Purchased product costs are marked up by 15% to cover the cost of warehousing, distribution, and freight. An additional markup is added 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 competitive 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 desk top deliveries. The current system of cost allocation is inadequate, as evidenced by the unexpected loss in 2000. An adequate cost allocation and pricing system would allow the management of DOP to anticipate shifts in costs and profitability. Activity-based pricing would allow for passing along costs of more expensive services to customers who use them at a higher rate.
Activity Based Cost System
The activity based costing system is detailed in Table 1. Freight activity was found to cost $6 per carton shipped commercially. Under the Desktop Delivery program, the cost of each delivery was calculated to be $220. Manual entry of orders cost $10 per order. An additional cost for manual orders was $4 per line item on the order. Orders originating from the internet resulted in a total cost of $5 per order, regardless of the number of line items, due to need for verification only. For cartons warehoused and handled through the facility, a cost of $52 per carton was calculated.
Under the original costing system used by DOP, Customer A was shown to be slightly less profitable than Customer B. However, this analysis showed the opposite – Customer A was slightly profitable at 5% profit as a percent of sales, and Customer B was not profitable, at a loss of (2.4%). Customer A was a consumer of low-cost services. Timely...