9-102-021 REV: FEBRUARY 18, 2005 ROBERT S

Subject:ManagementPrice: Bought3

Share With

9-102-021
REV: FEBRUARY 18, 2005

ROBERT S. KAPLAN

Dakota Office Products
John Malone, General Manager of Dakota Office Products (DOP) was concerned about the
financial results for calendar year 2000. 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).
Dakota 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. DOP had an excellent reputation for customer service and responsiveness.
DOP operated several distribution centers in which personnel 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, DOP personnel
drove forklift trucks around the warehouse to accumulate the cartons of items and prepared them for
shipment.
Typically, DOP shipped products to its customers using commercial truckers. Recently, DOP had
attracted new business by offering a “desk top” option by delivering the packages of supplies
directly to individual locations at the customer’s site. Dakota operated a small fleet of trucks and
assigned warehouse personnel as drivers to make the desktop deliveries. Dakota charged a small
price premium (up to an additional 2% markup) for the convenience and savings such direct delivery
orders provided to customers. The company believed that the added price for this service could
improve margins in its highly competitive office supplies distribution business.
DOP ordered supplies from many different manufacturers. It priced products to its end-use
customers by first marking up the purchased product cost by about 15% to cover the cost of
warehousing, distribution, and freight. Then it added another markup to cover the approximate cost
for general and selling 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. Actual prices to customers were adjusted based on long-term relationships and competitive
situations, but were generally independent of the specific level of service provided to that customer,
except for desk top deliveries.
Dakota had introduced electronic data interchange (EDI) in 1999, and a new internet site in 2000,
which allowed customer orders to arrive automatically so that clerks would not have to enter
customer and order data manually. Several customers had switched to this electronic service because
________________________________________________________________________________________________________________
Professor Robert S. Kaplan prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as
endorsements, sources of primary data, or illustrations of effective or ineffective management.
Copyright © 2001 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685,
write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical,
photocopying, recording, or otherwise—without the permission of Harvard Business School.

Downloaded by Handy Oen on 10/19/2015. Florida Institute of Technology-Melbourne, Faculty, July 2015


102-021

Dakota Office Products

of the convenience to them. Yet Dakota’s costs continued to rise. Malone was concerned that even
after introducing innovations such as desktop delivery and electronic order entry, the company could
not earn a profit. He wondered about what actions he should take to regain profitability.

Distribution Center: Activity Analysis
Malone turned to his controller, Melissa Dunhill and director of operations, Tim Cunningham for
help. Tim suggested:
If we can figure out, without going overboard of course, what exactly goes on in the distribution
centers, maybe we can get a clearer picture about what it costs to serve our various customers.
Melissa and Tim went into the field to get more specific information. They visited one of Dakota’s
distribution facilities. Site manager Wilbur Smith confirmed, “All we do is store the cartons, process
the orders, and ship them to customers.” With Wilbur’s help, Melissa and Tim identified four
primary activities done at the distribution center—process cartons in and out of the facility, the new
desk top delivery service, order handling, and data entry.
Wilbur described some details of these activities.
The amount of warehouse space we need and the people to move cartons in and out of storage and get
them ready for shipment just depends on the number of cartons. All items have about the same
inventory turnover so space and handling costs are proportional to the number of cartons that go
through the facility.
We use commercial freight for normal shipments, and the cost is based more on volume than on
anything else. Each carton we ship costs about the same, regardless of the weight or distance. Of
course, any carton that we deliver ourselves, through our new desktop delivery service, avoids the
commercial shipping charges.
The team confirmed the information with the warehouse supervisor who noted.
This desktop delivery is a real pain for my people. Sure, we offer the service, and it’s attracted
increased business. But I have had to add people since existing personnel already had more than
enough to do.
Melissa and Tim next checked on the expenses of entering and validating customer order data.
The order entry expenses included the data processing system and the data entry operators. They
spoke with Hazel Nutley, a data entry operator at Dakota for 17 years.
All I do is key in the orders, line by line by line. I start by entering the customer ID and validating our
customer information. Beyond that, the only thing that really matters is how many lines I have to enter.
Each line item on the order has to be entered separately. Of course, any order that comes in through
our new EDI system or internet page sets up automatically without any intervention from me. I just do
a quick check to make sure the customer hasn’t made an obvious error, and that everything looks
correct. This validity check takes about the same time for all electronic orders; it doesn’t depend on the
number of items ordered.
Melissa and Tim collected information from company data bases and learned the following:

2

Downloaded by Handy Oen on 10/19/2015. Florida Institute of Technology-Melbourne, Faculty, July 2015


