cost drivers in the key activity arcas in the warehousing and shipping process. 3.700 450 1,700 145 160 Tolal pulling and shipping costs $9,820 9.040 15.785 $18.305 Total Warehousing and Shipping Costs Amounis are shown in thousands (S000) Management's Estimates of Cost Drivers for Activities in Warehousing and Shipping The customer service activities in pulling and shipping are more diverse than in the other warehousing activities. Management of pulling and shipping believes that about 10 percent of ts costs pertain to setting up orders and preparing for shipment. The majority of this amount seems to be driven simply by the number of orders processed. An additional 30 percent of the pulling and shipping costs relate to loading orders onto trucks for shipment and for the shipping itself. This component seems to be driven by the retail value of the inventory shipped. The final 60 percent of pulling and shipping costs relate to providing special product handling services. This cost depends on the time spent pulling orders, packaging and repackaging products, and providing other special customer services. The time required for these activitics is driven by Jamestown management believes that the costs of facilities and the costs of inventory storage and handling are driven primarily hy the dollar volume of inventory stored in the facilities. A management analysis of inventory items indicated that products vary in size, weight, packaging, and shipping requirements. As a result of this inventory analysis, management believes that assigning the costs of these two activity arcas to customers based oin the dollar amount of inventory is logical and effectively matches the product-related services provided to customers with the costs of providing those services. Issues n Accounting Education Issues in Accounting Education Jamestown Electric Supply Company: Assessing Customer Profitability special packaging requirements. Specifically, management estimates that orders requiring special services take about three times as much labor per dollar of sales as those orders that do not require any special services. EXHIBIT 6 Additional Customer Data: Alternate Customer Profltablity System The information on W&S costs and production costs has been discussed at several management meetings. Executives' sentiments vary significantly about whether an altemate customer profitability system is necessary. Some executives think that it is just not worth the time, energy, and cost to develop and implement a more detailed customer profitability system. One executive, Jack Hannah, spoke candidly against developing an alternate customer profitability system, stating, "We already have a system in place. Besides, it probably will all avcrage out in the end, so why go to all the time and trouble?" However, other executives believed more analysis was necessary. For instance, Mandy White, Jamestown's chief accountant, stated. "I think we should take a closer look at the information we already have. Maybe we should use the data we gathered to look at the profitability of a few of our customers and sec how that comes out." After reading the information regarding Jamestown's industry, strategic focus, and initial and alternate customer profitability systems, respond to the following questions. A. Rank Alanson, Boyne, and Conway from most profitable to least profitable according to the initial system's estimate of the contribution of each customer to Jamestown's bottom- line profitability. What are Jamestown's options regarding the treatment of these three customers? Based on this initial customer profitability analysis, what action do you recommend Jamestown take with each of these three customers? What, if any, issues/challenges do you see with the customer profitability measurements from the initial customer profitability system, provided in Exhibit 2? What assumption(s) is the customer profitability system making implicitly, with respect to the way in which EXHIBIT 5 Cost Drivers in the Key Activity Areas within the Warehousing and Shipping Process B. C. Are the accounting customer profitability measures provided by the initial customer Facilities and Inventory Storage and Handling managers to make better decisions about corporate profitability), negative (i.e., provide Average days of inventory on band Pulling and Shipping Products corporate profitability) or neutral (i.e., provide cost information that does not affect ty)? D. Now consider the alternate customer profitability system that Jamestown is contemplating. How does the alternate system differ (c.g., underlying assumptions, categorization and Total number of orders Number of orders requiring special packaging E. Use the data provided from the alternate customer profitability system to calculate customer service charges for W&S activities for Alanson, Boyne, and Conway. Next, estimate the Average size of orders customers according to this new alternate customer profitability system. Rank Alanson, Boyne, and Conway from most profitable to least profitable according to the alternate system. Explain any significant