Indian Institute of Management

Ahmedabad IIMA/QM0008(A)

Kamdhenu Dairy(A)

"Why do you maintain that FA milk is more profitable than any of your other products?"
Professor Puranik asked Mr Mathias, General Manager of Kamdhenu Dairy.

Mathias replied, "This is so because we incur very little overheads for this product as
compared to others: for instance, we have no advertising or other promotional expenditure for
this product. The production process is very simple and the product has an assured market.
However, you can study our costs for all our products and satisfy yourself about the validity
of my statement. I am sure you will come to the same conclusion as I have after many years
of experience in the industry."

This was the discussion that took place between Mathias and two professors of a leading
management institute. The two professors had visited the dairy in April 1964 to study the
problem it was facing with the supply of FA milk to the government of a large state in western
India.Kamdhenu Dairy was located in Sanand, a small town on the railway line connecting
leading cities in western India. The dairy had been started mainly for providing better
marketing facilities to farmers for marketing the milk they produced. In 1945 the state
government of a western state had started a milk scheme for supply of milk in a major city in
the state. According to this scheme, milk was to be collected from Kheda district, in which
Sanand was located, and supplied to consumers in the city. During the initial stages of the
scheme collection of milk was left to collectors and private dairies, with the result that very
little of the increase in price offered by the state government was received by the farmers. In
order to get the benefit of the increased prices, the farmers decided to start a union of milk
producers and a central processing unit at Sanand. It was decided that this union would
collect milk from the farmers, pasteurize it, and sell it to the state government. A building and
some old machinery belonging to the government of India was leased by the union to start a
pasteurizing unit at Sanand. This marked the beginning of Kamdhenu Dairy.

From June 1948, the dairy started pasteurizing about 250 litres of milk a day. The cooperative
movement amongst milk producers became very popular, and the organization grew at a very
rapid rate. In 1953 it was found that the state milk scheme could not accept all the milk
collected by the union in winter months. This was because the state scheme required that the
state be supplied with a more or less constant quantity of milk, while production varied
widely between summer and winter seasons. In winter production was 250 per cent of
summer production. This left Kamdhenu Dairy with two alternatives:

restrict drastically the collection of milk during winter months

find alternative ways of consuming the surplus milk collected in winter months.

Prepared by Professors D.K. Desai and V.L. Mote

Cases of the Indian Institute of Management, Ahmedabad, are prepared as a basis for class discussion.
Cases are not designed to present illustrations of either correct or incorrect handling of administrative
problems.
Copyright © 1964 by the Indian Institute of Management, Ahmedabad.
2 of 10 IIMA/QM0008(A)

The first alternative was not satisfactory, as the farmers wanted to be assured of a year-round
market for all the surplus milk they desired to sell. In order to assure the farmers a year-round
market, the management of Kamdhenu Dairy decided to construct a dairy plant to convert
milk into milk products. It obtained assistance from UNICEF and the government of New
Zealand and, with an investment of Rs. 50 lakh, a plant was put into operation in October
1955.

The opening of the new dairy gave a great incentive to milk production in Kheda district and
the union was able to procure more and more milk each year. The progress of the union after
the new factory was built is illustrated in Exhibit 1.

Milk collected by Kamdhenu Dairy was converted into the following main products:

1. FA milk for the state milk scheme 2. Butter

3. Ghee 4. Skim milk powder
5. Baby food 6. Cheese

Exhibit 2 gives the production processes for these products and the quantities produced
during the financial year 1963-64.

In early 1964, Mr Shrivastava, Assistant General Manager of Kamdhenu Dairy, attended a

management development programme organized by the management institute mentioned
before. During this programme he discussed with a senior professor of the institute the
problem he faced in deciding the quantity of FA milk the dairy should commit itself to supply
to the state milk scheme. The difficulty had arisen because of the variation and the uncertainty
involved in the procurement of raw milk. The professor asked him to contact Professors S.
Puranik and D.K. Mehta who were interested in problems of this nature.

In April 1964 the two professors visited Kamdhenu Dairy and met Mathias and Shrivastava to
understand the problem. Shrivastava explained:

Milk supply from our societies is at its minimum in the month of June and reaches
its maximum in December-January. Though this variation is known, it is possible
to predict with certainty the quantity of milk we will be able to procure in the lean
and peak periods. Ideally we would like to vary our supply of FA milk to the state
milk scheme according to the variation of our milk procurement. Unfortunately
our contract terms do not permit us to do so. According to the contract we have to
supply them a more or less uniform quantity of FA milk throughout the year. In
case we fail to supply the requisite quantity we have to pay a penalty at the rate of
8 paise for every litre that is falling short of the contracted quantity. You must
remember that FA milk is our most profitable product. In case we contract too
small a quantity with the state because of the fear of not being able to supply it in
summer, we lose profit. On the other hand, if we contract too large a quantity we
have to pay a penalty. In view of this, I would like to know what is the optimum
quantity that I should settle for.

