Ethical Drugs (A) Ethical Drugs, Inc., is a decentralized pharmaceutical company Marketing (S&M) division oversees all distribution activities of its pharmaceutical products. The division buys products from the various production divisions at pre- determined transfer prices which are set by headquarters annually. The company identifies three main distribution channels: . The Sales and A. General supermarket chains B. Drugstore chains C. "Ma and Pa" single-store pharmacies For many years, the S&M division has used gross margin percentage ([revenue minus cost of goods sold] divided by revenue), to evaluate the relative profitability of its different distribution channels. The calculated gross margins for the three distribution channels for April were: General Ma and Pa ingle $1,980,000 Supermarket Drugstore Chains Chains Stores $3,708,000 $3,150,000 Revenues Cost of Goods Sold 3600,000 3,000,000 Gross Margin Other Operating Costs Operating Income $8,838,000 8,400,000 438,000 351,080 800,000 $108,000 150,000 2.91% 476% 9.09% 4,96% The overall gross margin % of Ethical Drugs was 4.96% ($438,000+$8,838,000). The overall operating profit margin % of Ethical Drugs was 0.98% ($86,920+$8,838,000) Laurie Anderson was recently appointed as the new CFO of the S&M division. To get acquainted with the business, she met with sales and other managers from different areas. What struck her was the repeated concern regarding the true profitability of the different distribution channels. Several sales managers challenged the prevailing perception that the "Ma and Pa" single stores were the most profitable. Preliminary analysis of the April data indicated a wide variation in the characteristics of the different channels. Adapted from Horngren, Datar, and Foster. Revised 1/11