JOHNSON BEVERAGE, INC. As president and primary owner of Johnson Beverage, Inc. (JBI), Jack Johnson was beginning to realize that retaining long-term customers was becoming a challenge. During a delivery run yesterday, driver Joe Stevens had noticed a competitor's sales manager talking with the general manager of Saver Superstore, one of JBI's largest customers. Then, that morning, Johnson's sales manager, Marsha Ketchum, had mentioned that, during her visit with the same general manager on Wednesday, he was starting to make some noises about wanting to negotiate a lower price. This could cause a dilemma because this customer had been one of the company's largest and most loyal customers for years. Johnson leaned back in his chair. These things always seemed to come up on Friday just in time to monopolize his thoughts over what otherwise would have been a restful weekend. Deciding to address the situation head on, he scheduled a meeting with Stevens, Ketchum, and several others for later that afternoon. Company Background JBI distributed beverages to retail customers. The company had been in business for two decades and had become a preferred distributor among several retail outlets in the local area. JBI primarily distributed bottled sports drinks made by small specialty beverage companies, and its business had grown steadily with the popularity of sports drinks over the past 10 to 20 years. Last year, JBI's revenues totaled $12 million. The company serviced about 20 customers whose beverage purchases totaled anywhere from about $100,000 to over $1 million annually. The undiscounted list price on the sports drinks that JBI distributed was $15.20 per case of 24 bottles. The full cost (excluding customer service costs) of the bottled drinks was $13.10 per case. The company offered discounts to some of its customers, which varied by customer based on a number of factors, including the volume of drinks the customer purchased, the future potential of the customer, and the negotiating success of the company's sales representative, among others. The Meeting Johnson opened the meeting by summarizing what he had heard from Stevens and Ketchum over the past couple of days. "It looks like we've got some competition for one of our best customers: Saver Superstore. I guess I'm not too surprised. They're a big customer." "This isn't the first time this has happened," added Ketchum. "You might remember that this same competitor has approached Saver Superstore before. But that time, we were able to keep the business by offering a bit more of a discount. I think we'll have to do more of that this time, or I'm afraid we'll lose the customer." Johnson responded quickly. "We can't get into a price war on this. I know this is a big customer, and a loyal one too, but it's certainly not one of our most profitable. I had Jim pull some numbers together on several of our accounts. Saver Superstore is one of our lowest-margin customers. Take a look." Jim Thomas in accounting, who was also in the meeting, had prepared a report (Exhibit 1), which Johnson laid on the table for the others to look at. Thomas explained how the accounting group compiled the numbers: For each customer, we just pull the revenues right out of the accounting system We know what they ordered and what we shipped, and we know what price we charge each customer, so that part is pretty easy. And we know that the cost per case, excluding our customer setvice costs, is $13.10. So we can multiply S13.10 per case by the number of cases we shipped to get our cost of goods. Then, we subtract our cost of goods from revenues for each customer and get a gross margin. Now, you may remember that we've talked about how hard it is to trace our customer service costs to any particular customer. Our customer service costs run about $1.2 million a year, roughly 10% of revenues. To make things easy, we allocate those to each customer based on its share of the company's total revenues. So if a customer accounts for 5% of our revenues, we allocate it 5% of our customer service costs. Then, we calculate a customer margin for each customer Johnson looked at the numbers and said: I don't think we can lower our price to Saver Superstore much more and make any money on this one. And just think, if we offer a larger discount to them, then we'll have our other customers wanting the same thing especially the other big ones. I can see it now: Marsha is going to walk in here next month and tell us that Oscar's OddLots has heard about the deal we struck with Saver Superstore, has been talking with that competitor, and they want the same thing. Oscar's OddLots, a large local retailer on the edge of town, was another of JBL's large customers Jason Rodgers, the operations manager for JBI was listening carefully. This was the first he had heard of the situation, but to a careful