The director of logistics at Happy Chips Incorporated had recently circulated a letter that came from the only mass merchandiser, Buy 4 Less, complaining of poor performance. Buy 4 Less is looking for Happy Chips to increase deliveries by one per week to ensure no stockouts occurred, install an automated order inquiry system costing $10,000 to increase customer service responsiveness, and to decrease prices by five percent.
Happy Chips management decided to complete a segment profitability analysis to see where they may be able to increase company profits. Through extensive research the paper shows that out of the three segments Buy 4 Less was losing the company money, while the grocery and drug segments were both producing profits. This paper will also show what it would look like if Happy Chips followed through with the Buy 4 Less requirements and what profits would look like if the mass merchandise segment was dropped all together and prices were raised by twenty percent.
While several things can factor into company operations, the research also focused on how completing a activity-based costing analysis may benefit Happy Chips and could ultimately allow the 90 year old company a second opportunity of expansion outside the metropolitan Detroit area. Performance Control at Happy Chips Incorporated Happy Chips Incorporated was founded in 1922 and is the fifth largest potato chip manufacturer in the metropolitan Detroit market (Bowersox, Closs, and Cooper, 2010).
After an unsuccessful attempt at expanding outside the Detroit area, Happy Chips have remained a local company that manufactures and distributes a single type of potato chips to three different retailers; grocery, drug, and mass merchandise. The largest percentage of business is in the grocery segment with over fifty percent of the annual revenue, followed by the drug segment with more than twenty-seven percent of the annual revenue, and last is the mass merchandise segment carrying almost twenty two percent of the annual revenue.
Recently the mass merchandise customer, Buy 4 Less, has been complaining of poor operating performance, citing frequent stockouts, poor customer service responsiveness, and high prices for products. Buy 4 less also suggested Happy Chips provide one more delivery per week, install an automated order inquiry system, and decrease product prices (Bowersox, Closs, and Cooper, 2010).
This research will provide answers to several questions that have arose since the Buy 4 Less complaints and suggestions circulated throughout Happy Chips, such as; counter arguments of managers by determining the profitability for each of Happy Chips’ business segments, should Happy Chips consider the desired Buy 4 Less changes, eliminate a business segments, what it would look like if Happy Chips increased prices to mass merchandise stores, and any other factors that might be considered for analysis.
Using an income statement and a logistic cost by segment statement, a segment profitability analysis was completed on Happy Chips to determine the revenue, net margin, and fixed costs while coming up with the ultimate goal of profit per segment. The results of the segment profitability analysis can be found on page eight of this document. As you can see by the analysis, the grocery segment was by far the most profitable across the board. The grocery segment produces fifty percent of unit sales but carries almost eighty percent of Happy Chips profit.
According to the profitability analysis, the drug segment contributed to just over twenty percent of Happy Chips profit while producing over twenty-two percent of Happy Chips sales. Ironically enough, the mass merchandise segment produces over twenty-seven percent of unit sales and just under twenty-two percent of the revenue, but loses $878. 40 annually due to the expensive labeling requirement of Buy 4 Less. Buy 4 Less has required Happy Chips to produce a sticker or label that would cover the suggested retail price with the new Buy 4 Less price.
This machine has an annual rental fee of $5,000, throw in labor and material cost and you can add $. 03 per unit. Buy 4 Less accounts for 22,000 annual sales causing Happy Chips to pay an additional $5,660 annually that is not required in the grocery or drug segment. Buy 4 Less has now presented Happy Chips with three new service requests that must be accomplished to remain a supplier. The first request is to add one extra delivery a week to eliminate stockouts. The current annual delivery for Buy 4 Less is three deliveries a week to three locations at $6. 00 per delivery.
The last request from Buy 4 Less is for Happy Chips to install an automated order inquiry system to increase customer responsiveness costing $10,000, and let us not forget about the extra labeling fee that will be incurred on the extra delivery per week. As you can see by the segment profit analysis and the information presented above goes against the manager of marketing idea that Buy 4 Less is clearly Happy Chips most important customer, and that the company should immediately implement the suggested changes (Bowersox, Closs, and Cooper, 2010). As matter of fact they are undoubtedly the worst customer, costing Happy Chips over $875 a year.
Furthermore, Happy Chips should not accept the requirements that have been presented by Buy 4 Less as it will ultimately lose the company even more money than it currently is. This goes right along with the ideas of the director of manufacturing who believed that the additional manufacturing cost required to meet Buy 4 Less’s requirements was to high (Bowersox, Closs, and Cooper, 2010). By just dropping Buy 4 Less as a retailer all together Happy Chips will immediately increase profits and can use the extra units to slowly attempting to expand again and start reaching a little further out of the Detroit metropolitan area.
Happy Chips could put all of Buy 4 Less units into the most profitable segment, the grocery segment, which will make the sales force happy, as they felt the grocery segment was most important and Happy Chips best customer (Bowersox, Closs, and Cooper, 2010). Happy Chips could also look at separating the additional units into both the grocery and drug segment allowing them more flexibility while searching for new customers. By not only dropping Buy 4 Less as a retailer, Happy Chips could also look at a price increase to maximize profit.
If Happy Chips would increase prices by twenty percent across the remaining two markets, that would take the prices to $2. 28 per unit in the grocery segment and $2. 76 in the drug segment. This increase in price would drive the current grocery segment annual revenue to $91,200, or a $15,200 increase and the drug segment annual revenue to $49,680, or an $8,280 increase. The grocery segment profit would jump to $22,740. 80 while the drug segment profit would increase to $10,206.
Activity-based costing suggest that costs should be traced back to the activities performed, then activities should be related to a specific product or customer segments of the business (Bowersox, Closs, and Cooper, 2010), meaning that Happy Chips operational costs should be directly related to the process that created them. Using activity-based costing could raise the price in the segment that is your primary customer and requires operations on a more frequent basis, while lowering the price to another segment that does not require the same frequency of service.
By looking at this process Happy Chips may see an opportunity to expand outside of the Detroit area by enticing a new retailer with lower prices, while making up the difference by raising some prices on the largest retailer. By completing a segment profitability analysis, Happy Chips now has a better idea of what needs to be done within the company to improve profits. The analysis showed that the grocery segment was producing almost eighty percent of a profit and the drug segment produced a profit of just over twenty percent, while the mass merchandise, Buy 4 Less, was losing almost $900 annually.
With this being said, you can see why Happy Chips should eliminate Buy 4 Less as a retailer and work on profits within the other two segments. One way would be to raise prices by twenty percent, in turn increasing profits by over 280 percent. A second way is to look at using activity-based costing to raise and lower operational costs by the process that creates them, and possibly allow them to once again attempt an expansion outside of the metropolitan Detroit area.