Then, that morning, Johnny’s sales manager, Marsha Ketchum, had mentioned that, during her visit with the same general manager on Wednesday, he was starting to make some noises about wanting to negotiate a lower price. This could cause a dilemma because this customer had been one of the company’s largest and most loyal customers for years. Johnson leaned back In his chair. These things always seemed to come up on Friday -?? Just In time to monopolize his thoughts over what otherwise would have been a restful weekend.
Deciding to address the situation head on, he scheduled a meeting tit Stevens, Ketchum, and several others for later that afternoon. Company Background JIB distributed beverages to retail customers. The company had been in business for two decades and had become a preferred distributor among several retail outlets in the local area. JIB primarily distributed bottled sports drinks made by small specialty beverage companies, and Its business had grown steadily with the popularity of sports drinks over the past 10 to 20 years. Last year, JPL’s revenues totaled $12 million.
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The company serviced about 20 customers whose beverage purchases totaled anywhere from about $100,000 to over $1 million annually. The undistorted list price on the sports drinks that’s distributed was $15. 20 per case of 24 bottles. The full cost (excluding customer service costs) of the bottled drinks was SSL 3. 10 per case. The company offered discounts to some of its customers, which varied by customer based on a number of factors, including the volume of drinks the customer purchased, the future potential of the customer, and the negotiating success of the company’s sales representative, among others.
This case was prepared by Associate Professor Allan J. Lynch. It was written as a I OFF an administrative situation. Copyright 0 2009 by the University of Virginia Darned School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e- mail to [email protected] Com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-??electronic, mechanical, photocopying, recording, or otherwise -??without the permission of the Darned School Foundation.
Rev. 6/09. Page 1 of 7 DardenBusinessPublishing:209044 -2- This document is authorized for use only by Madeline Mann at Douglas College. The Meeting Johnson opened the meeting by summarizing what he had heard from Stevens and Ketchum over the past couple of days. “It looks like we’ve got some competition for one of our best customers: Saver Superstore. I guess I’m not too surprised. They’re a big customer. ” “This isn’t the first time this has happened,” added Ketchum. Muff might remember that this same competitor has approached Saver Superstore before.
But that time, we were able to keep the business by offering a bit more of a discount. I think we’ll have to do more of that this time, or I’m afraid we’ll lose the customer. ” Johnson responded quickly. “We can’t get into a price war on this. I know this is a big customer, and a loyal one too, but it’s certainly not one of our most profitable. I had Jim pull some numbers together on several of our accounts. Saver Superstore is one of our lowest-margin customers. Take a look. ” Jim Thomas in accounting, who was also in the meeting, had prepared a report (Exhibit 1), which Johnson laid on the table for the others to look at.
Thomas explained how the accounting group compiled the numbers: For each customer, we Just pull the revenues right out of the accounting system. We know what they ordered and what we shipped, and we know what price we charge each customer, so that part is pretty easy. And we know that the cost per case, excluding our customer service costs, is $13. 10. So we can multiply $13. 10 per case by the number of cases we shipped to get our cost of goods. Then, we subtract our cost of goods from revenues for each customer and get a gross margin.
Now, you may remember that we’ve talked about how hard it is to trace our customer service costs to any particular customer. Our customer service costs run about $1. 2 million a year, roughly 10% of revenues. To make things easy, we allocate those to each customer based on its share of the company’s total revenues. So if a customer Then, we calculate a customer margin for each customer. Johnson looked at the numbers and said: I don’t think we can lower our price to Saver Superstore much more and make any money on this one.
And Just think, if we offer a larger discount to them, then we’ll have our other customers wanting the same thing-??especially the other big ones. I can see it now: Marsha is going to walk in here next month and tell us that Scar’s Dolts has heard about the deal we struck with Saver Superstore, has been talking tit that competitor, and they want the same thing. Page 2 of 7 -3- Scar’s Dolts, a large local retailer on the edge of town, was another of JPL’s large customers. Jason Rodgers, the operations manager for JIB, was listening carefully.
