What course of action do you recommend to Shirley Davis? Support your recommendation with appropriate facts and analysis.

Garden Patch Foods: Analyzing the Purchasing-through-Payables Process

Charles E. Davis and Elizabeth B. Davis

ABSTRACT: Analyzing nonstrategic functions has become a major focus in todays business environment. This case presents the facts behind a decision faced by Garden Patch Foods, a prepared foods company that is looking for ways to increase efficiency and to improve the bottom line. As management considers how to increase efficiency of support operations, two major alternatives arise: (1) create a shared-services arrangement for the three divisions or (2) outsource the support functions. The case requires you to assume the role of a staff accountant and analyze the case facts and research issues relevant to shared-services arrangements and outsourcing. You will then communicate your recommendation in a written report to the CFO. Several references are included in the case to facilitate Internet-based research.

Shirley Davis had the touch when it came to growing fruits and vegetables. In her small town of Farmville, North Carolina, Shirley would supply most of her neighbors with fresh produce throughout the year. Many of these neighbors encouraged Shirley to start a business selling her crops, but she didnt feel she had the time to devote to both her family and starting a new business. After her children were grown, Shirley started experimenting with different methods of canning her produce. Her neighbors were always willing to be guinea pigs, and told her that her products had a better flavor than those available at the local grocery store. In 1940, Shirley was able to convince her local grocer to begin carrying her products under the label Garden Patch Foods. Within two years, the grocer was asking for more products than Shirley could supply, so she expanded her business by adding two cooks and one truck driver. She also needed to find additional suppliers of the raw fruits and vegetables. Shirley moved the operations from her home kitchen to a downtown warehouse. And so began the growth of Garden Patch Foods. As more and more stores began to carry the Garden Patch Foods label, Shirley had to expand the business to meet the increasing demand. Shirley hired an Operations Manager to oversee the production process, allowing her to spend more time investigating new canning techniques. In 1944, Shirley became aware of new methods of freezing foods that had been developed by Birdseye. She believed that this technology was the way of the future, and she was able to convince one of Birdseyes employees to join Garden Patch as director of research, primarily with the purpose of staying abreast of changes in freezing technology. This foresight catapulted Garden Patch Foods into a new era.

In 1950, when the business had grown to sales of approximately $300,000 with 20 employees, Shirley decided to capitalize on the success of the companys frozen food product line. She bought out Mama Goode, a local bakery with a wonderful reputation for its baked goods, and began packaging frozen breads, cakes, and pies using their recipes and Garden Patch Foods freezing processes. Because the bakery was already in operation, she decided not to disrupt the food preparation process with changes other than management. She retained the building and staff and added the machinery necessary for freezing the products. In 1977, Garden Patch Foods purchased a snack-making company in Richmond, Virginia. The company saw this acquisition as a natural progression of its bakery operations. The snack maker continued to operate in the same fashion, retaining all operations and most administration, but began to produce under the name Mama Goode. Garden Patch hoped that this would help to spur the snack food sector by name recognition with its already successful baked-goods products. By 1999, Garden Patch Foods enjoyed a national reputation for quality frozen foods, baked goods, and snacks. Sales had grown to $50 million and the company employed 400 workers. Although many changes had occurred in management as the control of the business passed down through the Davis family, success had been achieved by focusing on what the company did well freezing high-quality foods.

THE CURRENT GENERATION

While Garden Patch Foods had been an innovator in terms of food preservation, it had not paid the same level of attention to business operations. As a result of the companys philosophy of retaining the entire operations of each of its two acquisitions, the company now consisted of three relatively autonomous divisions. Shirleys great-granddaughter, Mary Smith, has just been promoted to president and is beginning an initiative to analyze Garden Patch Foods business processes to seek the most cost effective way to operate. She recognizes the potential inefficiencies and redundancies in the current divisional organization of operations and is seeking to make a change. Mary has some ideas of her own as to the companys future, but she wants to hear what the rest of the companys leaders think. Mary met with the CFO, Ty Brown, and the Productions/Operations Supervisor, Bill Young, to discuss cost control opportunities. Mary began: The reason for this meeting is to devise a new plan for increasing efficiencies in our divisions while saving costs. As you know, we must try to minimize our costs while maintaining our high quality. No matter what changes we make, I dont want to jeopardize the quality of our foods. Lets toss out some ideas. Ty and Bill started thinking out loud, so it wasnt clear whose ideas were whose. Changes such as automation, just-in-time inventory management, and streamlining production processes were offered as possible solutions. Mary interrupted, You both are probably correct that maintaining three separate and independent production facilities and inventory management systems may be costing us more than is necessary. Yet, we cannot do anything that will jeopardize the quality of our products. Each of our plants is optimized for production of a specific type of food, so I dont think we want to combine the production of frozen foods, baked goods, and snacks in a single location. Give me other thoughts. Bill thought for a moment and then replied, Well, besides actual production, at each location we have purchasing, payables, receivables, and cash disbursements, as well as human resource management, an IS group, and an on-site management team. What if instead of combining the production facilities, we centralize one or more of the support functions? I think this is called a shared-services arrangement, and lots of companies are moving in this direction. Instead of running three individual purchasing, accounting, HR and IS departments, we would have one centralized department for each function. It seems to me that the centralized departments would be even more efficient because of the similarities of our processes at all of our locations, contributed Bill. We could use the most efficient people from each location to perform the tasks for all locations. I bet we could save on both labor and processing costs.

