growing sales, Dakota Office Products saw its profit margin evaporate in fiscal 2000 as expenses became untenable. Anxious to restore profitability, Dakota Office Products (Dakota) turned to our firm in order to determine the culprit behind these runaway expenses. In order to do so, we looked to the financial statements provided to us by John Malone, General Manager at Dakota and spoke with Dakota's Controller, Melissa Dunhill, and Director of Operations Tim Cunningham.
Our findings revealed that Dakota had made several structural changes to business operations, as was revealed in an audit of Dakota's distribution center conducted by Mrs. Dunhill and Mr. Cunningham. A report written subsequent to the conduction of this audit demonstrated to us how expenses had been materially affected by several changes implemented by upper management, which included:
The Introduction of Desktop Delivery
The Introduction of an Online System for the Processing of Orders (Electronic Data Interchange.)
As both of these systems have had a substantive impact on expenses, we will review each of them and develop a new profit statement which breaks Dakota's business into several operating units, consisting of ones that have been effected by recent changes and ones that haven't. In this review, we will show that Desktop Delivery has augmented expenses to an extent that has cost Dakota its profitability, and discuss alternate scenarios where Desktop Delivery is priced in accordance with the expenses that it generates, and where it is eliminated altogether. We will then review the extent to which Electronic Data Interchange (EDI) has ameliorated the effect of Desktop Delivery on earnings. In addition, we will discuss the matter of multiple orders and their effect on profitability. We will conclude by introducing a pricing system that will hopefully cause profitability to return to pre-2000 levels.
Electronic Data Interchange
We have found the implementation of Electronic Data Interchange (EDI) to have had a positive overall effect on performance. In the past, the company has chosen to adopt a pricing system that reflects the cost of goods plus a premium reflecting variable costs and profit. EDI has enhanced profits because it allows Dakota to provide the same service at an arguably greater level of convenience while experiencing lower labor costs. Of the total amount of time spent by data entry clerks entering orders in 2000, only 5% of this time was spent on electronic orders, while the rest was spent on manual orders despite the electronic orders representing 1/3 of the total number of orders received by Dakota. If such orders could be increased to 1/2 of the total number of orders received by Dakota, this alone would result in a savings of 21.25% in labor costs associated with Data Entry Operators. Theoretically, if all orders were completed electronically, such expenses could be reduced by 85%. Because the nature of the Data Operating function would be significantly scaled back, this operation could be outsourced to a smaller firm specializing in data entry.
Dakota could build revenues by taking actions to encourage EDI purchases, which would exploit these cost disparities. One option would be to initiate a promotion that would put people in the habit of ordering things online. It can be assumed that once adopt EDI as a method of submitting purchases, that they will be more likely to do this in the future rather than relying on traditional purchase methods. Because such a rebate would be non-recurring, these customers will continue to use the automatic system without a discount and allow Dakota to profit from the new system's economies by reducing the size of its staff. Another option would be to get the delivery staff responsible for the Desktop Delivery process to prompt customers to ask them questions about the new system in order to pique interest. This will benefit the company with the market segment that is slow to adopt a new technology and must rely on personal guidance in order to familiarize itself with a new system. Our group feels that if this system had not been implemented, losses experienced in 2000 would have been much worse.
Desktop Delivery is negatively affecting corporate performance, accounting for over 40% of Dakota's losses in fiscal 2000. A premium placed on the sales price for this type of order amounting to approximately 7% would result in these sales meeting expenses. There is a possibility that Desktop Delivery has resulted in other negative repercussions, including but not limited to those pertaining to employee performance. An optimist wishing to preserve this feature could argue that efficiencies will be developed over time, otherwise we would recommend the replacement of this feature with a courier service or a partnership with a firm specializing in shipping, as this feature falls outside Dakota's core competency as a warehousing and retailing operation.
Desktop Delivery accounted for 5,000 cartons shipped in 2000; 6.25% of the total. These cartons were shipped in 2,000 shipments and required the attention of 10% of the distribution center workforce. If it can be said that there was some nominal parity between the cost of employees involved in Desktop Delivery and the cost of regular employees, it can be said that this 10% of personnel cost 240 thousand dollars, out of a total labor cost of 2.4 million. In addition, 200 thousand was spent on truck expenses related to Desktop Deliveries, in comparison with 450 thousand spent on regular freight shipping.
A comparison of income statements with and without Desktop Delivery is provided in appendix A. In calculating the estimated effect of Desktop Delivery, we used the figures provided by Dakota. For freight, delivery, and personnel, we used figures reported to us by Dakota's management and assumed that expenses associated with direct delivery were equal to those associated with conventional freight when determining figures for other categories, including sales, cost of items purchased, warehousing expenses excluding personnel, interest expense, order entry expenses and general and selling expenses. It was found that in order to meet expenses, Desktop Delivery items would have had to be sold at a 7% premium.
Although this premium may look like an attractive option, it must be remembered that the expenses associated with the direct delivery service mostly center around those associated with labor and with the maintenance of trucks. Whereas the maintenance of trucks can be directly and exclusively tied to the direct delivery service, it must be remembered that the assignment of personnel to these tasks may results in general expenses not covered in Dakota's report.
Dakota lists four categories of services handled at the distribution center. These include regular warehouse services, direct delivery, clearing orders, and data entry. It has already been demonstrated that Dakota might be able to outsource data entry if this activity was transitioned to a role where it was handled exclusively by electronic means. There are presumably expenses associated with the training of personnel and continuing education; their visit with site manager Wilbur Smith revealed that most of the staff were new as responsibilities associated with this new positon were beyond the time capacities of existing workers. In addition, the support staff for personnel associated with direct delivery and that associated with warehousing is different.
Mr. Smith claims "this desktop delivery is a real pain for my people. Because a comprehensive evaluation of personnel satisfaction has not been conducted, this observation is of interest to us for several reasons. First, if the new service is compromising employee satisfaction, we must reasonably determine the effect of this on employee costs, which are already disproportionately high for Dakota's facility. Second, if we can find that Desktop delivery has resulted in employee dissatisfaction, we must determine whether or not this has affected the efficiency levels previously maintained by staff members. Because, as stated, most of the employees hired to work with Desktop Delivery are new, this may merely be a matter of a learning/experience curve and the company may eventually recover and return to profitability. However, there is also a chance that genuine, long-term deficiencies in employee morale and effectiveness have resulted from the program's introduction. If this is the case, another option would be for Dakota to rely on a commercial firm specializing in package delivery, such as FedEx and UPS. Another option would be to partner with a local service that has already developed a competency in this function, and to develop cost incentives based on volume.
Multiple and Consolidated Orders
It has been demonstrated that Dakota experiences greater expenses when handling a large number of small orders than it does when handling a small number of large orders. However, this competency is not reflected in the way that clients are billed. To change the billing structure to reflect this feature of order placement would serve several immediate goals.
It would more aptly reflect Dakota's billing methodology.
It would allow for more transparency in the company's financial statements.
It would provide incentive for customers to utilize EDI.
Dakota's billing methodology is one that could be called 'value-added.' The price of a product is…