It was at this point that Professor Puranik asked Mathias the question stated at the beginning
of the case. As the question of profitability of various products was very important in this
problem, the two professors decided to examine the cost structure of various products and
ascertain the profitability of each product.

Mathias suggested that Shrivastava, Ramaswamy (the accountant), and the two professors get
together so that Ramaswamy could explain the cost structure of various products. At a
3 of 10 IIMA/QM0008(A)

subsequent meeting, Ramaswamy presented the statement given in Exhibit 3 and made the
following comments:

Our contention that FA milk is the most profitable product is borne out by facts.
You will notice that in other products, except for whole milk powder and FA milk,
we are either breaking even or losing money. For example, consider cheese, Mr
Shrivastava's favourite product. In estimating the profitability of this product, I
have not accounted for the expenditure that we incurred on the development of
this product; even so, we are losing heavily on cheese. I am wondering why we
should not drop this product. As for baby food, we do not make any money; but,
as Mr Mathias says, we are a cooperative society and must look to the welfare of
the people in general, and should not concentrate merely on profit. For your
information, this is our prestige product. However, I must say that the concept of
defining alternatives as I have used in the statement was something which I
learned from the discussions with the professors. Formerly we used to evaluate
profitability of products individually, rather than by combinations, which is the
correct way of looking at things from the technical as well as the accounting point
of view.

At this point Professor Puranik commented, "We are glad that you have started considering
product combinations rather than individual products. However, we are not sure as to how
far the cost you have worked out is relevant for deciding the cost profitable product mix."

Shrivastava said, "Ramaswamy, the management boys always talk of relevant costs. At the
management development programme they always used to tell us that while choosing
amongst alternatives, one should consider only the costs that had to be incurred in future and
not worry about the sunk costs. As they said, let bygones be bygones. I don't see how you
could be wrong in your findings. You have not missed any relevant costs. However, let the
professors scrutinize the cost statements and advise us."

He continued, "I am interested in finding out the optimum product mix. Today we are
enjoying a seller's market, and have not difficulty in selling all we produce. Our whole milk
powder is purchased by the government of India for defence needs; our cheese has a good
demand and I can hope to sell cheese at the rate of a thousand tonnes a year without any
difficulty. In short, marketing is no problem at present and I think conditions will remain the
same for some time to come. Our only constraints are the production capacities [listed in
Exhibit 5], availability of raw milk, and contractual obligations of supplying FA milk to the
state milk scheme at the rate of 75,000 litres a day. You may perhaps be aware that we have a
big programme for expansion. We would like to know the direction in which we should
expand."

The professors were considering what they should do next.

4 of 10 IIMA/QM0008(A)

Exhibit 1
Kamdhenu Dairy
Progress from 1955-56 to 1962-63

Year ending Number of Number of Share Monetary value Cost of milk

31st March societies farmer capital of the of milk and products
members of union collected sold
the societies (Rs.) (Rs.) (Rs.)
Position before the new dairy was built
1955-56 64 22828 217400 11136343 7636000
Position after the new dairy was built
1956-57 107 26795 361500 14164000 8847000
1957-58 130 29003 393900 21156400 13447000
1958-59 168 33068 473500 27557800 21165000
1959-60 167 40181 567100 22927000 18210000
1960-61 195 40500 741100 23513000 19833000
Position after the dairy was expanded for baby food and cheese
1961-62 219 46400 748700 65398429 31528820
1962-63 254 58400 819200 50417811 45624311
5 of 10 IIMA/QM0008(A)

Exhibit 2
Kamdhenu Dairy

2.1 Raw milk received daily from contributing farmers at weighing scales (1) goes into raw milk tanks
(2). The milk is then conveyed to pasteurizers (3a) and (3b). A portion of the pasteurized milk is
mixed with skim-milk stores in a milk condensing plant (14) and the mixture is conveyed to
insulated railway milk tanks (5) as FA milk. The remaining quantity of pasteurized milk is stored in
insulated milk tanks (4) to be processed into three main products, viz. butter, ghee, and skimmed
milk powder, and the two by-products, viz. casein and lactose.

Butter
From the storage tanks (4) milk is conveyed to cream separators (6) to be separated into cream
and skim milk. The separated cream is then conveyed to the vacreator (7) and the vacreated
cream to the cream cooler (8). The cooled cream is conveyed to jacketted cream ripening vats (9)
and then to the butter churn (10) where butter is made, and brought to the butter wrapping
machine (11). The finished product is then stocked in the cold store (12) and is ready for the
market.

