dex.com basket case study

DEX.com We assumed the Internet would be a perfeet way to distribute our produets. We had big sticcess with our direct sales, but now we could reach a larger audience. Our baskets appeal to people everywhere. I thought about opening stores in other towns or maybe even franchising, but the web offers a way to expand without losing control. That's why the results for the finst quarter of our web-based unit are so disappointing. We expected a small loss, because of marketing and other start-up expenses, but I was not prepared for the beating we took. Mary Martinez, President and CEO DEX Enterprises Organization DEX Enterprises is a small, family business that produces and markets wooden baskets. The company was founded in 1937 in Oakland, California by Autumn Martinez as a way of supplementing the family income. The business remained small until 1990 , when Mary Martinez took it over from her mother. Until then, all orders were taken by the senior Ms. Martinez and all baskets were handmade by her. In 1990, Mary moved to a model of having "dealers" take orders and opened a small workshop where part time labor produced the baskets. The dealers were also looking to supplement their incomes and, supplied with a small display inventory, displayed the baskets at home or at parties, and took orders. Order fulfillment was handled directly by DEX Enterprise personnel, who shipped finished baskets directly to customers. Little production inventory was kept. In January 2000, Mary Martinez evaluated the costs and benefits of two alternative distribution channels in an attempt to expand the business beyond the San Francisco Bay Area. One alternative was to franchise the business. Mary was concerned that she and the managers of DEX would lose control, especially control over quality, which she felt distinguished DEX baskets. The other alternative was to begin taking orders over the Internet. Mary chose the Internet option. The company added a new managerial position, Chief Technology Officer, established a subsidiary, DEX.com, to handle the new business. In an unusual move for the company, Mary went outside the small circle of family and friends and hired as the CTO Jessica Brown, who had experience on both the technical and management side of a Local internet start-up. Jessica was looking for something new where she could be in charge of an entire operation and was excited that she could combine this with her interest in basket weaving. It was agreed that if she could meet or exceed her budget for the first year of operation, she would be given a substantial piece of DEX.com. Most of the staff functions for DEX.com were provided and controlled by DEX Enterprises. The marketing budget was decided jointly by Jessica and Donna Cunha, the Senior VP of Marketing for the parent company. While the budget was decided jointly, media decisions and advertising campaigns were run directly from the parent organization. Personnel and financial services were also centralized. Exhibit 1 shows the organization chart for DEX Enterprises. Jessica contracted with Bell Atlantic (now Verizon) to provide Web hosting services for the operation. She wanted to go with a major telecommunication company rather than a local Internet Service Provider (ISP) for reasons of reliability. The back office operations (billing, payroll, etc.) would be maintained on personal computers at the DEX.com office. The Initial Plan DEX Enterprises (and DEX.com) have a July 1 fiscal year and the launch of DEX.com was designed to coincide with the beginning of FY2001 (July 1, 2000). It was decided that DEX.com would initially offer only one of the company's many baskets for sale. Company managers believed this would simplify production scheduling and help maintain quality control for the workforce. The basket to be offered was the round basket, one of the company's most popular baskets. The standard cost sheet for the basket is shown in Exhibit 2 . The cost accounting system at DEX Enterprises and the one adopted for DEX.com is a full absorption, standard cost system. Overhead is assigned to products (at standard cost) and not recognized in income until the product is sold. Variable overhead is allocated on the basis of direct labor hours and fixed overhead on the number of units. The fixed overhead rate is based on an estimated production level for the quarter. All variances from standard are recognized in the period recorded. Because of the uncertainty surrounding the demand for baskets using this new channel, the first quarter budget was designed to be "easy" to meet. In addition, relatively large marketing expenses were budgeted for promoting the new channel at related web sites and in craft publications. This was especially important in some of the East Coast publications because DEX had a small share in these markets. The first quarter operating budget is shown in Exhibit 3. The marketing and administration budget included the costs incurred by the parent for providing these services, as well as the cost of the small staff assisting Jessica and Jeffrey Grange, the Production Manager at DEX.com. First Quarter Results At first, things went well for DEX.com. Sales in July were sufficiently strong that managers thought the initial sales forecast may have been too limiting. Beginning in mid-August, however events turned against the new operation. Workers at Verizon went on strike. At first, there was some