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 companys 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. (Dont 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?