observer, his nod would have revealed what he was thinking. He said: You know, I'm not a bit surprised to hear all this. Saver Superstore is a great customer. They buy lots of beverages, and they're easy to deal with. They place their orders on a regular basis and almost never ask for anything special. I don't remember the last time we had to run around in the warehouse pulling together a rush order from them. Who wouldn't want that business? Stevens agreed, "You're right. I almost never have to change my delivery schedule because they've asked for quick delivery. And they're right around the comer, so they're easy for us to get to." Rodgers continued I think about some of our other customers. They seem to never be able to anticipate that they'll be out of stock. Then they call us and make it our problem to deal with. It seems like we have some customers that we work on all day every day. Why can't that competitor go after those customers? It's hard for me to believe that some of those customers are more profitable than Saver Superstore, Maybe we ought to add what we guys in the warehouse call a "pain factor onto those other customers and then see who is most profitable for us. As Johnson listened, he realized kdgers might be onto something. "Jim, what types of costs are included in those customer service costs?" Thomas replied, "Well, that number includes several things." He continued: It includes anything related to handling the beverages, like picking the beverages from the warehouse shelves according to the order instructions, moving the beverages over to the dock, and loading them on the delivery truck. It includes any costs related to taking, coordinating, and administering the orders, like what we pay the people in the sales office who take phone orders from customers, the supervisory costs to administer the order, and similar things. It includes anything related to delivering the beverages to the customer's location, like the cost of the delivery trucks, truck maintenance, and what we pay Joe and people like him to drive the trucks. It includes anything related to all those rush orders you're talking about, like overtime, extra scheduling, and stuff like that. And it includes what we pay Marsha for what she does, like visiting the customers to check in on them. So there's quite a bit of stuff in there, Johnson thought about this. "So you're telling me that there are some customers that you are spending a lot more time on than others? And it's not Saver Superstore? "That's right," Rodgers replied. Johnson continued. "But since our accounting system is allocating these customer service costs based on revenues, and since Saver Superstore is one of our biggest customers, it's allocating a large share of those costs to Saver Superstore." "Exactly," Thomas said. Let me do this: Let me spend a couple of days collecting some information. I'll need some help from each of you because I want to try to find out how much of your time you are spending on each of our customers. Maybe it's time to get more sophisticated about how we look at these customer service costs. It may be worth the effort. Stevens, Ketchum, and Rodgers all agreed to spend some time with Thomas so he could summarize the amount of activity they devoted to cach customer. They would meet again the following Friday. Thomas promised to compile an analysis that might help them determine how profitable each of their customers really was. Activity Analysis Before he left for the weekend, Thomas decided to pull together some information about the customer service costs he had described in the meeting: handling the product, taking the orders, delivering the product, expediting rush orders, and visiting the customer. He searched through the accounting system and del prmined how much of the annual SI.2 million in customer service costs was associated with each of those categories (Table 1). Table 1. Customer service costs during the prior year by area of activity, Area of activity Totals Product handling Taking orders from customers Delivering the product Expediting deliveries (other than automobile) Sales visits to customers Total S 672,000 100,000 140,000 198,000 90.000 S 1.200.000 Then, on Monday, Thomas met individually with Stevens, Ketchum, and Rodgers. With their help, he determined what he thought to be the primary driver of the costs in each of those customer service categories (Table 2). Table 2. Cost drivers by area of activity. Area of activity Cost driver Product handling Taking orders from customers Delivering the product Expediting deliveries (other than automobile) Sales visits to customers Number of cases sold Number of purchase orders Number of miles traveled Number of expedited deliveries Number of sales visits Thomas determined from the company's accounting records that the company sold 800,000 cases of beverages and