concessions to customers. One concession was free shipping on all orders over $100. Initially, shipping was billed to the customer at cost. This added $13,000 to the Marketing and Administration expenses for the quarter. Also at Jessica's request, additional marketing campaigns costing $30,000 were launched in craft magazines and on cable television. As sales were falling, the company was also hit by the booming economy in the state when the basket makers were finding better part time employment in the local industries. As a result, DEX.com had to increase the wage rate simply to maintain production. Not all the news was bad, however. Jessica had immediately identified a modification in the production process at the Harrisburg workshop that reduced the scrap on each basket by 20%. This modification was used on all baskets produced in the quarter. In the original process, scrap occurred in the initial cutting of the material and, therefore, no labor was lost because of the scrap. In addition, she maintained the level of quality, so the company received no returns and many comments about future purchases. Still, she was concerned that poor first quarter showing was going to be difficult to make up. I came here because I wanted to work at a company that, first, I had a significant ownership stake in and, second, that allows me to pursue my interest in the craft of basket-weaving full-time. I'm afraid that, because of the strike, I won't meet the first year budget and will lose my bonus shares. I think Mary is a fair person, but she has to answer to the other owners. They may not be so willing to assume that these results are because of events out of my control. Exhibit 4 shows the actual results for the quarter. The actual direct (material and labor) production inputs are shown in Exhibit 5. Actual total variable overhead for the quarter was $5,760 and actual fixed overhead was $16,000. Next Steps As Mary contemplates the future of the new distribution channel, she is concerned as well about the effect of the first quarter on the agreement with Jessica. Should we re-write the agreement with Jessica? From what I have seen, she is very dedicated to the business. On the other hand, an agreement is an agreement. If we revise it now, what kind of problems will we have in the future? Exhibit 1 Organization Chart \begin{tabular}{|c|} \hline Mary Martinez \\ President \& CEO \\ \hline \end{tabular} \begin{tabular}{|l|l|} \hline Jessica Brown & Samuel Parks \\ Chief Technology \\ Officer & Sinance \\ \hline \end{tabular} \begin{tabular}{c|} \hline Jeffrey Grange \\ VP - Production \end{tabular} Exhiblt 3 First Quarter Operating Budget Exhibit 5 Exhibit4FirstQuarterResultsActualDirectProductionQuantitiesandCosts DEX.com We assumed the Internet would be a perfeet way to distribute our produets. We had big sticcess with our direct sales, but now we could reach a larger audience. Our baskets appeal to people everywhere. I thought about opening stores in other towns or maybe even franchising, but the web offers a way to expand without losing control. That's why the results for the finst quarter of our web-based unit are so disappointing. We expected a small loss, because of marketing and other start-up expenses, but I was not prepared for the beating we took. Mary Martinez, President and CEO DEX Enterprises Organization DEX Enterprises is a small, family business that produces and markets wooden baskets. The company was founded in 1937 in Oakland, California by Autumn Martinez as a way of supplementing the family income. The business remained small until 1990 , when Mary Martinez took it over from her mother. Until then, all orders were taken by the senior Ms. Martinez and all baskets were handmade by her. In 1990, Mary moved to a model of having "dealers" take orders and opened a small workshop where part time labor produced the baskets. The dealers were also looking to supplement their incomes and, supplied with a small display inventory, displayed the baskets at home or at parties, and took orders. Order fulfillment was handled directly by DEX Enterprise personnel, who shipped finished baskets directly to customers. Little production inventory was kept. In January 2000, Mary Martinez evaluated the costs and benefits of two alternative distribution channels in an attempt to expand the business beyond the San Francisco Bay Area. One alternative was to franchise the business. Mary was concerned that she and the managers of DEX would lose control, especially control over quality, which she felt distinguished DEX baskets. The other alternative was to begin taking orders over the Internet. Mary chose the Internet option. The company added a new managerial position, Chief Technology Officer, established a subsidiary, DEX.com, to handle the new business. In an unusual move for the company, Mary went outside the small circle of family and friends and hired as the CTO Jessica Brown, who had experience on both the technical and management side of a Local internet start-up. Jessica was looking for something new where she could be in charge of an entire operation and was excited that she could combine this with her interest in basket weaving. It was agreed that if she could meet or exceed her budget for the first year of operation, she would be given a substantial piece of DEX.com. Most of the staff functions for DEX.com were provided and controlled by DEX Enterprises. The marketing budget was