Use the provided case to answer Question C (last photo). Please use evidence and explanations in answer.

Lester E. Heitger and Dan L. Heitger ABSTRACT: Customers increasingly demand that companies offer a wide variety of products and services. As a result, many companies spend millions of dollars conducting profitability analyses of their customers. For instance, the banking industry alone spends an estimated $500 million per year on customer profitability analyses. Accordingly. customer profitability analysis is listed as one of the recent major developments in managerial accounting (Cotion 2005). 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, Sprint Nextel drew the attention of imvestors, analysts, and customers alike when it "fired" 1,000 of its worst customers via a form letter (Srivastava 2007). 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 heips 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 Tamestown 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 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 Unversity. The authors are grateful for heipful comments and suggestions from three anonymous reviewers, Sue Ravenseroft, and Pekin Ogan. In addition, the authors are grateful to the company presidents, vice-presidents, corporate controllers. plant managers, operating persoanel, and numerous other executives at Tomkins, Ple, as well as the graduate and undergraduate syudents at Indiara University, Miami University, and Auburn University who have particigated and provided extensive feedback teganling this case. 262 Heitger and Heitger 261 products. Jamestown 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. Jamestown started supplying various automotive customers with wiring hamesses, headlight systems, and a variety of other electrical parts and components over 30 years ago. The company has continued to upgrade its research 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 perspectives. Other uses for electronics and microeiectromechanical 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. FINANCIAL CHALLENGES FOR JAMESTOWN The automotive industry has been a mainstry of Jamestown's business. During 207, the automobile segment provided 55 percent of the 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 goel has not been easy. Competition for business has been fierce from both domestic and intemational competitors. Jamestown has developed its market position with automobile companies by offering a variety of services that facilitate clients" production activities. These services include overnight delivery of electrical component products, just-intime (JIT) inventory deliveries to clients' plants, warchousing of client parts, special part support services, and many other customer services designed to gain and maintain clients. Jamestown has hundreds of different contracts with many different divisions and plants of each 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 all). Although Jamestown's total sales-including sales in the automotive segment - have continued to rise, total profits as a pereentage of sales have not kept pace. Exhibit 1 shows summarized income statements from 203 through 207. 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. Jamestown Electric Supply Company: Assessing Customer Profitabilaty 263 Amounts are shown in thousands ($000). bxhibit 2 contains financial data for specific customers (i.e. Alanson, Boyne, and Conway). W WSS (Warchousing and Shipping) a G\&A (General and Administrative) Jamestown's management believes that support for cuslomer sales is critical to building and maintaining market share and customer satisfaction. Therefore, key warchousing, shipping. and customer service personnel also receive bonuses based on the volume of sales. A second bonus pool, equal to 10 percent of net income, comprises the bonus pool for all other key personsel. PART I-ASSESSING CUSTOMER PROFITABILITY An Initial Custemer Profitability System In an effort to determine why profits bave continued to shrink during a period of rising 5ales, Jamestown's executive team tricd early in 207 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 decided to implement a customer profitability system This customer profitability system inchuded 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 (GeA). With the help of accounting personnel, the marketing department developed a method of internally charging customers for W\&S services. For intemal 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 clicnt, 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 Isuies in Acoounting Eifucation 264 Heiger and Heitger words, a customer purchasing products with a COGS amount of $100 would be assigned an internal W\&S charge of $11.75. Jamestown's customer profitability model also uses retail sales volume to assign GEA costs to customers. Budgeted retail sales for 207 were $225 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 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). Results from the Initial Customer Profitability System After using the initial customer profitability system for a year (20X7). Jamestown management hoped to better understand costs and, therefore, be able to improve company profits. Instead of improved profits, however, the company's profits declined yet again, this time by 13 pereent, as sales continued to rise. EXIIBIT 2 20X7 Custemer Data: Initial Customer Profitability System - Alanson is a large automobile clicnt, Boyne is a small noe-aukomotive clicnt, Codrary is a small andomobile client. Wixhibit I contains argregatod annual financial datu for all cussomers. * WAS (Warehousing and Shipping) costs are allocated at a rane of 11.75 petcent of COCS. A G.A. (General and Administrative) costs are allocatod using a rate of 18.67 perect of sales. Jamestown Electric Sapply Campany: Assessing Customer Profitahility 265 EXHIBIT 3 Jamestown 207 Sakes Mix (by Sales Velume and Industry) "Amounts are shewn in thousands (5000). 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 siznificant cost increases for the company, Both W\&S and production management do not find the current customer profitability system belpful 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 resulting from the rising sales. These discrepancies caused increased tensions amoag the various Jamestown managers and made the January 3, 20X8, Board of Directors meeting quite contentious. 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 issue on the agenda at the 20X8 Board of Directors meeting The Search for Better Profitability Measures: An Alternate Customer Profitability System 266 Heitger and Heitger 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 firm's business. John wasted no time in responding to Janiee's point, bluntly stating, "That may be true, but these rush orders are costing us a lot of money.." Frank Alben (the Chairman of the Board) questioned Fred Hanson, head of warehousing 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-warchouses 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, Jamestown 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, "I don't think most of you have any idea how much of my 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 orders than it does to pick and package regular orders. To get a better idea of the possible financial impact of customer mix on profitability, Jamestown managers decided to have the intermal audit staff look into some of the issues discussed at the meeting. The results of the internal auditors' analysis follow. The Warehousing and Shipping Process 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 area 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 accumblated in an effort to document some of the cost drivers in the key activity areas in the warehousing and shipping process. Management's Estimates of Cost Drivers for Activities in Warehousing and Shipping Jamestown management believes that the costs of facilities and the costs of inventory storage and handling are driven primarily by 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 areas to customers based on the dollar amount of inventory is logical and effectively matches the product-related services provided to customers with the costs of providing those services. Isstwes in Accounting Education Jamestown Electric Supply Company: Assessing Customer Profitability 267 EXHIBIT 4 Costs in the Key Activity Areas within the Warehousing and Shipping Process "Amounts are ahew in thouand ( (5000) 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 its 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 activities is driven by Issaws in Accounting Education 268 Heitger and Heitger 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. Moving Fonward The information on W\&S costs and production costs has been discussed at several management meetings. Executives' sentiments vary significantly about whether an alternate 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 altemate customer profitability system, stating. "We already have a system in place. Besides, it probably will all average out in the end, so why go to all the time and trouble?" However, other executives belicved more analysis was neeessary. 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 see how that comes out." 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 data. Issues in Accounting Education Jamestown Electric Supply Company: Assessing Customer Profitability 269 Part 1 Requirements After reading the information regarding Jamestown's industry, strategic focus, and initial and alternate customer profitability systems, respond to the following questions. C. Are the accounting customer profitability measures provided by the initial customer profitability system positive (i.e., provide supportive cost information that leads Jamestown managers to make better decisions about corporate profitability), negative (i.e., provide cost information that leads Jamestown managers to make worse decisions about corporate profitability) or neutral (i.e., provide cost information that does not affect Jamestown managers' decisions about corporate profitability)