1. Assess the implementation of the time-driven ABC system at Kemps. What do you like about it? What are you less happy with, and would have done differently? One of the best aspects of the way the time-driven ABC system was put into place at Kemps was how efficiently and accurately management determined the main issues with the current cost system and responded with appropriate and relevant solutions.
For example, one of the greatest problems the company was facing was that many of its operating costs were spread out equally over a customer base that was growing more diverse and demanding more personalized and varied service, effectively cutting or potentially eliminating entirely Kemps’ profit margins for a product. Therefore, the CEO set out to properly distribute costs such as storing, picking and delivery of products over their wide variety of customer orders through the use of time equations.
These equations helped management to determine the specific costs associated with the various orders they encountered, and to pass these on to the customer. The executives also made great effort to ensure that any changes made would not negatively impact either productivity or customer relationships. Many updates to the firm’s operations were made as a result of the information acquired from the models, and therein lay the potential downfalls inherent in Kemps’ system. As management soon discovered, important decisions regarding the company could not be made by relying on the data alone.
For instance, a model could not be created that would correctly determine which products should be discontinued; instead, these assessments needed to be made on a case by case basis. Similarly, the long-term effects of such decisions can never be known for certain and the potential always exists that what the data seems to show as an obvious choice could actually be harmful. Therefore, it is important to always view the information as just that and for management to use it mainly as a tool in the decision making process. 2.
What types of actions are Kemps managers now taking with their new ABC reports? Once management received early data reports after implementation of the process several changes were made within the corporation that, while seemingly minor, can have a large effect on profits when considered in the aggregate. For example, the current method of delivering orders as they came in was resulting in unnecessary drive and changeover times that were able to be reduced by encouraging customers to follow a more standardized weekly ordering system.
Another change was related to the issue of long changeover times on the production lines, which was addressed by updating the labeling process so as to reduce the amount of times new labels would need to be introduced to the line. As illustrated in the case, the reduced costs associated with such changes were not the only benefit realized by Kemps. Because of its implementation of activity-based costing, it now enjoyed strengthened relationships with customers and suppliers that had already been using the system due to the new opportunities for cost savings to all parties involved.
The reputation that Kemps’ successful use of ABC earned them also worked to their advantage when looking to acquire new business. By explaining their cost saving methods to potential partners, Kemps is able to demonstrate in empirical terms how they are able to pass the savings on, giving them a distinct advantage in the marketplace. 3. How should Kemps deal with the customer decisions described on page 8 of the case? a. Unprofitable high-end ice cream retailer
The ice cream retailer is unprofitable mainly due to its relatively low consumption, specialized products and inefficient delivery methods. As pointed out in the case, when Kemps determines that a SKU is not profitable, there are a variety of options available to remedy the situation. First, Kemps could work with the customer in order to increase the price of the products in order to cover the additional expenses incurred to produce and deliver them. Second, costs could be reduced by consolidating deliveries so as to eliminate the additional cost of transporting less-than-full truck loads.
Additionally, packaging could be standardized so as to reduce changeover times on the production floor. Should none of these options (or any appropriate combination of them) be acceptable, Kemps may need to consider discontinuing the relationship with the customer. b. National branded chain of retail food outlets that was soliciting bids from dairy suppliers As previously mentioned, the use of activity-based costing gives Kemps an advantage when competing for customers in an ever more competitive and growing market.
However, the ability to succinctly distinguish how many small changes, when taken together, can have a large impact on cost savings (and therefore profit), is necessary in order to convince customers who may not be familiar with the many benefits of ABC. Mainly, management would want to demonstrate how the cost savings that they enjoy are ultimately passed on to their customers, perhaps by showing some of the improvements that have been made to their own company as a result of implementation, specifically focusing on advancements that would have a direct impact on the customer’s business. c.
