New Farm Organics You recently joined New Farm Organics Ltd as a management trainee. As soon as you join, you notice that retaining long-term customers is becoming a challenge for the company. During a delivery trip on 18th April 2023, New Farm Organics delivery specialist Timothy Cook noticed a competitors sales manager talking with the general manager of Thirst Quenchers Corp. Thirst Quenchers Corp is a large business selling beverages in and around Brisbane via vending machines across offices, educational institutions, and public places. On 19th April 2023, New Farm Organics sales manager (Paolo Ferry) met with the purchasing manager of Thirst Quenchers Corp for taking orders. During this meeting, the purchasing manager of Thirst Quenchers Corp informed that Thirst Quenchers Corp would not continue to place new orders unless New Farm Organics offered a further discount on the beverages they purchased from New Farm Organics. Johnny Lind (founder of New Farm Organics) was concerned about this situation as Thirst Quenchers Corp had been one of the companys largest and most loyal customers since New Farm Organics was established. Realising the urgency and importance of this situation, Johnny immediately scheduled a meeting inviting you (as management trainee), Timothy, Paolo, and several others. Company background New Farm Organics Ltd is based in New Farm sells fresh organic juices. The company prepares and bottles fruit juices from the fresh organic produce it sources. New Farm Organics supplies bulk orders of organic fruit juices to large beverage distributors and speciality restaurants around Brisbane. The companys business had grown steadily with the popularity of organic fresh fruit juices amongst health-conscious customers. Last year, New Farm Organics net revenues totalled $12 million. The company serviced about 15 customers whose beverage purchases totalled anywhere from about $100,000 to over $1 million annually. The recommended retail price of the fruit juices that New Farm Organics distributed was $6.50 per 350 ml bottle. The full cost (excluding customer support cost) of the juice bottles was $4.25 per 350 ml bottle. New Farm Organics offered discounts to its large customers. The discount varied primarily based on the following factors: Volume of drinks the customer purchased, the future potential of the customer, and the negotiations of the companys sales professionals. The meeting Johnny opened the meeting by summarising what he had heard from Timothy and Paolo over the past couple of days regarding Thirst Quenchers Corp. Johnny: It looks like weve got some competition for one of our largest customers. Paolo: This isnt the first time this has happened. You remember that this same competitor had approached Thirst Quenchers Corp last quarter. But that time, we were able to retain Thirst Quenchers Corp by offering a bit more of a discount. I think well have to do more of that this time, or else well lose this significant customer. Johnny quickly replied: I know Thirst Quenchers Corp is a big customer and a loyal one too, but its certainly not one of our most profitable customers as per Manuella (Book keeper of New Farm Organics). Manuella: Ive looked at some numbers on several of our accounts. I can confirm that Thirst Quenchers Corp is one of our lowest-margin customers. Look at this report (see Exhibit 1). Manuella noted that it is hard to trace our customer service cost to any particular customer. Our customer service costs are about 10% of the net revenue. To make things easy, it has been the companys practice to allocate customer service costs to each customer based on its share of the companys total net revenues. If a customer accounts for 3% of our net revenue, then we allocate that customer 3% of our customer service costs. Then we calculate a customer margin for each customer. Johnny looked at the numbers and said: We wouldnt make any money by selling to Thirst Quenchers Corp if we offered any further discounts. Moreover, if our other customers come to know about the discount we offered to Thirst Quenchers, then other customers would ask for the same discount especially the other big customers. Johanna said: Thirst Quenchers Corp is a great customer. They buy a lot of beverages and theyre easy to deal with. They place their orders on a regular basis and almost never ask for anything special. Who wouldnt want that kind of business? Timothy agreed: Youre right. I never had to change my delivery schedule for Thirst Quenchers Corp. Johanna continued: Some of our other customers are not able to anticipate that theyll be out of stock. Then they call us and persuade us to make quick deliveries for them. Its hard for me to believe that some of these other customers are more profitable than Thirst Quenchers Corp. Maybe we ought to add how much time and effort the operations team puts to service customers and