Autisp Stationery Propucts (A) Background Allied Stationary Products was founded in 1866 in'Den- ver, Colorado. What began as a one-man operation pro- ‘ducing note paper and cards to be sold in general stores me a corporation with throughout the frontier had become Fes expeced io top 8900 milion in 1982 If Jethro Givens were still around today, he would probably not believe what he saw. A farmer, who moved ‘west from Virginia, he was disabled in an accident and could no longer work the farm. He took up drawing and realized he might be able to make some money selling letter paper and cards decorated with his designs. By 1875, wnder the name of Givens Notes, his stationery had become popular throughout the West. When Jethro died in 1892, sales had reached $50,000 from the print- ing plant he had built in Denver. Jethro's sons and grandsons continued the business after his death. In 1926, sales reached $3 million, and the ‘company was renamed Allied Stationery Products. Soon after, the company began expanding into different types of finished paper products, such as writing paper, note- ‘books, typing paper, and greeting cards, the same time, Allied became a supplier to indus- try: In addition to more generic paper products, they ‘manufactured and printed business forms. By 1986, they hhad become the sixth largest firm in the U.S. business forms industry. At that time, Lionel Givens, CEO of Allied and Jethro's great grandson, decided that the company should expand into genera business forms management. ‘This was something that he understood some of the com- petition was doing. It was an area where Allied could potentially add great value. Forms management services ‘were one way to differentiate the firm from other forms manufacturers. Allied embarked on a campaigntoenroll its corporate clients for whom it traditionally only man- tufactured business forms, letterhead, and computer paper, in a program that it called “total forms control” (IFC), Allied considered general forms (forms refers to all paper products, generic or custom-designed) man- ‘agement to be a key tothe company's future success. Its product line included an entire array of forms and paper products, everything from stock computer and fax paper to custom designed forms tailored to meet the ‘exact business-needs-of the client with the assistance of Allied’s team of forms design consultants. By 1992, sales from those clients enrolled in TFC ‘were estimated at $60 million and Allied had established a separate division to handle these accounts. The types of services provided under TRC included the warehous- ing and distribution of forms (including inventory financing) as well as inventory control and reporting. Allied had a sophisticated computer systems network that enabled them to monitor aclient's forms inventory, forms usage, and ordering activities. They provided this information to their clients via comprehensive, yet sim- ple to read management reports, designed to help the client make informed management decisions. As partof its distribution services, Allied also offered “pick pack” service, where highly trained and experi- enced workers actually picked through cartons to meet the exact needs of the clients. Allied’s philosophy was that a well-run warehousing and distribution network is vital to any forms management program. It said, “we know what you need... the righr product at the right piace at the right time.’ For a small number of clients Allied also offered “desk-top delivery,” where Allied personnel would cis- tribute the forms within the company instead of the clients doing this themselves (ie., forms were usually delivered only to the loading dock where the client would then be responsible for appropriately dispatching them). Some companies felt that desk-top delivery was more cost effective for them since they required this ser- Viee infrequently and, therefore, did not have to hire # “This case was prepared by Professor Vijay Govindsrjan and Jay ‘Weise (193) ofthe Amos Tuck School, Dartmouth College. Copy- sight by Osceola Insinne,Current Cost Accounting System fulltime person to perform this task. As a comprehen sive forms management provider, Allied’s product line also had to be comprehensive, “Allied also had the ability to custom design its forms ‘management services to more exactly meet the needs of its clients. Allied clients ranged from small businesses that desired only basic inventory contol 0 those who had comprehensive forms management programs. Sirt~ ply put, it may be cost effective for a small business to have only basic monthly inventory status reports, while larger