differences in the estimated contribution to profitability of these three customers when using the initial customer profitability system Somewhat reluctantly, most of the managers at the last meeting decided Ms. White made a good point about looking more carefully at the data. Therefore, additional data were gathered about the three customers used in the initial system. Exhibit 6 displays the additional customer F. G. Explain why the alternate system does or does not provide better information about customer profitability than the initial system. Based on the results of the alternate customer profitability system, how might Jamestown alter its treatment of Alanson, Boyne, and H. How might Jamestown need to alter its incentive system for management to achieve larger profits? What other issues might Jamestown management want to consider in implementing and operating a customer profitability system? Issues in Accounting Education ISSUES IN ACCOUNTING EDUCATION Vol. 23, No. 2 261-271 Jamestown Electric Supply Companv: Assessing Customer Profitability Lester E. Heitger and Dan L. Heitger ABSTRACT: Customers increasingly demand that companies offer a wide variety of products and services. As a result, industries collectively spend well into the billions of dollars on customer profitability analyses. Accordingly, customer profitability analysis often is listed as one of the recent major developments in managerial accounting Customer profitability analysis refers to the practice of estimating the profitability of individual customers and identifying both customers that create value for the company and, just as importantly, those customers that destroy value. Effective customer profitability analysis provides the company with a strong competitive advantage by improving key strategic and operating decisions involving customer selection and retention. For example, managers at Kraft Foods used data analytics and customer profitability analysis to identify Velveeta super-consumers who represented only 10% of buyers but accounted for 30-40% of revenue and more than 50% of profits (Yoon et al 2014) This case reflects the experiences of several international companies in the automotive supply industry and provides you with an opportunity to enhance your knowledge about customer profitability. First, the case demonstrates the importance of customer profitability analysis. Second, the case enhances your ability to perform customer profitability analysis. Third, it helps you improve your critical thinking and analytical reasoning skills. Finally, the case enables you to integrate business knowledge across functional boundaries Keywords: customer profitability analysis; business processes; activity cost analysis incentives; performance measurement; management control systems. THE AUTOMOTIVE ELECTRONICS INDUSTRY amestown Electric Supply Company has been designing, manufacturing, and supplying electrical supplies in various forms to a wide variety of businesses over the past 45 years One of Jamestown's main customer groups is the automotive industry. The worldwide market for semiconductors in the automotive electronics industry exceeds $10 billion. In addition, telematics-or wireless data delivery-currently is estimated to be a $20 billion industry, and experts predict that soon 50 percent of all new cars and 90 percent of higher-end models will possess telematic-capable devices. Also, many experts estimate that 30 to 40 percent of the production value of all automobiles consists of electrical products. Jamestown Lester E. Heitger is the BKD Distinguished Professor of Accounting at Missouri State University and Dan L. Heitger is the Deloitte Professor and Isaac & Oxley Center for Business Leadership Co-Director at Miami University The authors are grateful for helpful comments and suggestions from three anonymous reviewers, Sue Ravenscroft, and Pekin Ogan. In addition, the authors are grateful to the company presidents, vice-presidents, corporate controllers, plant managers, operating personnel, and numerous other executives at Tomkins, Plc., as well as the graduate and undergraduate students at Indiana University, Miami University, and Auburn University who have participated and provided extensive feedback regarding this case. 262 Jamestown Electric Supply Company: Assexsing Customer Profitahility 263 Heitger and Heitger 261 historically has invested heavily in researching and developing automotive electronic technology in order to provide customers with state-of-the-art functionality, safety, and performance. Jamestown continues its heavy investment in this research and development arena because the resulting product features quickly devolve from being "cutting edge" features that create a competitive advantage to commodities that customers regard as standard features on all automobiles. EXHIBIT 1 Jamestown Income Statements for 20X3 to 20X7 20X4 20x6 20x7 20X3 20X5 Jamestown started supplying headlight systems, and a variety of other electrical parts and components over 30 years ago. The company has continued to upgrade its rescarch and development and manufacturing