Ghee
Butter, when it comes out of the butter churn (10), is conveyed to the ghee pan (13), stocked in the
cold store (12) and is ready for the market.

Skimmed Milk Powder

The separated skim milk from the cream separators (6) is conveyed to the milk condensing plant
(14). The condensed skim milk is conveyed;to the milk drying plant (15) and the dried skim milk
powder is conveyed to the milk powder filling machine (16). The finished product is taken to the
milk powder store (17) and is ready for the market.

2.2 Production of milk products in 1963-64

A. Total milk received from societies: 6,04,30,000 litres (see Exhibit 5)

B. Production (Rs. '000)

1. FA milk 35,519
2. Standardized milk 1,362
3. Baby food 1,839
4. Butter 1,385
5. Whole milk powder 569
6. Skimmed milk powder 224
7. Ghee 398
8. Cheese 81
6 of 10 IIMA/QM0008(A)

Exhibit 3: Kamdhenu Dairy – Statement Showing Profitability of Different Products

Alternatives Qty.of Qty. of Qty. in Cost of Processing Allocated Total Revenue From Net Profit
raw milk litres/ Kgs of milk* & packing overhead
used (in Kgs of by- cost* cost#
litres) main product
product
Main By- Main By- Total Total Per ltr.
product product Product produc of raw
t milk
1 FA Milk Butter 10000 9874(L) 62 6953 500 130 7583 7553 403 7956 373 0.037
2 FA Milk Ghee 10000 9874(L) 48 6953 551 130 7634 7553 399 7952 318 0.033
3 Skimmed Milk Butter 10000 813(K) 992 6953 1285 699 8937 2334 6448 8782 –155 –0.016
Powder
4 Skimmed Milk Ghee 10000 813(K) 756 6953 1301 699 8953 2334 6275 8609 –344 0.034
powder
5 Whole Milk Butter 10000 1179(K) 606 6953 2000 598 9551 5876 3987 9863 312 0.031
Powder
6 Whole Milk Ghee 10000 1179(K) 448 6953 2000 598 9551 5876 3822 9698 147 0.015
Powder
7 Baby Food Butter 10000 1307(K) 696 6953 4478 988 12419 7772 4524 12296 –123 –0.012
8 Baby Food Ghee 10000 1307(K) 529 6953 4494 988 12435 7772 4308 12080 –355 –0.036
9 Cheese Butter 10000 1094(K) 560 6953 3864 6581 17398 9010 3640 12650 –4748 –0.475
10 Cheese Ghee 10000 1094(K) 426 6953 3983 6581 17517 9010 3536 12546 –4971 –0.497
11 Standardized milk Butter 10000 8675(L) 681 6953 1052 427 8432 4338 4426 8764 332 0.033
12 Standardized milk Ghee 10000 8675(L) 519 6953 1060 427 8440 4338 4307 8645 205 0.021
* Cost of milk is taken to be Re 0.6953 per litre
** Includes:(1) Cost of utilities in processing like cost of electricity steam etc.
(2) Packaging cost and other material cost, e.g., of salt, sugar, colour, etc.
Refer Table 2 Exhibit 4 for explanation
7 of 10 IIMA/QM0008(A)

Exhibit 4
Kamdhenu Dairy

Table 1
Statement Showing Overhead Costs and Allocated Overhead Costs per Unit of Product for
1963-64

Milk 1963-64 Labour Depreciattion** Advertising Total Allocated

products Production cost* (Rs. '00000) (Rs. '00000) (Rs. overhead cost
(Units (Rs. '00000) per unit of
'00000) '00000) production
(6/2)
1 2 3 4 5 6 7
FA Milk 344(L) 1 2.1 3.1 0.01
Butter 13.9 3 2.2 1.75 6.95 0.5
Baby Food 18.4 3 0.9 5.2 9.1 0.49
Cheese Rs. 0.8 2 0.9 1.75 4.65 5.76
S.M.P. 2.2 Kg

2.0 2.0 0.25

W.M.P. 5.7
Total 9 8.1 8.7 25.8
*Total labour cost is distributed to the different products on the basis of labour used. The labour force and
wage structure are not affected by change in product mix and hence labour costs are accounted as overhead
costs.
** Allocated on the basis of the machine capacities used for manufacturing different products in the year
1963-64.