organizations may desire additional reporting such as low stock notices and order history reports. Allied organized its manufacturing and its distribu- tion/sales activities as separate profit centers. The trans- fer price for products transferred: to sales and distri- bation was set a fair market value. ‘Allied manufactured business forms in 13 locations. ‘Although the company encouraged internal sourcing for ‘customer orders, salespeople had the option of out- sourcing product. The sales force then marked up the cost of product and services by 20 percent, on average ‘Clients who participated in the forms management program kept their inventory of forms at one of Allied’s 10 distribution centers. The forms would be distributed to the client as they were needed. The client was then charged monthly service fees to cover the cost of ware hhousing and distribution, which was based on the cost Of sales of the product for that month regardless of the level of service provided to the client. The charges were as follows: ‘© Warehousing/distribition, 20.5 percent of product cost ‘© Inventory financing, 4.7 percent of product cost Freight out to the customer, 7 percent of product cost ‘Therefore, if a TFC client made use of the distribu. tion services provided by Allied, it would be charged an additional 20.5 percent of product cost of sales to cover all warehousing and distribution expenses, every thing from storage and requisition handling up to and including desk-iop delivery; 4.7 percent to cover the cost of capital: and 7 percent to cover freight expenses. “These percentages were determined based on actual 1990 financial dats. They were calculated on un aggre ‘gate basis so thar. in total, all expenses were covered (see Exhibie 1, Understanding Customer Profital With TEC profitability suffering in October 1992. Gen- ral Manager John Malone began to question the appro- priateness of the distribution charges. lity “The Business Forms Division used 10 make a 20 percent ——rerur-on-investment-{ROH)- But ceturns have been drop- ping ever sinee. TEC is projected to make an ROI of 6 percent for 1992. Something tells me that we are not man- Aging this business very well! Itseems i me thatthe charge for services needs closer scrutiny. { believe the charges should have nothing to do with the cost of the product. ‘Shouldn't we just charge our clients for the amount of ser- vices they use? It doesn’t seem fair that if two clients huy the same amount of product From us. but one keeps & ht of inventory at our distribution center and iy constantly requesting small shipments and the other hardly bothers us tall that they should poy the sume service Fees John looked through his records and found. .wo accounts of similar size, accounts A and 8, which were handled by different salespeople. Accounts A and B oth had annual sales of $79,320 with the'cost of the product being $50,000. Under the current system. these accounts carried the same service charges, but John noticed that these accounts were similar only in the Exaupir! Calculation of Service Fee Charges (current method) ($0005) 1990 predact sales at cos 1990 warehousinglstibution expense ‘eo prt cont 1990 aveageinvemory Balance 1990 average costo pita “Total cot of inventory Financing ‘ product cost 1960 toa eight charges product cost Spoorvalue ofthe product being sold; they were very different on the level of service they required from Allied. Tn the past year, customer A had submited 364 ro tisitions for product with a total of 910 lines! all of them “pick-pack”) while customer B had submited 790 req- tisitions with a total of 2,500 lines (all “pick-pack)— ‘more than double the activity of customer A. That wasn’t all, Customer A kept an average of 350 cartons of inventory atthe distribution center while customer B ‘kept 700 on average. Also the value ofeach of Customer B's cartons was greater. Customer B's average monthly: inventory balance was $50,000 ($7,000 of which had been sitting around for a whole year) while that of cus~ tomer A was only $15,000. Because of the greater activ- ity on customer B's account, a shipment went out three ‘times a week at an-annual freight cost of $7,500 while Customer A required only one shipment a week at az annual freight cost of $2,250. In addition, customer B hhad requested desk-top delivery 26 times during the past year, while customer A did not request desk-top deliv- ery: John Malone double-checked his records and con- firmed that the two accounts had indeed been charged the same fee for distribution services (see Exhibit 2). ‘With corporate breathing down his neck, John Mal- one turned to