Ty Brown got up from his end of the table and began to pace. This seems like a lot of work for us. Do we have the expertise to create a shared-services group? I was reading an article recently that was touting the benefits of outsourcing, and this may be the way for us to go. The article pointed out that the procurement-through-payables cycle could represent a great cost to a company, and this process is rarely among a companys core competencies. The article said that as much as 80 percent of all transaction volume, 70 percent of time and effort, and 90 percent of the supplier base are incurred for individual purchases of $200 or less. I havent run the numbers on this information for our company, but I would guess that we fall within that class. Outsourcing would give us the opportunity to use the experts skills and expertise to obtain our goods, and we could benefit from greater economies of scale in our purchasing activities. I dont know that outsourcing is an option for us, Mary countered. We must maintain the high quality of our materials in order to make our food products. Besides, the food industry is highly regulated to provide safety to our consumers. We must be able to determine exactly which ingredients from which supplier were used in producing each specific lot of product. We have a great deal of experience in purchasing our raw materials and have developed long-term relationships with our suppliers. I have to think that Garden Patch Foods can purchase these items for itself and its divisions far more effectively than any one else. You are absolutely correct, agreed Ty. The items you mentioned are our strategic purchasesthose integral components to the output of our business. But there are several other nonstrategic purchases we make for which we have no particular expertise. Are you saying you want to implement an outsourcing program in order to save a few bucks on office supplies? challenged Mary. No. I am saying that we could outsource the procurement-through-payables processes for all of our nonstrategic purchases. Just think about how many of these items we purchase each year. We buy office supplies, postage, and freight of course, but we also buy lots of other items. We go through tremendous amounts of uniforms, gloves, and hairnets. We purchase maintenance items like oil for the machines. We also hire a janitorial staff, temporary services, and building maintenance. Think about the amount we spend on insurance and travel arrangements; our people dont have time to research and purchase the lowest costs for all of these. Maybe we could consider outsourcing these purchases to people who do. Mary replied,

I dont know that this will help control costs significantly. I would like to implement something with significant impact on our bottom line. It doesnt seem like these processes are costing us that much. Ill consider the idea if it will truly save us money. Think about our current system, continued Ty. Each subsidiary maintains its own purchasing department, meaning we have three sets of people doing essentially the same thing. We have people completing the purchase orders, researching suppliers, processing invoices, and making cash disbursements. And then there is all the time that purchasing spends developing and maintaining relationships with our suppliers so that we get the level of service we desire. At each step of the process there is data entry activity to update our systems. You are right, responded Mary, the process does encompass quite a few steps. I am still not certain that outsourcing would save us money though. After all, we still would have to pay the outsourcers. Why dont you both work up some numbers for me showing the costs we are incurring with our present purchasing and payables functions. If we come up with a reasonable solution here, well think about our other support functions later. Ty, you investigate how and where we are spending money on nonstrategic purchases and our potential for outsourcing. Bill, you analyze the labor effort put into the purchasing and payable processes and see if you can get some estimates of the cost of implementing a shared-services group for this particular function. Well meet again next week to discuss the findings. Thanks for your help.

