Harvard Business School 104 073 Rev April 26, 2005 Rob FRT ✓ Solved

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Harvard I Businessjschool9 104 073rev Arril 26 2005robfrt S 1 Apla

Harvard I Businessjschool9 104 073rev Arril 26 2005robfrt S 1 Apla

HARVARD I BUSINEssjscHOOL REV ArRIL 26, 2005 ROBFRT S. 1-:APLA'IJ Midwest Office Products John Malone, general manager of Midwest Office Products (MOP) was concerned about the financial results for calendar year 2003. Despite a sales increase from the prior year, the company had just suffered the first loss in its history (see summary income statement in Exhibit 1). Midwest Office Products was a regional distributor of office supplies to institutions and commercial businesses. It offered a comprehensive product line ranging from simple writing implements (such as pens, pencils, and markers) and fasteners to specialty paper for modern high-speed copiers and printers.

MOP had an excellent reputation for customer service and responsiveness. Warehouse personnel at MOP's distribution center unloaded truckload shipments of products from manufacturers and moved the cartons into designated storage locations until customers requested the items. Each day, after customer orders had been received, MOP personnel drove forklift trucks around the warehouse to accumulate the cartons of items and prepare them for shipment. MOP ordered supplies from many different manufacturers. It priced products to its end-use customers by first marking up the purchased product cost by 16% to cover warehousing, order processing, and freight. Then it added another 6% markup to cover general, selling, and administrative expenses, plus an allowance for profit.

The markups were determined at the start of each year, based on actual expenses in prior years and general industry and competitive trends. Midwest adjusted the actual price quoted to a customer based on long-term relationships and competitive situations, but pricing was generally independent of the specific level of service required by that customer, except for desktop deliveries. Typically, MOP shipped products to its customers using commercial truckers. Recently, MOP had introduced a desktop delivery option in which Midwest personnel personally delivered supplies directly to individual locations at the customer's site. Midwest had leased four trucks and hired four drivers for this service.

Midwest charged a price premium (up to an additional 5% markup) for the convenience and savings that direct delivery provided to customers. The company believed that the desktop delivery option would improve margins and foster customer loyalty in its highly competitive office supplies distribution business. Midwest had also introduced electronic data interchange (EDI) in 1999 and a new internet site in 2000, allowing customer orders to arrive automatically, eliminating the need for manual data entry by clerks. Several customers had switched to this electronic service for its convenience.

Despite these innovations, costs continued to rise, and Malone was concerned that the company was not earning a profit. He sought advice on potential strategic actions to improve profitability. Malone consulted with Melissa Dunhill, Controller, and Tim Cunningham, Director of Operations. Tim suggested analyzing specific activities within the distribution center to better understand costs associated with processing orders and serving customers.

Distribution center manager Wilbur Smith described the activities: storing cartons, processing orders, and preparing shipments via commercial freight or desktop delivery. He noted that warehouse space and handling costs are proportional to the number of cartons processed, with costs for commercial shipments being volume-based and costs for desktop deliveries involving trucks, drivers, and delivery times. The detailed operations indicated variability in delivery times and costs based on customer distance and requirements.

Melissa and Tim examined order entry expenses and collected data: 80,000 cartons processed in 2003, with 75,000 shipped via commercial freight and 5,000 through desktop delivery; 2,000 desktop deliveries made, averaging 2.5 cartons each. The total driver compensation was $250,000 annually, with each driver working around 1,500 hours per year. The 16 order-entry operators had annual costs totaling $840,000, working approximately 1,500 productive hours annually after vacations and holidays.

Operators required about 9 minutes (0.15 hours) to manually enter each order, with an additional 4.5 minutes (0.075 hours) per line item. Electronic orders took about 6 minutes (0.10 hours) to verify, regardless of the number of items. The company processed five representative orders, each with merchandise costing about $500 and marked up at 22%. Orders requiring delivery had an additional 4.5% surcharge.

The analysis aims to understand actual profitability by considering order processing costs, delivery expenses, order characteristics, payment periods, and the impact of various order types on costs and revenues. This understanding guides strategic decisions on pricing, cost control, and service enhancements to boost profitability.

Sample Paper For Above instruction

Analyzing Cost and Profitability Strategies at Midwest Office Products

Midwest Office Products (MOP), a regional distributor of office supplies, faced a crucial challenge in 2003: despite sales growth, the company suffered its first-ever loss. A comprehensive analysis of its operations reveals critical insights into how costs, pricing strategies, and service innovations impact profitability. This essay explores the operational and financial intricacies that influence MOP's profitability and proposes strategic avenues for improvement.

Understanding the Business Model and Revenue Structure

MOP's core business involves sourcing office supplies from multiple manufacturers, marking up these products by 16% to recover costs, and adding an additional 6% for profit and administrative expenses. The company also introduced a premium service—desktop delivery—charged with a further markup of up to 5%. These pricing strategies are based on historical cost data, competitive positioning, and customer relationships, not necessarily aligned with actual logistics or service costs.

Operational Activities and Cost Drivers

The distribution center handles approximately 80,000 cartons annually, with a nearly even split between commercial freight shipments and desktop deliveries. The activities include storing cartons, order entry, packaging, and shipment preparation. Handling costs are proportional to the number of cartons, with volume-based freight charges for commercial shipments and variable costs associated with truck operations for desktop deliveries.

Cost Analysis of Delivery Services

Desktop deliveries involve leased trucks, drivers, and variable delivery times depending on distance and customer site complexity. Data indicates an average of 1,500 operational hours per driver annually, with total driver compensation of $250,000. Delivery times vary from 30 minutes to eight hours, depending on proximity, impacting the labor and vehicle utilization rates and, consequently, the delivery cost per carton.

Order Processing and Data Entry Costs

The company employs 16 order-entry operators with an annual cost of $840,000. Manual order entry time averages 0.15 hours per order, with additional time for line-item entry, while electronic orders require about 10 minutes (0.10 hours) for verification. Understanding these costs is essential to assess the true expense of processing different order types and to identify potential efficiencies.

Profitability of Orders and Strategic Implications

Order analysis shows that products cost about $500 each from suppliers, with a standard markup of 22%, translating into a sales price of approximately $610. Orders with added delivery surcharge tend to incur higher direct costs but may not be reflected adequately in the pricing. The order profitability depends on accurate allocation of processing, delivery, and associated overhead costs.

Recommendations for Profitability Improvement

To enhance profitability, MOP should consider aligning its pricing strategies more closely with actual costs. Implementing activity-based costing could better identify high-cost activities like manual order entry and delivery logistics. Additionally, investing in order processing automation and optimizing delivery routes could reduce variable costs. Strengthening customer segmentation and tailored service offerings may also enhance margins, leveraging premium delivery options where appropriate.

Finally, strategic pricing adjustments, especially for delivery-intensive orders, can help recover costs and improve margins. Exploring partnerships, upgrades in order management systems, and expanding profitable service lines could position MOP for sustainable growth despite competitive pressures.

Conclusion

Midwest Office Products' profitability challenges stem from cost structures that are not currently aligned with revenues derived from evolving service offerings. A comprehensive approach involving accurate cost analysis, process optimization, and strategic pricing will be essential to regain profitability and sustain long-term growth. By focusing on cost drivers and customer value, MOP can transform operational inefficiencies into competitive advantages, ensuring its future viability in the office supplies distribution industry.

References

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