Division Controller Melissa Dunhill and Director of Operations Tim Cunningham for help. As a ammir2 Actual Service Fee Charges (current method) ‘customer Customer B ee Product cos. ‘ssog00 $50,000, ‘Warchousing/disuibution (205%) 10230 $10.250 Inventory financing (4.7%) ‘$2380 $2350 Freight out 0) $350 $3500 ‘Tol service fees 16100 si6.t00, Maricap G0) siz $13.20, Netsales 79320 $79.320 oa TAlipe sa request for any amount ofa given item. Whenever caxomer requires forms, they submit a requisition. This requisition ‘an have orders fr as many diferent products a they need Each “Tine” isa separate produc request. Ifthe request is for whole ca tons, this is considered a “ean ine.” For quantities es than a whole ean, hii considered a“pck- peck” ne. first step, they were able to provide John with the fol- Towing information: ‘The total expenses to be incurred in the distribution centers in 1992 were estimated as follows ($°000"s): Rent siaas Depreciation 208 lies ra Salaried payroll us Fring benetis—salaried Tet ‘Telephone 96 Security 3 “Tenesinurance ——14 ‘Teel Eaerainment 40 Postage 36 Hourly payrot—admin. 259 Fringes—hourly admin. 37 ‘Temp. help 0 ‘Variable warehouse payroll 1398 Warehouse Fnges 336 ‘Dats processing on Teal $5,708 ohn said, “This looks like good information, but how ‘am I going to use it to solve my problem?” “Well.” Tim said, “if we can figure out, without going overboard of ‘course, what exactly goes on in the distribution centers. maybe we can take these financial numbers and assign them tothe activities that are going on in the distribution, center. If we can do that, we'll have 2 much better idea Cf what it costs to serve our clients." Tim knew that two primary activities took place in the distribution cen- ters-—the warehousing of forms and the distribution of those forms in response to 2 customer requisition, but he figured that they should talk to some people in the field to get more specific information. Distribution Center: Activity Analysis John and Tim visited Allied’s Kansas City, Mo. distri Site manager Wilbur Smith confirmed. [All we dois store the cartons and process the requisitions 1 tell you, the amount of warehouse space we need just depends on the number of cartons. It seems like we've got ‘locof cartons that jus sichere forever. If we get into some Flexible lease programs and changed aisle configurations, ‘we could probebly adjust our space requirements if the ‘number of cartons we stored were to change. The other thing that really bothers me is that we've gor some inven-tory that’s been siting here forever. What's to the client? Isn'tthere a way we can make them get this stuff out of here. ‘As far as the administration of the operation gots. ‘everything depends on the aumber of requisitions thet ‘come through here, but on a given requisition the customer could request as many different items as they like. ‘The team then went to interview warehouse Supervi- sor, Rick Fosmire, who savr it this way, Idon'tcare iff get a hundred requisitions with one line each or one requisition with a hundred lines on it, my guys stil have to go pick a hundred items off the shelves. And those damn *pick-pack” requests. Almost everything is “pick: {otiier ‘pack” nowadays. No one seems to order a whole carton ‘anymore, Do you know how much more labor itrequires 10 pick through those cartons? And on top ofthat this desk top delivery isa real pain for my guys. Sue, we offer the service, but you figure te clients who useit should have to ay something extra I's not like my guys don’t have ‘engugh to do. John and Tim were starting to get a pretty good ides ‘af what goes on in the distribution centers, but there was still one person left to talk to, They knew that a lot of money was spent on data processing, mostly labor. They ‘needed to know how those people spent their time. Hazel Nutley had been a data entry operator at Allied for the last 17 years, “AIIT do is key in those requisi- tions, line by ine by line, I've gotten tothe point where know the customers so well that all the order informa- tion is easy. The only thing that really matters is how ‘many items they make me enter.” ohn and Tim retumed to Denver with a good idea of ‘what happened in a distribution center. From what they observed, they broke the distribution center down into six primary value added actvities—storage, requisition, handling, basic warehouse stock selection. “pick-pack”™ activity, data entry, and desk-top delivery. With Melissa help, they took the financial plans and assigned costs to these activities as follows ($'000"s). (See Exhibit 3 for calculations): Storage $1,550 