# AOP 1

ABC—Seven Steps
1) 2) 3) 4) 5) Define activity cost pools—the value chain steps Assign costs to the pools Determine the “driver(s)” for each pool Measure aggregate activity units for the “driver(s)” Divide costs (step 2) by driver units (step 4) to get cost per driver unit 6) Measure driver units for a customer (or product) for each cost pool 7) Activity-based cost for the customer equals: cost driver units (step 6) x cost per driver unit (step 5), summed across all cost pools

. Salaries Fringe Benefits Rent Depreciation • • • TOTAL STEP 1 STEP 2 Value Chain Stages (Step 1) Stock Selection.. \$5.. TOTAL \$1550 .. Data Entry...700 Define the “Cost Pools” (The Value Chain Stages) Assign Costs to the Cost Pools .AOP 2 Steps 1 and 2 The Basic Cost Matrix (Step 2) Line Items Storage...

Lines 775.500 \$30.550 Cartons in Inv.AOP 3 Steps 1 through 5 (1) (2) (3) (4) (5) Value-Added Total FY92 Cost Cost Driver Activities Expense per Driver Units Service Defined as: Activity (000) Defined FY92 Plan Costs Storage \$1.81 Warehouse Activity \$761 Req.44 Requisition Handling \$1.00 Desk Top Delivery \$250 \$5.000 \$0.98 Pick Packing \$734 (PP) Lines 700.000 \$5. Lines 775.801 Requisitions 310.79 Per Time ~8.708 Freight Charge Actual Cost Inventory Finance Inventory Value × Capital Charge* .000 \$4. 350.000 \$0.000 \$1.05 Data Entry \$612 Req.

320 364 910 350 \$15. \$68. 52 0 \$2.163 = \$68.AOP 4 Step 6—A Saga of Two Customers p g Annual Revenue Requisitions q Requisition Lines (all “pick pack”) Average Inventory at the Centers— Cartons \$ Per carton— Cost Average Revenue* Shipments— Number “Desk Top” Freight. Revenue of \$79. \$ Freight/Shipment F i ht/Shi t Customer A \$79. (A) = \$50 000 ÷ \$71 = 704 cartons Revenue of \$79 320 ÷ 704 = \$113 (B) \$50.320 \$113. \$43. \$43 Customer B \$79.000 cartons. .163 cartons.000 \$71.250. \$79.320 790 2.000 \$43. 156 26 \$7. \$113.320 ÷ 1.500 700 \$50.000 ÷ \$43 = 1.500 \$48 *Cartons shipped = \$50.

79/line \$719 \$ 19 2500 lines x \$.44/carton \$3.81/requisition \$2.590 2500 lines x \$.AOP 5 Step 7 Storage Customer A 350 Cartons x \$4.98/line \$892 Customer B 700 Cartons x \$4.44/carton \$1.05/line x \$1.554 364 requisitions x \$5.98/line \$2.975 \$1 9 .81/requisition \$4.115 910 lines x \$.108 790 requisitions x \$5.79/line \$1.450 \$2 450 Requisition Handling Warehouse Activity Additional "Pick Pack" Charge910 pick-pack lines 2500 pick-pack lines x \$1.05/line \$956 \$2.625 \$2 625 Data Entry 910 lines x \$.

000 inventory x 1 5% 1.250 Customer B 26 times x \$30/time \$780 \$7.5%) x 13 5% 13.5% \$2.025 \$6.510 \$7.000 inventory (Estimated WACC of 13 5%) 13.AOP 6 Step 7 C S 7—Continued i d Desk Top Delivery Customer A 0 times x \$30/time \$0 \$2.500 Freight Out (Actual) Inventory Financing \$15.093 .750 Inactive Inventory Surcharge \$0 inventory (A proxy f obsolete inventory for b l t i t x 1 5% 1.5% cost borne by TFC) x 3 months \$0 Total Service Charges—ABC Basis \$10.5% x 13 5% 13.000 inventory \$50.5% x 3 months \$315 \$30.

2% of product cost) Customer A \$79.000) Service Fees (per ABC) (10.000) (16.810 Gross Profit % 24% Which is the better customer? .510) Gross Profit \$18.220 17% Customer B \$79.100) \$13.220 17% Customer B \$79.000) (16.320 Product Cost (50.320 (50.320 (50.100) \$13.093) (773) Negative Gross Profit Gross Profit % G P fit Activity-Based Analysis Customer A Sales \$79.000) (30.AOP 7 Allied TFC—Customer Profitability TFC Customer Analysis Old Method Sales Product Cost Service Fees (32.320 (50.

Customer A is much more vulnerable to a p g competitor who would charge use-based prices. Customer A does not fit the business—TFC cannot build a business around customers who d ’t use it d t h don’t its services! .AOP 8 Customer A now appears much more profitable than before and dramatically more profitable than Customer B. And. But.

Of course. but they don’t pay for them. Customer A is very profitable for TFC. they may only like it g y y as long as they don’t have to pay for it! So Customer B really uses the services TFC . But. y p y offers.AOP 9 Customer B now shows losses. . but they don’t use much of the service which is the basis for TFC’s business. they are a heavy user of the services—they like what services they TFC offers.

AOP 10 Moving From Analysis to Action • Marketing Strategy Decisions — Customer Selection — Pricing • "Value-Engineer" The Cost Structure .

AOP 11 Marketing Strategy Decisions • Pi i Pricing – SBP Pricing (Services Based Prices) – Implementation Issues Raise Prices for “B’s”? Lower Prices for “A’s”? • Customer Selection – Do we want more As or Bs? – Wh t kind of new customers to seek? What ki d f t t k? – What to do with the current customers? • The Value Proposition “Vending” versus “Value Selling” .

AOP 12 1. B is getting a “free ride” and A is being overcharged. b. based on a cost-benefit trade-off. c. a. b Pricing should allow the customer to decide which services to use. the heavy users should pay h ld more than light users. Right now. L i ll th h Logically. 1 Yes for menu pricing pricing. .

Lowering prices to the A’s will not make them happy. b. Raising prices to the B’s will encourage them to change suppliers.AOP 13 2. What is the justification for a price increase? Blaming it on a “new accounting system” won’t impress most customers. a. d. Why drop a price when A i h b Wh d i h is happy now at th hi h price? t the higher i ? c. . No for menu pricing. This will drive our unit costs even higher.

Cost is C t i not di t directly relevant f tl l t for th the user. What do we know about customer p perceptions of value here? Not much! p c. The real issue is value to the customer. SBP is a variation on old-fashioned cost based pricing pricing. . aybe o e up c g a. It may or may not represent good value to customers. “Maybe” for menu pricing. value is.AOP 14 3 3. b.