abilities to keep pace with changing technologies. For instance, Jamestown designs, produces, and installs a direct measurement tire pressure sensor and monitoring system for many of its automotive clients. Demand for this system has grown tremendously, as Jamestown has gone from producing 3,000 tire pressure sensor devices per week to 250,000 per week. Jamestown has found such growth challenging to manage from both cost control and cost forecasting various automotive customers with wiring ab $200,000 S210,000 S212,000 $220,000 $230,000 042.040 Sales Cost ofgoods sold Gross profit W&s G&A Net Income (130,000) 70,000 (138.600) 71,400 (14,500) (15,200) 3750 39.400) (l49.600) 70,400 (15.785) 17,220) 0.58.700) 71,300 (18,305) 69,960 (39335(3998O 41495 $ 18,000 S 16,800 S 14,840 13,200 11,500 Other uses for clectronics and microclectromcchanical systems include "smart airbags," carbon monoxide sensors, angular rate sensors, Global Positioning System-based navigation systems, and rollover-sensing modules that measure vehicle lateral and angular rotations; these modules are useful in automatic countermeasure deployment mechanisms that stabilize vehicles during rollovers. Amounts are shown in thousands ($000). Exhibit 2 contains financial data for specific customers (1.c., Alanson, Boyne, and Conway). W&S (Warehousing and Shipping) G&A (General and Administrative) FINANCIAL CHALLENGES FOR JAMESTOWN The automotive industry has been a mainstay of Jamestown's business. During 20X7, the automobile segment provided 55 percent ofthe firm's gross sales. Growing, and even maintaining, sales volume in this crucial business segment is one of Jamestown's core strategic goals, but achieving this goal has not been easy. Competition for business has been fierce from both domestic and international competitors Jamestown has developed its market position with automobile companics by offering a variety of services that facilitate clients' production activities. These services include overnight delivery of electrical compont products, just-in time (JIT) inventory deliveries to clients' plants, warehousing of client parts, special part support services, and many other customer services designed to gain and maintain clients. Jamestown's management believes that support for customer sales is critical to building and maintaining market share and customer satisfaction. Therefore, key warehousing, shipping, and customer service personnel also receive bonuses based on the volume of sales. A second bonus pool, cqual to 10 percent of net income, comprises the bonus pool for all other key PART IASSESSING CUSTOMER PROFITABILITY An Initlal Customer Profitability System In an effort to determine why profits have continued to shrink during a period of rising sales, Jamestown's executive team tried carly in 20X7 to evaluate production, marketing, distribution, and customer support. In particular, many of Jamestown's top managers were concerned about which customers provide profits and which customers do not. Therefore, they Jamestown has hundreds of different contracts with many different divisions and plants of cach of the major automobile manufacturers. Most of these contracts show reasonably sound gross profit margins on sales. However, because of the different commitments that Jamestown sales personnel have promised, it is not clear which contracts (customers) provide acceptable bottom-line profits (or any profits at ). Although Jamestown's total sales-including sales in the automotive segment have continued to rise, total profits as a percentage of sales have not kept pace. Exhibit 1 shows summarized income statements from 20X3 through 20X7 decided to implement a customer profitability system This customer profitability system included an "internal charging" system for Jamestown customers. Besides cost of goods sold (COGS), Jamestown has two major cost categories: warehousing and shipping (W&S) costs, and general and administrative costs (G&A). With the help of accounting personnel, the marketing department developed a method of internally charging customers for W&S services. For internal analysis purposes, customers are charged a user fee, which is based on the volume (i.e., COGS) of each customer's purchases. The service rate used for this customer service charge is determined at the beginning of the year by dividing the estimated total W&S costs for the coming year by the estimated total COGS for the coming year. In order to help Jamestown managers evaluate whether the customer is an attractive client, this service rate is then used for assigning W&S costs to customers. During 20X7, the cstimate of W&S cost was $18.2 million, and the estimated cost of goods sold was $155 million, resulting in a customer service charge for internal analysis purposes of 11.75 percent. In other At first, Jamestown's top managers believed that as long as sales growth remained positive, any problems with profits would surely work themselves out. Unfortunately, that has not happened: even though sales have risen, profits have fallen. Selling expense has averaged about 10 percent of