Table 2
Table Showing Allocation of Overhead Costs to the Alternatives in Exhibit 3

Main product By- Qty. of Qty. of Allocated Allocated Allocated

product main by- overhead cost overhead overhead
product product per litre/Kg of cost per Kg of cost
(in Rs) main product by-product (Rs)
(Rs) (Rs)
1 2 3 4 5 6 7
1. FA Milk Butter 9874 62 0.01 0.5 130
2. FA Milk Ghee 9874 48 0.01 0.66 130
3. S.M.P. Butter 813 992 0.25 0.5 699
4. S.M.P. Ghee 813 756 0.25 0.66 702
5. W.M.P Butter 1179 606 0.25 0.5 598
6. W.M.P. Ghee 1179 448 0.25 0.66 590
7. Baby Food Butter 1307 696 0.49 0.5 988
8. Baby Food Ghee 1307 529 0.49 0.66 990
9. Cheese Butter 1094 560 5.76 0.5 6581
10. Cheese Ghee 1094 426 5.76 0.66 6583
11. Standardized milk Butter 8675 681 0.01 0.5 427
12. Standardized milk Ghee 8675 519 0.01 0.66 429
8 of 10 IIMA/QM0008(A)

Exhibit 5
Kamdhenu Dairy

Table 1
Production Capacities of Different Milk Products

Sr. No. Product Production capacity

per day
1 Butter 10000 Kg**
2 Ghee 2500 Kg
3 Milk Powder 6000 Kg*
4 Baby Food 7000 Kg
5 Cheese 2000 Kg
*Powder-drying capacity
** All the butter required for making ghee must come
from the butter churns.

Table 2
Monthwise Collection of Milk for the year 1963-64

Year Month Actual milk

collection in
'00000 litres
1963 April 48.1
1963 May 40.5
1963 June 31.3
1963 July 32.8
1963 August 41.8
1963 September 46.3
1963 October 53.0
1963 November 60.7
1963 December 67.7
1964 January 65.0
1964 February 58.3
1964 March 59.1
Total 604.3
9 of 10 IIMA/QM0008(A)

Exhibit 5 (contd)

Table 3
Contractual Obligations

FA milk to be supplied to the state milk scheme at the rate of 75,000 litres per day

Supplement to the Case: Kamdhenu Dairy

The discussion of the case "Kamdhenu Dairy" will be facilitated a great deal if there is some uniformity in
the computations. In order to achieve this uniformity it is suggested that we define as follows the units for
various products.

With the help of Exhibit 3 it can be seen that 10,000 litres of raw milk would be required for producing
each of the following 12 alternatives:

Alternatives Corresponding to 10,000

litres of raw milk
Qty. of main Qty. of by-
product product
1. FA milk + Butter 9,874(L) 62
2. FA milk + Ghee 9,874(L) 48
3. S.M.P. + Butter 813(K) 992
4. S.M.P. + Ghee 813(K) 756
5. W.M.P. + Butter 1,179(K) 606
6. W.M.P. + Ghee 1,179(K) 448
7. Baby Food + Butter 1,307(K) 696
8. Baby Food + Ghee 1,307(K) 529
9. Cheese + Butter 1,094(K) 560
10.Cheese + Ghee 1,094(K) 426
11. Standardized Milk + Butter 8,675(L) 681
12. Standardized Milk + Ghee 8,675(L) 519

Let us Define

1. 10,000 litres of raw milk 1 unit of raw milk

2. 1,000 Kg of butter 1 unit of butter
3. 1,000 Kg of ghee 1 unit of ghee
4. 9,874 litres of FA milk 1 unit of FA milk
5. 813 Kg of S.M.P. 1 unit of S.M.P.
6. 1,179 Kg of W.M.P. 1 unit of W.M.P.
7. 1,307 Kg of baby food 1 unit of baby food
8. 1,094 Kg of Cheese 1 unit of cheese
9. 8,675 litres of standardized milk 1 unit of standardized milk
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For example, in these units, one unit of raw milk yields one unit of cheese and 0.56 unit of butter. In
terms of these units, the capacity restraints can be defined as under:

Production Units
capacity per
day
Butter 10,000 kg 10
Ghee 2,500 kg 2.5
Milk Powder 6,000 kg 7.38 of S.M.P. or
5.09 of W.M.P.
Baby food 7,000 kg 5.36
Cheese 2,000 kg 1.83 of cheese

The following questions would help us in the analysis of this case. However, the discussion need not be
confined only to these questions.

1. Should cheese be dropped from the product line as suggested by Mr. Ramaswamy?

2. Let us assume that the dairy will be able to procure raw milk as under:

Units per day

May to August 11.9
September to April 19.0

In view of this supply position what should be the production programme for the dairy if:

a) It had no contractual obligations to supply FA milk to the state milk scheme.

b) In case you were negotiating a contract with the state, what quantity of FA milk would you
commit to supply?
c) In case the dairy was planning to expand its butter churning and powder drying capacity, how
much money should it invest in this expansion?