decided jointly by Jessica and Donna Cunha, the Senior VP of Marketing for the parent company. While the budget was decided jointly, media decisions and advertising campaigns were run directly from the parent organization. Personnel and financial services were also centralized. Exhibit 1 shows the organization chart for DEX Enterprises. Jessica contracted with Bell Atlantic (now Verizon) to provide Web hosting services for the operation. She wanted to go with a major telecommunication company rather than a local Internet Service Provider (ISP) for reasons of reliability. The back office operations (billing, payroll, etc.) would be maintained on personal computers at the DEX.com office. The Initial Plan DEX Enterprises (and DEX.com) have a July 1 fiscal year and the launch of DEX.com was designed to coincide with the beginning of FY2001 (July 1, 2000). It was decided that DEX.com would initially offer only one of the company's many baskets for sale. Company managers believed this would simplify production scheduling and help maintain quality control for the workforce. The basket to be offered was the round basket, one of the company's most popular baskets. The standard cost sheet for the basket is shown in Exhibit 2 . The cost accounting system at DEX Enterprises and the one adopted for DEX.com is a full absorption, standard cost system. Overhead is assigned to products (at standard cost) and not recognized in income until the product is sold. Variable overhead is allocated on the basis of direct labor hours and fixed overhead on the number of units. The fixed overhead rate is based on an estimated production level for the quarter. All variances from standard are recognized in the period recorded. Because of the uncertainty surrounding the demand for baskets using this new channel, the first quarter budget was designed to be "easy" to meet. In addition, relatively large marketing expenses were budgeted for promoting the new channel at related web sites and in craft publications. This was especially important in some of the East Coast publications because DEX had a small share in these markets. The first quarter operating budget is shown in Exhibit 3. The marketing and administration budget included the costs incurred by the parent for providing these services, as well as the cost of the small staff assisting Jessica and Jeffrey Grange, the Production Manager at DEX.com. First Quarter Results At first, things went well for DEX.com. Sales in July were sufficiently strong that managers thought the initial sales forecast may have been too limiting. Beginning in mid-August, however events turned against the new operation. Workers at Verizon went on strike. At first, there was some concessions to customers. One concession was free shipping on all orders over $100. Initially, shipping was billed to the customer at cost. This added $13,000 to the Marketing and Administration expenses for the quarter. Also at Jessica's request, additional marketing campaigns costing $30,000 were launched in craft magazines and on cable television. As sales were falling, the company was also hit by the booming economy in the state when the basket makers were finding better part time employment in the local industries. As a result, DEX.com had to increase the wage rate simply to maintain production. Not all the news was bad, however. Jessica had immediately identified a modification in the production process at the Harrisburg workshop that reduced the scrap on each basket by 20%. This modification was used on all baskets produced in the quarter. In the original process, scrap occurred in the initial cutting of the material and, therefore, no labor was lost because of the scrap. In addition, she maintained the level of quality, so the company received no returns and many comments about future purchases. Still, she was concerned that poor first quarter showing was going to be difficult to make up. I came here because I wanted to work at a company that, first, I had a significant ownership stake in and, second, that allows me to pursue my interest in the craft of basket-weaving full-time. I'm afraid that, because of the strike, I won't meet the first year budget and will lose my bonus shares. I think Mary is a fair person, but she has to answer to the other owners. They may not be so willing to assume that these results are because of events out of my control. Exhibit 4 shows the actual results for the quarter. The actual direct (material and labor) production inputs are shown in Exhibit 5. Actual total variable overhead for the quarter was $5,760 and actual fixed overhead was $16,000. Next Steps As Mary contemplates the future of the new distribution channel, she is concerned as well about the effect of the first quarter on the agreement with Jessica. Should we re-write the agreement with Jessica? From what I have seen, she is very dedicated to the business. On the other hand, an agreement is an agreement. If we revise it now, what kind of problems will we have in the future? Exhibit 1 Organization Chart \begin{tabular}{|c|} \hline Mary Martinez \\ President \& CEO \\ \hline \end{tabular} \begin{tabular}{|l|l|} \hline Jessica Brown & Samuel Parks \\ Chief Technology \\ Officer & Sinance \\ \hline \end{tabular} \begin{tabular}{c|} \hline Jeffrey Grange \\ VP - Production \end{tabular} Exhiblt 3 First Quarter Operating Budget Exhibit 5 Exhibit4FirstQuarterResultsActualDirectProductionQuantitiesandCosts