sales. Half of this amount tends to be sales salaries and commissions. Because Jamestown's incentive plans relate primarily to sales and market growth, marketing personnel are paid a base salary plus commissions based on dollar volume of sales; most marketing employees generate about 80 percent of their earnings through sales commissions. suey in ccowting Education Issues in Accounting Education Heitger and Heitger Jamestown Electric Supply Company: Assexsing Customer Profitahility words, a customer purchasing products with a COGS amount of $100 would be assigned an internal W&S charge of S11.75 Jamestown's customer profitability model also uses retail sales volume to assign G&A costs to customers. Budgeted retail sales for 20X7 were S225 million, and budgeted G&A costs (excluding W&S) were $42 million. Therefore, the allocation rate for G&A is 18.67 percent. Jamestown management tested this initial customer profitability system by applying it to three key customers: Alanson, Boyne, and Conway. If the results appear to be informative and useful, then it will be applied to all customers. Alanson is a large automobile industry client; Boyne is a medium-sized, non-automobile industry client: and Conway is a small automobile industry client. Exhibit 2 displays the estimated profits Jamestown makes through sales to Alanson, Boyne, and Conway EXHIBIT 3 Jamestown 20X7 Sales Mix (by Sales Volume and Industry) Custoner Industry Automotive Non-Automotive $41,400 S41,400 S20,700 $103.500 Total $117,300 $79,350 $75,900 Large Mediumm Sales Volume $12,650 $126,500 Exhibit 3 describes the mix of sales to Jamestown's customers in the aggregate, classifying customers by industry type (automotive versus non-automotive) and by volume of sales to that customer (small, medium, and large S230,000 Total Amounts are shown in thousands Results from the Initial Customer Profitability System There is no shortage of opinions about the potential reasons for falling profits. Marketing managers still believe that more sales will solve the problem. Warchousing and shipping (W&S) management thinks that customer services are out of control and causing significant cost increases for the company. Both W&S and production management do not find the current customer profitability system helpful in determining the cause of the large increase in costs to service customer demands. While the bonuses of most managers are decreasing, marketing managers are actually getting larger bonuses because of the rising commission and bonus pools caused incrcascd tensions among the various Jamestown managers and made the January 3, 20X8, Board of Directors meeting quite After using the initial customer profitability system for a year (20X7), Jamestown management hoped to better understand costs and, therefore, he able to improve company profits. Instead of improved profits, however, the company's profits declined yet again, this time by 13 pervent, as sales continued to rise. EXHIBIT 2 20X7 Customer Data: Initial Customer Profitabillty System resulting from the rising sales. These di lanson Conway $1,800,000 1260,000 540,0000 In addition, mounting shareholder frustration over declining profitability raised significant pressure on the Board of Directors to take appropriate action. As a result, the customer profitability system was an important issuc on the agenda at the 20X8 Board of Directors meeting. Sales Cost of goods sold Ciross Prolit W&S service charge $14,500,000 55,600,000 3,892,000 1,708,Dx) 457,310 045.520 205,170 10,150,000 350.010 1,192,625 2,707.150 S450,225 336,060 The Search for Better Profitability Measures: An Alternate Customer Profitability System The Annual Board Meeting Customer Profitahility Alanson is a large aulomobile clienl: Boyne is a small mon aukomolive client: Conway is a small aulumobile At the annual Board of Directors meeting on January 3, 20X8, the CEO, board members, and other top management decided that the customer profitahility system implemented in 20X7 had done little to help identify profitable versus unprofitable customers. The customer profitability analysis indicated that high-volume customers provide the most profit for client Exhibit 1 contains apgrepated annual tinancial data for all cstomens W&s (Warchousing and Shipping) costs are allocated at a rate of 11.75 pea of COGS dG&A General and Administrative) costs are allocated using a rate of 18.6 percent ot sales. Jamestown, while low-volume customers provide the least profit. In hopes of finding ways to obtain more useful information about the relationship of customer mix to profits, the company held a series of management meetings. At one such recent meeting, key company executives discussed issues possibly contributing to the decline in profits. One board member asked John Myers, the head of manufacturing, about the rising cost of direct labor for Jamestown's electrical component products. John responded that his peers at other manufacturing companies claim that their labor costs are decreasing. John then firmly stated, "Perhaps labor costs would go down at Jamestown, too, if it were not for the