CASE 10

The Cooper Processing Company

The Cooper Processing Company (CPC) is a manufacturer/processor of food products. Located in the city of Lansing, Michigan, the company services a national market with processed and packaged meat items such as hot dogs, bologna, sausage, etc. Because the company has been experiencing increased costs in marketing and logistical activities it has hired you as an expert to analyze costs and investments and make recommendations to management. In its most recent fiscal year, the company achieved sales of $100,000,000.

The company sells its products through two separate channels of distribution and each is treated as a profit center with full financial responsibility for income statement and balance sheet. The first channel is to retail grocery stores and supermarkets. The second channel is to foodservice wholesalers who, in turn, sell to restaurants and other foodservice establishments. According to the company accounting records, the retail segment accounts for 60 percent of sales, foodservice for 40 percent. The cost accountant believes that both channels are profitable. He says that the company achieves an overall average gross margin of 60 percent on its sales.

The cost accountant also provides you with the following total costs for various marketing and logistics functions at CPC:

The total of all other expenses at CPC is $15,000,000.

The company's cost accountant has always allocated all expenses and investments to the channels based on the percentage of sales volume and has used the overall company average of 60 percent gross margin to determine the profitability of each channel of distribution.

You, being much wiser than the company cost accountant, decide to do a little further analysis. The first thing you discover is that, due to differences in product mix sold in each channel, gross margins actually are different in each. You find that the gross margin in the retail channel is 70 percent, in the foodservice channel it is 45 percent.

Next, you find that all of the salespeople are paid a straight salary and all receive exactly the same amount of salary. However, you find that of the 50 sales people employed by CPC, 40 of them are devoted to the retail channel, 10 of them are devoted to the foodservice channel. Since there are no sales managers and each salesperson pays for selling expense out of their salary, this accounts for all of the personal selling expense.

You learn that all sales promotions were conducted in the retail channel.

Next, you discover that there is a great difference in the number of orders placed by customers in each channel and the deliveries to each channel. You find that the retail channel accounts for 70 percent of the orders placed and 80 percent of the delivery expense. The foodservice channel accounts for 30 percent of the orders placed and 20 percent of the delivery expense. Your activity-based approach suggests that this is a reasonable way to trace the costs directly to each segment.

Next you learn that packaging differs for each channel. You discover that retail accounts for 80 percent of the packaging cost, foodservice for 20 percent. (Don't worry about how you discovered this.)

Next, you discover that only the retail channel requires "labeling." The company has a machine which applies these labels. The labeling expense of $2,000,000 includes materials, labor, and depreciation of the machine. The machine has an asset value of $10,000,000.

Next, you find that the company has inventory of $10,000,000 (this has also been the average amount of inventory held by the company during the year). You learn that the inventory is specialized by channel. For the retail channel, the inventory is $4,000,000. For the foodservice channel the inventory is $6,000,000. Inventory carrying costs for the firm are 20 percent.

Finally, you learn that the different channels have different terms of sale. Accounts receivable for the retail channel are (and have averaged) $3,000,000. Foodservice accounts receivable are (and have averaged) $1,000,000. You found that the cost of financing accounts receivable is 10 percent.

As hard as you have tried, you cannot find a reasonable basis to trace any other costs or assets directly to the channel segments.

Questions

1.     How "profitable" is each channel?

2.     What is the ROA of each channel?

3.     Any recommendations?