BA 220 (Day): Case 3 – Cantalejo, Rebecca; Saleh, Shadee; Uy John Lawrence

Case 3: Soft Drink and Beer

Point of View

We are taking the point of view of Carlito Buenafe, the owner of Phoenix Marketing Corporation(PMC).

Case Context

Phoenix Marketing Corporation (PMC) is a beer distribution company profitably operating in the last ten
years. Their franchise area consists of Surigao del Sur and Davao Oriental. The beer company reacquired
its subsidiary in the first quarter of 2001. PMC was selected to distribute a leading soft drink for the
second half of 2001 due to its sterling track record. The distribution contract is due for renegotiation at
the start of 2002. Because of this additional contract which took effect in July 2001, the company’s
operating margin and operating expense has been affected, owing to the additional commission and
costs for distributing the new product line. PMC has 7 fully depreciated trucks operating at full capacity
with dispatches of 5 times a week. The dispatches now have to be divided to cover the delivery of the
additional product line. Warehouse costs need to be reallocated to include soft drinks. Since the
contract will be re-evaluated at the start of year 2002, Mr. Carlito Buenafe (PMC owner) would like to
know if the distribution of soft drinks is contributing to the company’s profit as his basis for renewing
the contract. He is evaluating two ways to determine the allocation of warehouse costs which are
recorded as an annual expense: 1) using the relative proportion of the commissions from both products;
or 2) allocating the cost based on cost drivers. The result will determine if he will renew the contract for
2002.

Problem Statement

Should we renew or beg off from the contract of distributing softdrinks for 2002? What
allocation basis should be used for the decision?

Analytical Framework

To analyse the profitability of distributing softdrinks, we allocated the warehouse cost to both products
using proportion of commission for our 1st analysis and cost allocation based on relevant data on
warehouse costs given by the case brief.

For the first analysis, the allocation base used is total warehouse cost divided by total commission to get
the cost per commission. This is then used to allocate the warehouse cost based on the computed
allocation base.

For the second analysis, we divided each annual cost by 2 to allocate the 1st half of the year entirely to
beer and as stated by case fact 1 and used the following allocation rate for the corresponding
warehouse cost:
  Warehouse rent and security cost – Total annual rent and security cost was divided by two to
get the first 6 months of warehouse rent since only beer products were being stored during the
time period. For the next 6 months, remaining cost was allocated based on 60-40 floor area
used for storage of beer and soft drinks respectively as stated in the case.

 Salaries of dispatchers, warehousemen and checkers – Total salaries for 2nd half of the year
were allocated using the number of dispatches for both beers. Allocation base was computed by
dividing total annual cost by number of total annual dispatches to get cost per dispatch. The
resulting allocation base was then multiplied to the number of dispatches for beer (273) and
softdrinks (637) to get allocated salaries. Note that the number of dispatches for beer for the
second half of the year was computed by first dividing total annual dispatch by 2 then
subtracting total number of softdrinks dispatch from half of annual dispatch. This is in
consideration to the limitation of dispatches which is 151.66 dispatch per month.

 Salaries of admin staff – As stated in the case, salary for admin staff was allocated by dividing
half of the annual cost by 2 since there are 2 products for the 2nd half of the year.

 Utilities - Total annual utility costs was allocated using total number of cargo and delivery for
the year.

After allocating each warehouse cost to its corresponding cost drivers, we recomputed the total
warehouse cost, taking into account the figures incurred by distributing beer products only during the
first six months and the allocated warehouse cost for both beer and soft drinks for the remaining 6
months. Operating margin was then computed to include the allocated costs by deducting the allocated
warehouse cost from the partial operating margin given in the case brief. The final figure was then used
to determine if the soft drinks distribution is profitable.

Case Analysis

Looking at the first analysis where we used the proportion of commission to calculate warehouse cost
allocation, it can be seen that soft drinks distribution is not doing as well as the beer distribution
because of the higher commission of beer. However, we might arrive at the wrong decision to
discontinue soft drinks distribution as this analysis does not take into account the cost drivers
mentioned in the case which directly affects the cost incurred of each product. The second analysis
considers this cost drivers and as per computed warehouse cost, soft drinks distribution incurred more
warehouse cost in the second half compared to beer distribution. This is mainly because of the greater
number of soft drinks dispatch made during the first 6 months at 637 dispatches compared to 273
dispatches of beer. Also, in spite of having smaller dispatch number, beer products used up more area in
the warehouse which led to higher warehouse rent and security costs. This result alone shows that due
to the smaller commission gained from sold soft drink products, the profit was only able to barely cover
its warehouse cost. On the other hand, beer products distributed fell from an average of 151.66
dispatches per month for the first 6 months to 45.5 dispatches per month when PMC started
distribution of soft drinks. This led to a drop in commissions gained from beer distribution which led to
a proportional drop in its ability to cover its warehouse cost. Looking at the resulting profit margin, soft
drinks cannibalized beer’s commission which resulted to a negative operating margin of beer
distribution and negative net operating margin for both products in the second half of the year.
Resulting annual operating margin is smaller compared to the margins during the first half of the year.
The reason why beer has been operating profitably over the past ten years is because of its
commission’s ability to cover its warehouse cost.

Conclusion

Given the resulting operating profit margin, we therefore recommend for the commission price to be
renegotiated at the same price level of beer to cover its warehouse cost. If this is not possible, we
recommend for the soft drinks distribution to be stopped and continue with beer distribution.

Justification and Implementation