then see who is most profitable for us. Johnny: Manuella, what type of costs are included in those customer service costs? Manuella replied: Well, customer service costs are meant to include several things. It includes anything related to handling the beverages, picking the beverages from the refrigerators according to the order instructions, moving the beverages over to the dock, and loading them onto the delivery van. It includes any cost related to taking, coordinating, and administering the orders, like what we pay the people in the sales office who take phone orders from customers and the supervisory cost to administer the order. It includes anything related to delivering the beverages to the customers location, like the cost of the delivery vans, track maintenance, and what we pay drivers to drive the vans. It includes anything related to all those expedited or rush orders you're talking about (overtime, extra scheduling, etc). And it includes what we pay sales professionals for visiting the customers. So, customer service costs are meant to include quite a bit. Johnny asked: So youre telling me that there are some customers that youre spending a lot more than on others? And its not Thirst Quenchers Corp? Johanna said: Thats right. Johnny continued: But our accounting system allocates customer service costs based on revenues, and since Thirst Quenchers Corp is one of our biggest customers, its allocating a large share of customer service costs to Thirst Quenchers Corp. Manuella: Exactly. Johnny said: Manuella, can you please gather some data on how much time and effort is required for service of each of our customers. Ill need all of you to help Manuella with the data collection effort. May be its time to get more sophisticated about how we look at these customer service costs. It may be worth the effort. Timonthy, Paolo and Johanna agreed to help and provide necessary input to Manuellas data collection effort. Johnny said: Well, lets meet again on 27th April with some detailed data analysis. On the 19th of April 2023, Manuella sends out the following email to all meeting attendees (see Exhibit 3). Ahead of the meeting with the management on 27th of April 2023, you are required to analyse the data provided by Manuella and prepare a presentation summarising your analysis of the situation faced by New Farm Organics and make recommendations for future course of action. Also, outline the implications of your recommendations for New Farm Organics. Exhibit 1: Report of customer profitability for the 4 largest customers of New Farm Organics for the previous accounting year. Particulars Thirst Quenchers Corp Pesco Ltd Morrison's Retail 6 to Ten Stores Total for New Farm Organics Net revenues ($) 1,168,800 1,192,800 121,440 454,500 12,000,000 Cost of goods sold ($) 1,020,000 1,020,000 102,000 382,500 10,200,000 Gross profit ($) 148,800 172,800 19,440 72,000 1,800,000 Customer service costs ($) 116,880 119,280 12,144 45,450 1,200,000 Operating profit ($) 31,920 53,520 7,296 26,550 600,000 Operating profit (% of net revenue) 2.73% 4.49% 6.01% 5.84% 5.00% Exhibit 2: Additional information from previous accounting year for the 4 largest customers of New Farm Organics Particulars Thirst Quenchers Corp Pesco Ltd Morrison's Retail 6 to Ten Stores Total for New Farm Organics Average selling price per bottle $4.87 $4.97 $5.06 $5.05 $5.00* Number of orders 160 400 200 300 5,000 Total deliveries 220 800 400 460 10,000 Kilometres travelled per delivery 10 38 22 8 20 Number of expedited Deliveries 20 500 260 180 5,000 Number of sales visits 24 50 36 18 720 * Average selling price based for the companys total sales. Exhibit 3: Email sent by Manuella on the 19th of April 2023 Dear colleagues, I hope you are well. Following our recent meeting, Ive gathered necessary information on customer service costs by searching through the accounting records. The following table summarises the customer service costs by area of activity for the last accounting year. Activity Cost ($) Product handling 672,000 Taking customer orders 100,000 Deliveries (standard) 140,000 Deliveries (expedited) 198,000 Sales visits to customers 90,000 Total 1,200,000 Ive also met with a few colleagues individually to understand and determine some of the factors which drive customer support costs. The product handling costs seem to vary with the number of bottles sold. Timothy checked the delivery records and has informed me that the delivery vans had travelled a total of 100,000 kilometres for making standard deliveries. While the cost per standard delivery varies based on the number of kilometres, the cost incurred per expedited delivery is the same irrespective of the number of kilometres travelled per delivery. I hope this information is helpful for you to prepare for our next meeting on the 27th of April 2023. Thank you Kind regards Manuella Book Keeper New Farm Organics