THE NEXT WEEK

Mary, Ty, and Bill met the following week to review the information each had gathered about current costs of the procurement and payables functions. Ty began the meeting with an analysis of the nonstrategic purchases currently made by each of Garden Patch Foods divisions. I have investigated the purchasing practices of each of our divisions. Lets look at what we are buying. Exhibit 1 shows that the company spends over $8 million annually on nonstrategic items such as office supplies, postage, and telephone services. As the information was being collected, it became clear that there were certain categories of purchases that included similar products and services across all divisions. Those are the ones analyzed and listed separately in the exhibit. Some of those common purchases such as rent and insurance are already managed well, and I believe we are achieving the best prices given our current needs. The other 15 categories of purchases analyzed reveal some interesting information. Our three divisions purchase nonstrategic items in varying degrees from a wide variety of suppliers. For example, across the company we have 37 different suppliers for office supplies. Spreading the volume of our purchases over so many suppliers means that we limit our ability to leverage volume purchasing when negotiating prices with a particular supplier. My research indicates that having no more than five suppliers in any purchase category is considered a best practice. If we could move to that level of supplier concentration, we would be able to negotiate better prices because of the increased volume of business going to each supplier. As a result of using numerous suppliers within a single category, the company pays different prices on the same item, depending on which location makes the purchase. For instance, the bakery currently receives a 12 percent discount off uniform book rates, while the snack division gets 20 percent off the book rate. Centralizing the purchasing function into a shared-services arrangement would allow us to place orders for all subsidiaries through a common process, resulting in all locations paying the same price for the same item. Bill then spoke up. Ive done some asking around and found out how our people in Purchasing and Accounts Payable spend their time. This information is summarized in Exhibit 2. Its amazing that the equivalent of almost 20 full-time employees, at an annual cost of approximately $633,000, spend time on nonstrategic purchasing activities. Whats even more surprising is that the division controllers reported we process about 22,000 invoices annually for purchases. That translates into more than $28 per invoice just for labor, not to mention materials and support costs! Based on my interviews with the purchasing departments, about 70 percent of the time spent on nonstrategic purchasing activities involves investigating the best supplier in terms of cost and quality, placing purchase orders, and managing relationships with our suppliers. Even without managing our supplier base, it seems logical to expect that we would save some time and money if we would just create a shared-services environment for our three divisions. You know, if we intend to continue to expand through acquisition, this problem is just going to grow unless we have a system in place to bring the new company in and integrate it into an existing purchasing system. Remember, weve got that deal pending with Metropolitan Foods in Minneapolis. I also did some calling around to companies that have implemented similar shared-services concepts in procurement and payables. These companies found that creating a shared-services purchasing function eliminated much of the variability experienced in prices and suppliers and resulted in a 515 percent annual cost savings on nonstrategic items. Developing and managing the shared-services supplier base would require somewhere in the neighborhood of $45,000 in consultant fees. The result of this effort would be a centralized supplier database and a reduced number of suppliers. Reducing the number of suppliers will allow us to concentrate our purchases with a few suppliers, giving us greater leverage when negotiating contract prices. It may take us three to four months to achieve our maximum savings once we implement the program, but it will be worth the wait.

EXHIBIT 1

Garden Patch Foods Nonstrategic Spend Analysis Mama Mama Average $ Garden Patch Goode Goode Total Number of Spent per Product Category Foods Bakery Snacks Company Vendors Supplier Office Supplies $64,434 $35,055 $30,964 $130,453 37 $3,526 Postage 22,778 6,436 15,041 44,257 6 7,376 Freight 238,724 147,720 126,253 512,697 22 23,304 Shop Supplies 201,162 151,521 221,234 573,916 138 4,159 Gloves and Uniforms 272,470 223,540 203,679 699,690 10 69,969 Telephone 107,053 70,765 82,278 260,095 6 43,349 Janitorial Services 35,184 19,669 23,561 78,414 4 19,603 Travel 132,235 98,918 69,368 300,521 18 16,696 Temporary Employment Services 47,544 0 16,391 63,935 6 10,656 Building Maintenance 44,390 32,089 38,851 115,330 25 4,613 Equipment Rental 78,818 0 84,496 163,314 13 12,563 Auto Rental/Expense 37,084 30,816 42,782 110,682 8 13,835 Gas and Oil 26,053 16,438 26,282 68,773 34 2,023 Computer Leases 64,266 15,635 0 79,902 12 6,658 Office Equipment 25,747 0 7,160 32,907 7 4,701 Subtotal $1,397,941 $848,601 $988,339 $3,234,883 Rent $224,134 $169,279 $196,544 $589,958 Insurance 107,984 67,720 84,530 260,234 Workers Comp. Insurance 41,091 32,170 36,545 109,806 Group Health Insurance 280,817 108,163 78,760 467,740 Total Analyzed Nonstrategic Purchases $2,051,967 $1,225,934 $1,384,718 $4,662,621 Total of All Nonstrategic Purchases $3,363,881 $2,270,247 $2,387,448 $8,021,576 Percentage Nonstrategic Purchases Analyzed 61.0% 54.0% 58.0% 58.1%