This was the first he had heard of the situation, but to a careful observer, his nod would have revealed what he was thinking. He said: You know, I’m not a bit surprised to hear all this. Saver Superstore is a great customer. They buy lots of beverages, and they’re easy to deal with. They place their orders on a regular basis and almost never ask for anything special. I don’t member the last time we had to run around in the warehouse pulling together a rush order from them. Who wouldn’t want that business? Stevens agreed, mire’s right.
I almost never have to change my delivery schedule because they’ve asked for quick delivery. And they’re right around the corner, so they’re easy for us to get to. ” Rodgers continued: I think about some of our other customers. They seem to never be able to anticipate that they’ll be out of stock. Then they call us and make it our problem to deal with. It seems like we have some customers that we work on all day every day. Why can’t that competitor go after those customers? It’s hard for me to believe that some of those customers are more profitable than Saver Superstore.
Maybe we ought to add what we guys in the warehouse call a “pain factor” onto those other customers and then see who is most profitable for us. As Johnson listened, he realized Rodgers might be onto something. “Jim, what types of costs are included in those customer service Thomas replied, “Well, that number includes several things. ” He continued: It includes anything related to handling the beverages, like picking the beverages from the warehouse shelves according to the order instructions, moving the beverages ever to the dock, and loading them on the delivery truck.
It includes any costs related to taking, coordinating, and administering the orders, like what we pay the people in the sales office who take phone orders from customers, the supervisory costs to administer the order, and similar things. It includes anything related to delivering the beverages to the customer’s location, like the cost of the delivery trucks, truck maintenance, and what we pay Joe and people like him to drive the trucks. It includes anything related to all those rush orders you’re talking about, like overtime, extra scheduling, and stuff like that.
And it includes what we pay Marsha for what she does, like visiting the customers to check in on them. So there’s quite a bit of stuff in there. Page 3 of 7 -4- Johnson thought about this. “So you’re telling me that there are some customers that you are spending a lot more time on than others? And it’s not Saver Superstore? ” “That’s right,” Rodgers replied. Johnson continued, “But since our accounting system is allocating these customer service costs based on revenues, and since Saver Superstore is one of our biggest customers, it’s allocating a large share of those costs to Saver Superstore. Exactly,” Thomas said. Let me do this: Let me spend a couple of days collecting some information. I’ll need some help from each of you because I want to try to find out how much of your time you are spending on each of our customers. Maybe it’s time to get more sophisticated about how we look at these customer service costs. It may be worth the effort. Stevens, Ketchum, and Rodgers all agreed to spend some time with Thomas so he could summarize the amount of activity they devoted to each customer. They would meet again the following Friday.
Thomas promised to compile an analysis that might alp them determine how profitable each of their customers really was. Before he left for the weekend, Thomas decided to pull together some information about the customer service costs he had described in the meeting: handling the product, taking the orders, delivering the product, expediting rush orders, and visiting the customer. He searched through the accounting system and determined how much of the annual $1. 2 million in customer service costs was associated with each of those categories (Table 1). Table 1 . Customer service costs during the prior year by area of activity.
Area of activity Total $ Product handling Taking orders from customers Delivering the product Expediting deliveries (other than automobile) Sales visits to customers Total Page 4 of 7 $ 672,000 1 ooh,ooh 140,000 198,000 90,000 -5_ Then, on Monday, Thomas met individually with Stevens, Ketchum, and Rodgers. With their help, he determined what he thought to be the primary driver of the costs in each of those customer service categories (Table 2). Table 2. Cost drivers by area of activity. Area of activity Cost driver Number of cases sold Number of purchase orders Number of miles traveled Number of expedited deliveries Number of sales visits
Thomas determined from the company’s accounting records that the company sold 800,000 cases of beverages and processed 500 purchase orders the previous year. Stevens checked the mileage records for the delivery vehicles and determined that the vehicles had traveled a total of 44,800 miles. Rodgers was able to determine that the company made 4,480 deliveries, 2,500 of which were expedited deliveries. And finally, Ketchum checked her daily travel log to determine she had made a total of 360 sales visits to the company’s customers. Thomas next step was to determine how much of these cost drivers were attributable to each customer.