High incidence of returns from convenience store outlets. There is no doubt that excess returns due to overstocking would be a major issue for Kemps, as it likely results in returned inventory for nearly every order that goes out to the locations who practice this. The costs associated with transportation and disposal of the goods, along with the refunds that must be given to customers, provide good incentive for Kemps to rectify the issue. As the case states, perhaps the best course of action would be to put into practice a program that works to incentivize store managers who minimize their returns.
This could be done through a sort of sliding scale, where as the amount of items returned increases, the refund given for each would be discounted based on a per item rate related to the linked costs of transport and disposal. This would force stores to keep more accurate inventories, resulting in great cost savings for Kemps. 4. How would you advise Kemps on the internal issues (described in the last paragraph of the case) that were being debated about use of the ABC system?
Although Kemps has created and executed a fairly successful costing system, it seems that the invaluable information received from it can still be widely open to interpretation, and the varying analyses (along with their accompanying recommendations) must all be considered carefully, so as to avoid unnecessary exposure to risk. The situation mentioned in the case is an excellent example of this; while the data seemed to suggest that closing a particular distribution route would reduce costs, the risk involved in loss of volume and customer relationships was simply too high to bear.
Also, it is clear that not all changes made will necessarily result in automatic cost savings; instead they may simply provide the possibility of savings. Because in these situations further action is required in order to realize the benefits, it is important that management analyze each change made to determine if more steps must be taken. 1. Do you believe time-driven ABC is superior to a more traditional ABC system, or do you believe that essentially there is no difference between the two systems? Why or why not?
As costing practices have developed and evolved over time it has become generally agreed upon that traditional methods utilizing such elements as plant-wide overhead rates and standardized markups, while appropriate for certain businesses, are often inefficient and occasionally completely ineffective. In some instances, the use of these methods can even harm a corporation by failing to allow for the complexities and variety of their operations, potentially resulting in distortions in pricing across an entire product mix and even strained relationships between the supplier and their customers.
In order to counter many of these negative effects activity-based costing (ABC) was created, wherein cost-driver rates are used to estimate the costs of individual activities related to the manufacture of a product or the providing of a service. The main benefit of using such a system is that it has the ability to compile a vast amount of different kinds of information made available by the divisions of the firm into relevant models that can measure the profit margins (and other pertinent information) of individual product lines. The information gleaned from such program can then be used by management to make decisions regarding merchandise pricing and whether or not to discontinue a product. While ABC programs are certainly a vast improvement over traditional cost systems, upon implementation many companies discovered that there were still problems with the idea. First, the method requires that each activity be assigned a time estimate and a cost-driver rate. While this may be fairly simple for smaller organizations, larger companies may have hundreds or even thousands of activities needing to be monitored, and the details of the activities may be periodically or constantly changing.
In these circumstances the expense associated with collecting and managing the data may be daunting, outweighing many of the benefits gained from use of the system. Another concern came from the fact that the information for time estimates came from surveys of the employees, who could give only subjective estimates that may have been distorted or overstated due to the tendency to include time in the estimates that was actually going unused.
Time-driven ABC attempts to simplify the entire process and correct these potential inaccuracies while making the process less expensive and more efficient. This is done by beginning with the capacity cost rate, the cost of a department for the period divided by the total units of capacity available (often given in time units). Then all management needs to do is gain time estimates for each activity, which is often done by direct observation.
By multiplying out the capacity cost rate by the time estimate by the quantity of the activity being performed and adding together the totals, executives can get a much more accurate picture of how much capacity is actually used. This information is very important because when this number is subtracted from the cost of the capacity supplied only unused capacity remains. Managers can decide to reduce the department’s budget to decrease unused capacity or they can choose to keep it available in case it is needed in the future.
Also, the use of time equations in time-driven ABC allows companies to combine many activities into one simple formula that allows for individual pricing and easy and routine updating should information change quickly. Although the needs of each firm will be different and some would benefit more from traditional ABC systems (or even completely traditional cost methods), it is clear that for most organizations time-driven ABC will be the best option due to its lower costs, its greater adaptability and the availability of more accurate information.