ever increasing demand by marketing for rush orders that have unrealistic promised delivery times, based on Jamestown's normal production planning and scheduling system." Janice Brody, director of corporate marketing, quickly defended the importance of her markcting department and its programs by saying, "I would like to point out that rapid responsc Issues in Acconing Education Issues in Accounring Education leitger and IJeitger Jamestown Electric Supply Company: Assessing Customer Profitability to customer demand is a corporate goal, and it is essential to attract new clients and to retain current clients! She also noted that the need for rapid response is particularly strong in the automobile segment of the fim's business. John wasted no time in responding to Janice's point, bluntly stating, "That may be true, but these rush orders are costing us a lot of money." EXHIBIT 4 Costs in the Key Activity Areas within the Warehousing and Shipping Process Frank Albert (the Chairman of the Board) questioned Fred Hanson, head of warchousing and shipping (W&S) operations, regarding the growing costs within his business process: "Warehousing costs are going up faster than sales revenue. Surely you can lay off some people or cut some other costs, can't you?" Fred, upset that his W&S operations were mentioned as a source of the waning profits, quickly defended his department: "My operation bends over backward to meet all of the demands put on us! Everyone always wants us to do more for customers, but no one ever thinks it will cost us more to accomplish it." As a result, Fred explained, the company now has what are, in effect, mini-warehouses in which inventory is stored for many larger customers, so Jamestown can ship it at a moment's notice. He further explained that his department also takes the time to prepare, repackage, and ship special electrical components to save time for many of Jamestown's larger customers. In addition, amestown offers customers an "Emergency Hot Line," so that customers can prevent production downtime by getting virtually instant shipments of Jamestown parts. Fred complained to the other managers, people's time the Hot Line and special repackaging activities really take." He concluded by noting that one analysis conducted last summer indicated it takes significantly more labor time per dollar of shipment to accommodate all of the extra requirements of special service ordeTs than it does to pick and package regular orders. Facility Costs Lease cost $1,400 $1,400 3.100 720 $1.400 tilities Total facility costs Inventory Storage and Handling Costs T00 taxes $470 320 "I don't think most of you have any idea how much of my Utilities/fucl Salaries and benefits Wages and benefits Communications lincs Office and miscellaneous expenses Tolal storage and handling costs 950 600 65 To get a better idea of the possible financial impact of customer mix on profitability Jamestown managers discussed at the meeting. The results of the internal auditors' analysis follovw 815 decided to have the internal audit staff look into some of the issucs Pulling and Shipping Costs Equipmenl depreciation/lease Utilities/fuel Salaries and benefits Wages and bencfits Temporary employee wages 1,410 $1,380 $1,450 The Warehousing and Shipping Process 850 800 2.700 200 Exhibit 4 summarizes the results of the study of the costs of major activities performed in the W&S process during the last three years (20X5-20X7). Discussions with W&S personnel suggested that significant differences exist among the amounts of services demanded by various customers. For example, personnel performing pulling and shipping activities believe that their costs associated with pulling, packaging, and repackaging products are heavily driven by the amount of time they spend providing special services for customers. During 20X7, the pulling and shipping activity arca used 250,000 hours for non-supervisory personnel. Of this amount, 200,000 hours were used primarily for special product handling (i.e., pulling and repackaging) services for some customers. Exhibit 5 displays historical data that the internal auditors accumulatedin an effort to document some of the cost drivers in the key activity arcas in the warehousing and shipping process. 3.700 450 1,700 145 160 Tolal pulling and shipping costs $9,820 9.040 15.785 $18.305 Total Warehousing and Shipping Costs Amounis are shown in thousands (S000) Management's Estimates of Cost Drivers for Activities in Warehousing and Shipping The customer service activities in pulling and shipping are more diverse than in the other warehousing activities. Management of pulling and shipping believes that about 10 percent of ts costs pertain to setting up orders and preparing for shipment. The majority of this amount seems to be driven simply by the number of orders processed. An additional 30 percent of the pulling and shipping costs relate to loading orders onto trucks for shipment and for the shipping itself. This component seems to be driven by the retail value of the inventory shipped. The final 60 percent of pulling and shipping costs relate