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Stuart Daw

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Stuart’s Branded Foods is not competitive in the market. Is there a different way that can be used to estimate the cost of services and products to the customers, such that the company can become competitive? Use the data about the two customers to demonstrate your proposal and calculate what would be the selling price per kit or per cup for each customer.

The traditional pricing approach is not appropriate to figure out the cost structure in this case. With 23% and 12% margin, the weighted average margin cannot be 5% margin. Mathematically, the net margin should be more than 12% as long as the margin rate is right. To figure out an exact cost structure, we can consider adopting activity-based costing system(ABC system). ABC system involves four steps. They are: 1. Identifying the major activities that take place in an organization; 2. Assigning costs to cost pools/cost center for each activity; 3. Determining the cost driver for each major activity; 4. Assigning the cost of activities to products according to the product’s demand for activities. Assumption : The company’s delivery capacity is 2,714 a year.

Transactions Selling price($) Small office 2,000 222.08 Restaurant 714 777.28 Total 2,714 1,000,000 The illustration of cost assignment with an ABC system Present Production activities Roasting Administration activities Purchasing invoice Research & Marketing Procurement activities Equipment Depreciation in equipment Delivery 70,000 Depreciation in vehicle Procurement activities Other overhead 70,000 70,000 Number of kits 27,777 $ 2.52 per kit 10,000 90,000 80,000 10,000 60,000 Number of kits Number of kits Number of deliveries Number of deliveries 27,777 27,777 2,714 2,714 $ $ 2.88 0.36 per kit per kit per delivery per delivery 220,000 20,000 100,000 100,000 Number of purchasing Number of invoices Number of kits 27,777 18,000 27,777 $ $ $ 0.72 5.56 3.60 per kit per invoice per kit 500,000 500,000 Number of kits 27,777 $ 18.00 per kit ABC system Activity cost Quantity Activity cost driver of activity cost driver Activity cost driver rate $ 22.11 $ 3.68

We breakdown all the costs to each activity Personnel costs  Purchasing, Invoice and Research & Marketing Equipment costs  Equipment and Depreciation in equipment Vehicle costs  Delivery and Depreciation in vehicle

Computation of ABC product costs
Activity cost driver rate $ 18.00 $ 0.72 $ 5.56 $ 3.60 $ 2.88 $ 0.36 $ 22.11 $ 3.68 $ 2.52 per kit per kit per invoice per kit per kit per kit per delivery per delivery per kit Quantity of cost driver for the small office 5 5 6.6 5 5 5 1 1 5 kits kits invoices kits kits kits delivery delivery kits Quantity of cost driver for the restaurant 20 20 6.6 20 20 20 1 1 20 kits kits invoices kits kits kits delivery delivery kits Activity cost assigned to small office $ $ $ $ $ $ $ $ $ $ customer price per kit per cup Sales (Transaction) margin 2,000 714 9% 20% $ $ $ 90.00 3.60 36.67 18.00 14.40 1.80 22.11 3.68 12.60 202.86 222.08 44.42 0.09 Activity cost assigned to restaurant $ $ $ $ $ $ $ $ $ $ $ $ $ 360.01 14.40 36.67 72.00 57.60 7.20 22.11 3.68 50.40 624.07 777.28 38.86 0.08

Activity

Roasting Purchasing invoice Research & Marketing Equipment Depreciation equipment Delivery Depreciation vehicle Other overhead Total costs Present

Suggestion (15% margin)

customer price per kit per cup margin

$ $ $

238.66 47.73 0.477 15%

$ $ $

734.20 36.71 0.073 15%

Under the assumption that transactions with small offices and restaurants are 2,000 and 714 respectively, we can get the detail cost structure of Stuart’s Branded Foods through ABC system. With the present price, its margins are 9% in small offices and 20% in restaurants because we assumed transactions in small offices are more than in restaurants. We suggest that the company decrease the price to $734.2 with restaurants(15% margin) and increase the price to $238.66(15% margin). Consequently, Stuart’ Branded Foods will be able to attract restaurants with low supply price and detract small offices in low margin.

If your pricing strategy is accepted by Stuart’s Branded Foods, what impact will it have on the performance of the business? What impact might it have upon the business strategy of the firm?

If the company successfully manages its transactions, the Stuart Daw will meet the aimed net margin and increased revenues. For example, if there are 1000 transactions with small offices and 1,700 transactions with restaurants next year, the company will be able to get $223,010 net income and 17.65% net margin. Small offices Transactions Sales Costs Net Income Net margin $ $ $ 1,000 238,660 202,863 35,797 $ $ $

Restaurants
1,700 1,248,140 1,060,927 187,213 $ $ $

Total
2,700 1,486,800 1,263,790 223,010 17.65%

What advice would you offer to Stuart Daw?

First of all, the company should figure out its cost structure with the activity-based costing system. If the company finds out the exact costs of each activity, the customer price can be adjusted for the profit maximization. If the result is similar to the above case with our assumption, the company will be able to focus on the restaurants, which give high margin. Eventually the company could achieve the aimed net margin, 15%.

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