Requisition handing 1808 Basic warehouse sock selection 761 "Pick-pack” activity Te Dam entry oz Deaetop delivery 250 Toa! 3708 Exutorr3 Breakdown of Expenses by Activity (000) Tonal Share of Expense Expense? Rent slaawse Sia Depreciation 208 x85 7 Unites 7 85% 139 Security 3 3 ‘Total storage expense susso Rent S124 2156 sat Depreciation 208 x13 u wrasse 8 Salaries + Fringes 309 909 Telephone 96 36 ‘Taxevinsurnce 104 Jot ‘TeaveVesterainment woxIs% 2 Posage 56 56 Hourly payroll + Fringes 316 36 ‘Temp. belp 7 7 “Total requisition handling expense sigo1 Variable warchouse pay + Fringes $1735 suns “Travel and entrainment (25%) 025% 0 “Total warehouse activity sits Basie warehouse sock selection (44%) 761 “Pick-pack" activity (25) 74 Desk-top delivery (14%) 230 ‘Toul warehouse activity sins Data processing expense $612 $612 Tim then estimated the following for 1992 based ‘upon historical information and expectations about the coming year. ‘+ He figured that, on average, his 10 distribution centers scattered across the country. would have combined inventories of approximately 350,000 cartons mast cartons were of fairly standard size). ‘* TFC would process about 310,000 requisitions for product in 1992, * Each requisition would have an average of 2.5 lines cn it; these were called “arton lines.” ‘About 90% of the carton lines would require "pick pack” activity (as opposed to shipping an entire carton),‘This would cover the bulk of the distribution expenses, but they were still uncomfortable withthe way inventory financing and freight were charged out. John checked with the finance department and learned that Allied obtained financing at the prime rate pius 1 per- cent. He figured they could just pass that along. “Wait a second,” Melissa said, “you're probably only ‘going to adjust the charges every six months or every year. We'd better protect ourselves if our rate changes. ‘Why don’t we make it prime + 3.5 percent?” “Good thinking,” “T think that new computer system is coming on line soon that will rack individual freight charges,” said Tim, ‘What it costs us.” They all agreed that this sounded fair. ‘Some things that were said atthe distribution center stil stuck in Tim's mind. “Don't you think we should do ‘something to get that old inventory moving? How about ‘we charge something extra, say 1.5 percent per month, for anything that’s been there over nine months.” “Great idea,” Melissa said, “this will help protect us against the loss we sometimes take on old inventory ‘when the clients end up changing their forms. You know We just eat that and never charge them for it” ‘They were almost there, “What about desk-top deliv- ery?” Tim said. “I think we should charge extra for it, ‘but I don't want this to get too complicated.” John said, “How much extra time does it take your ‘guys on average to run around the client company?” “T'd say about an hour and a half to two hous.” “Alright. At15 per hour, that's about $30 each time. ‘Sound fais?” “Sounds OK to me.” “Me, too.” “Wait just one second,” Melissa said, “There's some- thing I don't quite understand, We are able to provide a great deal of information services to our clients. but some require only 2 minimal amount while others want tore sophisticated reporting. We haven't discussed if ferentiating the charges for that at al.” “That's a-good point,” John replied, “but you know that generating these reports really doesn't cost us very ‘much and that we need to provide some of these services as a marketing tool in order to win clients. Let’s say we still provide a monthly inventory status report free of charge, and we charge $15/month for yone wino wants the other more sophisticated reports.” “T guess that makes sense,” Melissa sid “The entire management team, including Doug Kings- 7 cal jist tim around and charge the client for —Tey, Chief Financial Officer ofthe Business Forms Divi- sion, knew that there had to be a better way of charging out distribution services and thatthe solution would help ‘TEC become more profitable. They now had a much bet- ter understanding of the drivers of costs involved in dis- tribution services. As the four headed off in Doug's ‘Sedan de Ville for the Broncos’ first home game. they tried to figure out how to use this information to find a workable solution. Questions 1, Using the information provided in the case, can you devise a better way for TFC to charge its Clients for distribution services? 2. How much would you charge Customer A and ‘Customer B under this new system? 3, Based on your analysis, what managerial and strategic recommendations would you make 10 improve TEC profitability?