EXHIBIT 2

Labor Effort Analysis Current System Full-Time Equivalent Efforta Average Extended Cost Strategic Nonstrategic Total Salaryb Strategic Nonstrategic Total Garden Patch Foods Purchasing/Receiving Warehouse 2.00 2.00 $31,000 $62,000 $62,000 Service Manager/Buyer 3.50 3.50 $40,000 $140,000 $140,000 Branch Manager 1.00 1.00 $58,750 $58,750 $58,750 Office Manager 1.00 1.00 $31,000 $31,000 $31,000 Purchasing Clerk 1.75 1.75 3.50 $25,000 $43,750 $43,750 $87,500 Accounts Payable Accounting Clerk 0.75 0.75 1.50 $30,000 $22,500 $22,500 $45,000 Controller 0.15 0.15 0.30 $40,000 $6,000 $6,000 $12,000 System Administrator 0.20 0.20 0.40 $40,000 $8,000 $8,000 $16,000 Clerical Assistance 0.25 0.25 0.50 $20,000 $5,000 $5,000 $10,000 Total Effort Garden Patch Foods 6.10 7.60 13.70 $206,000 $256,250 $462,250 Mama Goode-Bakery Purchasing/Receiving Warehouse 1.00 1.00 $31,000 $31,000 $31,000 Service Manager/Buyer 2.25 2.25 $35,000 $78,750 $78,750 Branch Manager 1.00 1.00 $56,000 $56,000 $56,000 Office Manager 1.00 1.00 $31,000 $31,000 $31,000 Purchasing Clerk 1.50 1.50 3.00 $25,000 $37,500 $37,500 $75,000 Accounts Payable Accounting Clerk 0.75 0.75 1.50 $30,000 $22,500 $22,500 $45,000 Controller 0.15 0.15 0.30 $50,000 $7,500 $7,500 $15,000 System Administrator 0.20 0.20 0.40 $40,000 $8,000 $8,000 $16,000 Clerical Assistance 0.25 0.25 0.50 $25,000 $6,250 $6,250 $12,500 Total Effort Mama Goode-Bakery 4.85 6.10 10.95 $168,750 $191,500 $360,250 (continued on next page) Garden Patch Foods: Analyzing the Purchasing-through-Payables Process 375 Issues in Accounting Education, November 2003

EXHIBIT 2 (continued)

Full-Time Equivalent Efforta Extended Cost Average Strategic Nonstrategic Total Salaryb Strategic Nonstrategic Total Mama Goode-Snacks Purchasing/Receiving Materials Manager 0.25 0.75 1.00 $30,000 $7,500 $22,500 $30,000 Service Manager/Buyer 1.50 1.50 $35,000 $52,500 $52,500 Branch Manager 0.50 0.50 $50,000 $25,000 $25,000 Office Manager 1.00 1.00 $31,000 $31,000 $31,000 Purchasing Clerk 1.50 1.50 3.00 $25,000 $37,500 $37,500 $75,000 Accounts Payable Accounting Clerk 0.75 0.75 1.50 $30,000 $22,500 $22,500 $45,000 Accounting Manager 0.13 0.13 0.25 $40,000 $5,000 $5,000 $10,000 System Administrator 0.20 0.20 0.40 $40,000 $8,000 $8,000 $16,000 Clerical Assistance 0.25 0.25 0.50 $25,000 $6,250 $6,250 $12,500 Total Effort Mama Goode-Snacks 3.58 6.08 9.65 $111,750 $185,250 $297,000 Total Analyzed Effort 14.53 19.78 34.30 $486,500 $633,000 $1,119,500 a Full-Time Equivalent (FTE) effort is a measure of personnel resources. It is stated as a percentage of time worked, so a full-time employee working 40 hours per week would be considered 1.0 FTE, while a part-time employee working only 20 hours per week would be considered 0.5 FTE. Percentages are derived by determining the portion of an employees total work time (based on hours) spent on an activity. When that amount is a fraction, a portion of an employees time is spent on other activities not relevant to this analysis. b Average Salary includes a 30 percent charge for taxes and other employee benefits.

