Product Costing: Department versus Activity-Based Costing for Overhead.
Advertising Technologies, Inc. (ATI) specializes in providing both published and online advertising services for the business marketplace. The company monitors its costs based on the cost per column inch of published space printed in print advertising media and based on the cost per minute of telephone advertising time delivered on "The Ad Line," a computer-based, online advertising service. ATI has one new competitor, Tel-a-Ad, in its local teleadvertising market; and with increased competition, ATI has seen a decline in sales of online advertising in recent years. ATI's president, Beard, believes that predatory pricing by Tel-a-Ad has caused the problem. The following is a recent conversation between Robert and Jane Minnear, director of marketing for ATI.
Jane: I just received a call from one of our major customers concerning our advertising rates on "The AD Line" who said that a sales rep from another firm (it had to be Tel-A-Ad) had offered the same service at $1 per minute, which is $1.50 per minute less than our price.
Robert: It's costing about $1.27 per minute to produce that product. I don't see how they can afford to sell it so cheaply. I'm not convinced that we should meet the price. Perhaps the better strategy is to emphasize producing and selling more published ads, which we're more experienced with and where our margins are high and we have virtually no competition.
Jane: You may be right. Based on recent survey of our customers, I think we can raise the price significantly for published advertising and still not lose business.
Robert: That sounds promising; however, before we make a major recommitment to publishing, lets explore other possible explanations. I want to know how our costs compare with our competitors. Maybe we could be more efficient and find a way to earn a good return on teleadvertising.
After this meeting, Robert and Jane requested an investigation of production costs and comparative efficiency of producing published versus online advertising services. The controller, Tim Gentry, indicated that ATT's efficiency was comparable to that of its competitors and prepared the following cost data:
PublishedOnline
AdvertisingAdvertising
Estimated number of production units..................200,000 10,000,000
Selling price.................................................$200$2,50
Direct product costs........................................$21,000,000$5,000,000
Overhead allocation*........................................$9,800,000$7,700,000
Overhead per unit.....................................................$49$0.77
Direct costs per unit................................................$105$0.50
Number of customers.........................................180,00025,000
Number of salesperson days..................................32,0005,500
Number of art and design hours..............................35,0005,000
Number of creative services subcontract hours..........100,00025,000
Number of customer service calls...........................72,0008,000
*Based on direct labor costs
Upon examining the data, Robert decided that he wanted to know more about the overhead costs since they were such a high proportion of total production costs. He was provided the following list of overhead costs and told that they were currently being assigned to products in proportion to direct labor costs.
Selling costs......................................................$7,500,000
Visual and audio design costs....................................3,000,000
Creative services costs.............................................5,000,000
Customer service costs.............................................2,000,000
Required
Using the data provided by the controller, prepare analyses to help Robert and Jane in making their decisions. (Hint: prepare cost calculations for both product lines using ABC to see whether there is any significant difference in their unit costs). Should ATI switch from the fast growing, online advertising market back into the well established published market? Does the charge of predatory pricing seem valid? Why are customers likely to be willing to pay higher price to get published services? Do traditional costing and activity-based costing lead to the same conclusions?