to providing special product handling services. This cost depends on the time spent pulling orders, packaging and repackaging products, and providing other special customer services. The time required for these activitics is driven by Jamestown management believes that the costs of facilities and the costs of inventory storage and handling are driven primarily hy the dollar volume of inventory stored in the facilities. A management analysis of inventory items indicated that products vary in size, weight, packaging, and shipping requirements. As a result of this inventory analysis, management believes that assigning the costs of these two activity arcas to customers based oin the dollar amount of inventory is logical and effectively matches the product-related services provided to customers with the costs of providing those services. Issues n Accounting Education Issues in Accounting Education Jamestown Electric Supply Company: Assessing Customer Profitability special packaging requirements. Specifically, management estimates that orders requiring special services take about three times as much labor per dollar of sales as those orders that do not require any special services. EXHIBIT 6 Additional Customer Data: Alternate Customer Profltablity System The information on W&S costs and production costs has been discussed at several management meetings. Executives' sentiments vary significantly about whether an altemate customer profitability system is necessary. Some executives think that it is just not worth the time, energy, and cost to develop and implement a more detailed customer profitability system. One executive, Jack Hannah, spoke candidly against developing an alternate customer profitability system, stating, "We already have a system in place. Besides, it probably will all avcrage out in the end, so why go to all the time and trouble?" However, other executives believed more analysis was necessary. For instance, Mandy White, Jamestown's chief accountant, stated. "I think we should take a closer look at the information we already have. Maybe we should use the data we gathered to look at the profitability of a few of our customers and sec how that comes out." After reading the information regarding Jamestown's industry, strategic focus, and initial and alternate customer profitability systems, respond to the following questions. A. Rank Alanson, Boyne, and Conway from most profitable to least profitable according to the initial system's estimate of the contribution of each customer to Jamestown's bottom- line profitability. What are Jamestown's options regarding the treatment of these three customers? Based on this initial customer profitability analysis, what action do you recommend Jamestown take with each of these three customers? What, if any, issues/challenges do you see with the customer profitability measurements from the initial customer profitability system, provided in Exhibit 2? What assumption(s) is the customer profitability system making implicitly, with respect to the way in which EXHIBIT 5 Cost Drivers in the Key Activity Areas within the Warehousing and Shipping Process B. C. Are the accounting customer profitability measures provided by the initial customer Facilities and Inventory Storage and Handling managers to make better decisions about corporate profitability), negative (i.e., provide Average days of inventory on band Pulling and Shipping Products corporate profitability) or neutral (i.e., provide cost information that does not affect ty)? D. Now consider the alternate customer profitability system that Jamestown is contemplating. How does the alternate system differ (c.g., underlying assumptions, categorization and Total number of orders Number of orders requiring special packaging E. Use the data provided from the alternate customer profitability system to calculate customer service charges for W&S activities for Alanson, Boyne, and Conway. Next, estimate the Average size of orders customers according to this new alternate customer profitability system. Rank Alanson, Boyne, and Conway from most profitable to least profitable according to the alternate system. Explain any significant differences in the estimated contribution to profitability of these three customers when using the initial customer profitability system Somewhat reluctantly, most of the managers at the last meeting decided Ms. White made a good point about looking more carefully at the data. Therefore, additional data were gathered about the three customers used in the initial system. Exhibit 6 displays the additional customer F. G. Explain why the alternate system does or does not provide better information about customer profitability than the initial system. Based on the results of the alternate customer profitability system, how might Jamestown alter its treatment of Alanson, Boyne, and H. How might Jamestown need to alter its incentive system for management to achieve larger profits? What other issues might Jamestown management want to consider in implementing and operating a customer profitability system? Issues in Accounting Education