In addition to creating a centralized supplier database, this would also be a good time to reevaluate our current systems. Each division currently has a different software package for purchasing and accounts payable. If we go to a shared-services arrangement, we will still need to provide a way for plant personnel to make purchase requisitions to the shared-purchasing department. The people I talked with said to expect spending around $300,000 to purchase and implement a good purchasing system. They also suggested implementing a compatible accounts payable system to facilitate a centralized settlement process. This type of system should run around $195,000 for a world-class solution. Thats a total cost of $540,000 to implement the shared-services system. And thats not including the ongoing operational costs. My contacts indicated that for a company of our size, the new system would require, in FTEs (full-time equivalents),1 2-3 Service Managers/Buyers, 1 purchasing office manager, 3-3.5 purchasing/accounting clerks, and .5 systems administrator to handle all the nonstrategic purchasing and payables processes, whether or not the purchases are from the centralized vendor list. That would reduce headcount considerably. Once system implementation begins, it would take us about six months to reduce headcount and reassign responsibilities.

This is some very interesting information, replied Mary. I had no idea we had so many people dealing with so many suppliers. Perhaps there is some merit to centralizing our purchasing function to see if we can reduce the number of suppliers we have to deal with. But thats a lot of money to spend if a cheaper solution could be found. What about outsourcing, Ty? How would it differ from creating a shared-services concept? Well, Mary, began Ty, I talked with PayOut, Inc., a procurement and payables outsourcing firm, to get an idea about the services they would provide. PayOut would roll us into their existing national supplier network. Because of the tremendous volume of business that PayOut commands, these suppliers have signed contracts with PayOut to provide goods and services at prices below their stated catalog prices. PayOut would install their existing world-class procurement and payables systems in our office. While all the processing would be done by PayOut, we would have the ability to generate purchase requisitions at each location as needed. Well still need those 6.5-8 FTEs Bill mentioned earlier to manage the process and get the information to PayOut, wont we? asked Mary. Actually, we wont. Well still have our people for the strategic purchases, but for nonstrategic purchases, our operations managers, secretaries, or whoever is making purchase requests now will continue to do so, said Ty. But instead of sending the request to Purchasing, the request is made online to PayOut. Requisitions would be consolidated by PayOut and then transmitted to the supplier. All settlement activitiesgetting the invoice and paying the billwould be handled by PayOut in one of two ways. They can either generate checks against our bank account to pay suppliers, or they can pay from their own account on our behalf. Under the second option, we would wire them money to cover the payments made for us. PayOuts system would interface with our general ledger to create the necessary journal entries. Any detail reporting we would need on procurement and payables activity would come from the PayOut system. PayOut would also handle all of our 1099 reporting at year-end.2 If we choose to go with PayOut, there would be a $40,000 fee to transition to their system. Additionally, PayOuts ongoing services would cost us $15,000 per month. This price is good up to an annualized volume of 30,000 invoices. PayOut could probably start saving us money on purchases in about two months, and labor reduction would take about three months. 1 An FTE (full-time equivalent) is a measure of personnel resources. It is stated as a percentage of time worked, so a fulltime employee working 40 hours per week would be considered 1.0 FTE, while a part-time employee working only 20 hours per week would be considered 0.5 FTE. 2 Federal income tax law requires that a Form 1099 be filed to report various types of payments to vendors and stockholders. Additional information of 1099 filings can be found on the IRS website at http://www.irs.gov/pub/irs-pdf/i1099_02.pdf.

Mary concluded the meeting with the following directive. It seems we have all the information we need. Ty, get your people to prepare a report that analyzes the financial implications of our options. I also would like the report to include the pros and cons of each option, aside from the numbers. Lets make a decision soon. REQUIRED Assume that you are a staff accountant at Garden Patch Foods and CFO Ty Brown has asked you to help him prepare the requested report for the president. Specifically, he wants you to run the numbers that have been gathered by him and Bill to estimate the financial impact of the options available to the company (remember that status quo is always an option). Additionally, he wants you to identify any nonfinancial issues that need to be considered, especially in light of the fact that the company intends to continue growing through acquisition. Information systems and internal control issues should be considered as part of these nonfinancial issues to the extent you believe they are relevant.

Since outsourcing and shared service arrangements are new to everyone at Garden Patch Foods, you are going to have to do some research to identify general issues relevant to these options and then apply those issues to the situation faced by Garden Patch Foods