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Dakota Office Products Robert S

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Dakota Office Products

Robert S. Kaplan

John Malone, General Manager of Dakota Office Products (DOP) was concerned about the
financial results for calendar year 2000. Despite a sales increase from the prior year, the company
had just suffered the first loss in its history (see summary income statement in Dakota Office
Products Exhibit 1).

Dakota Office Products was a regional distributor of office supplies to institutions and
commercial businesses. It offered a comprehensive product line ranging from simple writing
implements (such as pens, pencils, and markers) and fasteners to specialty paper for modern
high-speed copiers and printers. DOP had an excellent reputation for customer service and
responsiveness.

DOP operated several distribution centers in which personnel unloaded truckload ship-
ments of products from manufacturers, and moved the cartons into designated storage locations
until customers requested the items. Each day, after customer orders had been received, DOP
personnel drove forklift trucks around the warehouse to accumulate the cartons of items and
prepared them for shipment.

Typically, DOP shipped products to its customers using commercial truckers. Recently, DOP
had attracted new business by offering a “desktop” option by delivering the packages of sup-
plies directly to individual locations at the customer's site. Dakota operated a small fleet of trucks
and assigned warehouse personnel as drivers to make the desktop deliveries. Dakota charged a small price premium (up to an additional 2% markup) for the convenience and savings such direct delivery orders provided to customers. The company believed that the added price for this service could improve margins in its highly competitive office supplies distribution business.

warehousing, distribution, and freight. Then it added another markup to cover the approximate
cost for general and selling expenses, plus an allowance for profit. The markups were determined
at the start of each year, based on actual expenses in prior years and general industry and com-
petitive trends. Actual prices to customers were adjusted based on long-term relationships and
competitive situations, but were generally independent of the specific level of service provided to
that customer, except for desktop deliveries.

Dakota had introduced electronic data interchange (EDI) in 1999, and a new Internet site
in 2000, which allowed customer orders to arrive automatically so that clerks would not have
to enter customer and order data manually. Several customers had switched to this electronic
service because of the convenience to them. Yet Dakota’s costs continued to rise. Malone was
concerned that even after introducing innovations such as desktop delivery and electronic order
entry, the company could not earn a profit. He wondered about what actions he should take to
regain profitability.

Distribution Center: Activity Analysis
Malone turned to his controller, Melissa Dunhill, and director of operations, Tim Cunningham, for
help. Tim suggested:
If we can figure out, without going overboard of course, what exactly goes on in the
distribution centers, maybe we can get a clearer picture about what it costs to serve
Our various Customers.

Melissa and Tim went into the field to get more specific information. They visited one of
Dakota's distribution facilities. Site manager Wilbur Smith confirmed, “All we do is store the
cartons, process the orders, and ship them to customers.” With Wilbur's help, Melissa and Tim
identified four primary activities done at the distribution center—process cartons in and out of
the facility, the new desktop delivery service, order handling, and data entry.

Wilbur described some details of these activities:

The amount of warehouse space we need and the people to move cartons in and out
of storage and get them ready for shipment just depends on the number of cartons. Alll
items have about the same inventory turnover so space and handling costs are propor-
tional to the number of cartons that go through the facility.

We use commercial freight for normal shipments, and the cost is based more on volume
than on anything else. Each carton we ship costs about the same, regardless of the
weight or distance. Of course, any carton that we deliver ourselves, through our new
desktop delivery service, avoids the commercial shipping charges.

The team confirmed the information with the warehouse supervisor who noted:

This desktop delivery is a real pain for my people. Sure, we offer the service, and it’s
attracted increased business. But | have had to add people since existing personnel
already had more than enough to do.

Melissa and Tim next checked on the expenses of entering and validating customer order
data. The order entry expenses included the data processing system and the data entry opera-
tors. They spoke with Hazel Nutley, a data entry operator at Dakota for 17 years.

All | do is key in the orders, line by line by line. | start by entering the customer ID and
validating our customer information. Beyond that, the only thing that really matters is how
many lines | have to enter. Each line item on the order has to be entered separately. Of
course, any order that comes in through our new EDI system or Internet page sets up
automatically without any intervention from me. | just do quick check to make sure the
customer hasn’t made an obvious error, and that everything looks correct. This valid-
ity check takes about the same time for all electronic orders; it doesn’t depend on the
number of items ordered.

Dakota Office
biaidaaliaial piahdealibl Products Exhibit 3
Number of cartons ordered 200 200 Services Provided in
Number of cartons shipped commercial freight 200 150 Year 2000 to
Number of desktop deliveries - 25 Customers A and B
Number of orders, manual 6 100
Number of line items, manual 60 180
Number of EDI orders 6 -
Average accounts receivable $9,000 $30,000
Melissa noticed, however, that the two accounts differed on the service demands made on
Dakota. Customer A placed a few large orders, and had started to use EDI to place its orders
(half its orders, in year 2000, arrived electronically). Customer B, in contrast, placed many more
orders, so its average size of order was much smaller than for Customer A. Also, all of Customer
B's orders were either paper or phone orders, requiring manual data entry; and 25% of B’s orders
requested the desktop delivery option.
Melissa, concerned about increases in Dakota's borrowings from the bank, also noticed that
Customer A generally paid its bills within 30 days, while Customer B often took 90 or more days
to pay its bills. A quick study revealed that the average accounts receivable balance during the
year for A was $9,000, while it was $30,000 for B. With Dakota paying interest of 10% per year
on its working capital line of credit, Melissa thought this difference might be significant.
Dakota Office Products Exhibit 3 shows Melissa's summary of the actual ordering, delivery
and payment statistics for the two customers. She believed she was now ready to assess the
actual profitability of customers, and make recommendations about how to reverse Dakota’s
recent profit slide.

Required

1. Why was Dakota Office Products’ existing pricing system inadequate for its current operating
environment?

2. Develop an activity-based costing system for Dakota Office Products (DOP) based on year
2000 data. Calculate the activity cost-driver rate for each DOP activity in 2000.

3. Using your answer in requirement 2, calculate the profitability of Customer A and Cus-
tomer B. What explains any difference in profitability between the two customers?

4. What are the limitations, if any, to the estimates of the profitability of the two customers?