processed 500 purchase orders the previous year. Stevens checked the mileage records for the delivery vehicles and determined that the vehicles had traveled a total of 44,800 miles. Rodgers was able to determine that the company made 4,480 deliveries, 2,500 of which were expedited deliveries. And finally, Ketchum checked her daily travel log to determine she had made a total of 360 sales visits to the company's customers. Thomas's next step was to determine how much of these cost drivers were attributable to each customer. Again, he was able to obtain some of that information (e.g., number of cases) relatively easily from the company's records. Then his colleagues helped him determine customer numbers for the rest of the activities. Exhibit 2 presents this data for the four customers included in Thomas's first reportExhibit 1). Exhibiti JOHNSON BEVERAGE, INC. Report of Customer Profitability during the Previous Year for Four Customers Prepared by Jim Thomas Net revenues Cost of goods Gross margin Customer service costs Customer profit Customer profit (% of net revenues) Saver Superstore $1,168,000 1.045.000 $ 120,000 116,800 1.200 0.3% Oscar's Odd Lots $1,192,000 1.048.000 $ 144,000 119.200 2500 2.14 Midwellen Supermarket $ 121.520 104.800 $ 16,720 12.152 Downtown Retail $ 454,500 191.000 $ 61.500 45.450 S16050 3.5% Total for JBI $12,000,000 10.480.000 $1,520,000 1.200.000 120.000 2.7% 3.8% UVA-C-2292 Exhibit 2 JOHNSON BEVERAGE, INC. Additional Information from Prior Year for Four Customers Price per case Number of cases Number of orders Number of deliveries Miles traveled per delivery Number of expedited deliveries Number of sales visits Saver Oscar's Superstore Loddlots $14.60 $14.90 80,000 80,000 16 40 110 400 5 19 10 250 12 25 Midwellen Supermarket SI5.19 8,000 20 200 Downtown Retail S15.15 30,000 30 230 4 90 Total for JBI SI5.00 800,000 500 4,480 10 2,500 360 130 18 Objectives Design an Activity-Based Costing system for a supply chain Analyze a business case, recognizing how to deal with customers based on their contribution to the cost Assessing customer profitability Using customer cost and profitability data to make strategic decisions Instructions Read the case carefully to understand the situation of making this important decision of granting customers higher or lower prices based on the supply chain costs specific customers make. The case includes situational information, as well as numerical data, which should be combined to perform the appropriate analysis and reach the correct decision. An Excel template is provided for guidance on performing supply chain cost analysis, dissecting costs among customers, and assessing customer profitability. Through the case questions, you are walked step by step to reach your final decision. For grading, you should submit your Excel workbook, along with a word document answering land oynlaining case questions in detail The Word SHEET-1 Allocation Rates for Customer Service Activities (From Tables 1 and 2 and case data) Quantity of Allocation rate Driver 800000 S 0.84 per case Area of Activity Product Handling Taking orders from customers Delivering the product Expediting deliveries (other than automobile) Sales visits to customers Total Total (Table 1) Cost Driver $672,000 Number of cases sold Number of purchase orders Number of miles traveled Number of expedited deliveries Number of sales visits SHEET-2 Customer Profitability of Four Customers Using ABC System to Allocate Customer Service Costs Midwellen Saver Superstore Oscar's OddLots Downtown Retail Supermarket Net revenues 1168000 1192000) 121520) 454500 Cost of goods 1048000 10480001 104800 393000 Gross margin 120000 144000) 16720 61500 Customer Service Costs (from Sheet 1 and Exhibit) Product Handling 0.84 X 80000 67200 0.84 X 80000367200 0.84 X 8000 6720 0.84 X 3000025200 Taking orders from customers Delivering the product Expediting deliveries (other than automobile) Sales visits to customers Total customer service costs for each customer Customer Profit (for each customer) Customer profit of net revenues for each customer Case Questions 1. Use the information in case Exhibits 1 and 2 and other necessary data in the case on activities and costs to develop an Activity-Based Cost system for JBI, i.e., how much each activity is costing JBI for each customer. Excel templates are available (Sheets 1 and 2) to guide your work. 2. Use this ABC system to determine customer profitability for Saver Superstore, Oscar's Oddlots, Midewellen Supermarket, and Downtown Retail (Sheet 2 of the provided template). 3. Use your results from Sheet 2 to compare customer costs and profits of the traditional costing system to the ABC system you have designed in (1). According to your ABC system, would you recommend entertaining a lower price to Saver SuperStore? Thank you soo much for your precious time and help