Dakota Office Products

102-021

The distribution centers processed 80,000 cartons in year 2000. Of these, 75,000
cartons were shipped by commercial freight. The remaining 5,000 cartons were
shipped under the desktop delivery option. DOP made 2,000 desktop deliveries
during the year.
People felt this total amount of handling, processing and shipping was about the
capacity that could be handled with existing resources.
The data entry operators processed 16,000 manual orders, and validated 8,000 EDI
orders. The 16,000 manual orders had an average of nearly 10 items per order, or
150,000 order lines in total. As with the carton handling, shipping, and delivery
personnel, supervisors felt that the data entry operators were operating at capacity
rates with the existing business.
They then formed two small project teams, one made up of distribution center personnel and the
other of data entry operators, to estimate the amount of time people spent on the various activities
they had identified. The teams conducted interviews, asked some people to keep track of their time
for several days, and observed other people as they went about their daily jobs.
The distribution center team reported that 90% of the workers processed cartons in and out of the
facility. The remaining 10% of workers were assigned to the desktop delivery service. All of the other
warehouse expenses (rent, building and equipment depreciation, utilities, insurance, and property
taxes) were associated with the receipt, storage, and handling of cartons. The delivery trucks were
used only for desktop delivery orders. These estimates were reviewed by supervisors and felt to be
representative of operations not just in the current year, but in the past year (2000) as well.
The data entry team, from monitoring computer records, learned that operators worked 10,000
hours during year 2000. Further analysis of the records revealed the following distribution of time for
each of the activities performed by data entry operators.
Activity
Set up a manual customer order
Enter individual order lines in an order
Validate an EDI/internet order
Total

Data Entry Operators Time
2,000 hours
7,500 hours
500 hours
10,000 hours

Understanding Customer Profitability
Melissa looked through the customer accounts and found two typical accounts of similar size and
activity volumes. Customers A and B had each generated sales in year 2000 slightly above $100,000.
The costs of the products ordered were also identical at $85,000. The overall markups (21.2% for
Customer A, and 22.4% for B) were in the range of markups targeted by Dakota Office Products. The
markup for Customer B was slightly higher because of the premium charges for desktop delivery.
Both customers had ordered 200 cartons during the year. The existing customer profitability system
(see Exhibit 2) indicated that both customers generated a contribution margin sufficient to cover
normal general and selling expenses and return a profit for the company.
Melissa noticed, however, that the two accounts differed on the service demands made on Dakota.
Customer A placed a few large orders, and had started to use EDI to place its orders (half its orders,
in year 2000, arrived electronically). Customer B, in contrast, placed many more orders, so its average
size of order was much smaller than for Customer A. Also, all of Customer B’s orders were either
3

Downloaded by Handy Oen on 10/19/2015. Florida Institute of Technology-Melbourne, Faculty, July 2015


102-021

Dakota Office Products

paper or phone orders, requiring manual data entry; and 25% of B’s orders requested the desktop
delivery option.
Melissa, concerned about increases in Dakota’s borrowings from the bank, also noticed that
Customer A generally paid its bills within 30 days, while Customer B often took 90 or more days to
pay its bills. A quick study revealed that the average accounts receivable balance during the year for
A was $9,000, while it was $30,000 for B. With Dakota paying interest of 10% per year on its working
capital line of credit, Melissa thought this difference might be significant.
Exhibit 3 shows Melissa’s summary of the actual ordering, delivery and payment statistics for the
two customers. She believed she was now ready to assess the actual profitability of customers, and
make recommendations about how to reverse Dakota’s recent profit slide.

Dakota Office Products: Income Statement CY2000

Exhibit 1

Sales

42,500,000

121.4%

Cost of Items Purchased

35,000,000

100.0%

Gross margin

7,500,000

21.4%

Warehouse Personnel Expense

2,400,000

6.9%

Warehouse Expenses (excluding personnel)

2,000,000

5.7%

Freight

450,000

1.3%

Delivery Truck Expenses

200,000

0.6%

Order entry expenses

800,000

2.3%

2,000,000

5.7%

120,000

0.3%

(470,000)

-1.3%

General and selling expenses
Interest expense
Net Income Before Taxes

4

Downloaded by Handy Oen on 10/19/2015. Florida Institute of Technology-Melbourne, Faculty, July 2015


Dakota Office Products

Exhibit 2

102-021

Customer Profitability Report (Current Method)

Customer A
Sales

Customer B

103,000 121.2%

104,000

122.4%

Cost of Items Purchased

85,000 100.0%

85,000

100.0%

Gross margin

18,000

21.2%

19,000

22.4%

12,750

15.0%

12,750

15.0%

5,250

6.2%

6,250

7.4%

Warehousing, Distribution and
Order Entry
Contribution to general and
selling expenses, and profit

Exhibit 3

Services Provided in Year 2000 to Customers A and B

Customer A

Customer B

Number of cartons ordered

200

200

Number of cartons shipped
commercial freight

200

150

Number of desktop deliveries

-

25

Number of orders, manual

6

100

60

180

6

-

$9,000

$30,000

Number of line items, manual
Number of EDI orders
Average accounts receivable

5

Downloaded by Handy Oen on 10/19/2015. Florida Institute of Technology-Melbourne, Faculty, July 2015