MANAGEMENT CONTROL SYSTEM

ALLIED OFFICE PRODUCTS

Presented by:
Divya Dua – 09BS0000709

IBS GURGAON

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 ALLIED OFFICE PRODUCTS

CASE SUMMARY
Allied Office Products was a corporation in business forms and specialty paper products, such as
writing paper, envelopes, note cards, and greeting cards. In 1988, the company had expanded into
business forms inventory management services that Allied believed it could offer value-added service to
differentiate it from other business forms manufacturers. The forms manufacturing business was mature
by 1988, and all competitors were seeking ways to generate sales growth.

Allied Office
Products

Specialty paper Business form Business forms

manufacturing manufacturing inventory
division division management
service division

Allied embarked on a campaign to enroll its corporate clients in a program which it called “Total
Forms Control” (TFC) and Allied had established a separate company within the business forms division
to handle these accounts. The services provided under TFC included warehousing and distribution of
forms (including inventory financing) as well as inventory control and forms usage reporting.
Allied used a sophisticated computer systems network to monitor a client’s forms inventory, forms
usage, and ordering activities. They provided this information to their clients via comprehensive yet
simple-to-read management reports.

As part of its distribution services Allied offered:

 “Pick pack” service, where trained workers actually opened full cartons to pick the exact
number of forms requested by the clients.

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  “Desk top delivery” service, where Allied personnel would distribute the forms to individual
offices (forms were usually delivered only to the loading dock).
Allied operated its forms manufacturing and TFC activities as separate profit centers. The
transfer of product to TFC was at arm’s length with the transfer price set at fair market value. Although
the company encouraged internal sourcing for customer orders, TFC salespeople had the option of
outsourcing product if necessary.
The clients who participated in the forms management program were charged a service fee to
cover the cost of warehousing and distribution based on the standard charges of 32,2%, regardless of
the specific level of service provided to that clients. The sales force then marked up the cost of products
and services by an average of 20%.

PROBLEMS FACED
The Business Forms Division in 1988 earned a 20 percent Return on Investment (ROI). But
returns had been dropping for several years. TFC was projected to earn an ROI of only 6 percent for
1992, down from 20% in 1988. TFC profitability was suffering in October 1992. It tells that Allied was not
managing this business very well. It seems that the charge for services needs closer scrutiny.
General Manager John Malone believes that the charges should have nothing to do with the
cost of product. Allied should charge their clients for the services they use. It doesn’t seem fair that if
two clients buy the same amount of product from Allied, but one keeps a lot of inventory at our
distribution center and its constantly requesting small shipments and the other hardly bothers Allied at
all, both should pay the same service fee.
Under the current system, these accounts carried the same service charges. These accounts
were similar only in the value of the product being sold, they were different on the level of service they
required from Allied.
Under the order from Malone, Director of Operation Tim Cunningham and TFC Controller Melissa
Dunhill interviewed some people (Site manager Kansas City, Wilbur Smith; Warehouse Supervisor, Rick
Fosmire; and Data entry Operator, Hazel Nutley) in distribution center to find out the problem. After
that, Cunningham and Malone broke distribution down into six primary value-added activities:
 Storage and inventory financing
 Current cost - $1.55M
o Inventory obsolescence
o Excess inventory
 Current inventory – 350,000 cartons
o Cost of capital – 13%
 Customer does not pay for inventory until requisition submission
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 o It would be charged for 1.5% per month for over-nine-months inventory
 Requisition handling
o Current cost - $1.801M
o 310,000 requisitions per year
o Each requisition averages 2.5 lines
 Basic warehouse stock selection and “pick-pack” activity
o Current combined cost - $1.495M
 Stock selection - $0.761M
 Pick pack - $0.734M
o 90% of all orders are pick pack
 Data entry
o Current cost - $0.612M
o Labor intensive with all manual entry
o Requisitions submitted line by line
 Desktop delivery
o Current cost - $0.250M
o Premium service with no additional fees
o Average time to complete – 1.5 to 2 hours
o 8500 requests completed per year
o It would be charge for $15 per hour
 Freight activity
o Current cost for 1990 - $1.648M
o Charges based on a percentage of product cost, not actual utilization
o New computer system coming online to track individual freight charges

The Allied’s felt that there had to be a better way of charging out distribution service to make
TFC become profitable. They had a much better understanding of the driver of costs involved in
distribution services by using ABC system. But they also knew that it wouldn’t be easy getting the sales
force on board with an activity-based pricing program. Some accounts would see increases because of
additional distribution charges under a Services Based Pricing (SBP) scheme. These salespeople wouldn’t
be very happy. On contrary, some salespeople may see their margins increase. It will lead to an
organizational problem.
They were also not convinced that overall profitability would improve without significant
changes in marketing strategy. They were still wondering how to use their new ABC analysis to improve
the profitability of TFC.
As a way of understanding cunstomer profitability, TFC management reworked the information
in the database as if accounts had been charged service fees based on actual usage, leaving net sales

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and product cost the same as before. They recalculated contribution based on these figures and tried to
analyze it.
In general, the big problems faced by Allied are:
 “Customer Profitability.” Not all customers are profitable but very often without ABC, it is
very difficult to know which ones are profitable.
 “Pricing.” Charges for services needed closer scrutiny. It is not fair for two clients who buy
the same amount of product but uses different level of services to pay the same service fee.

Questions

1. Using the information in the text and in Exhibit 5, calculate ABC-based service costs for the TFC
business.
Cost Pools ($000's) %
Storage Expense 1.550 27.2%
Requisition Handling Expense 1.801 31.6%
Warehouse Activity ($1,750)
Basic Warehouse Stock Selections (44%) 761 13.3%
"Pick-Pack" Activity (42%) 734 12.9%
Desk Top Delivery (14%) 250 4.4%
Data Processing Expense 612 10.7%
Total 5.708 100.0%

2. Using your new costing system, calculate distribution services costs for “Customer A” and
“Customer B”.
3.
ACTIVITY TOTAL COST TOTAL COST DRIVERS OVERHEAD
UNIT ALLOCATION
Storage $1,550.000 350.000 $4.43
Requisition Handling $1,801.000 310.000 $5.81
Basic Warehouse Stock $761.000 775.000(310.000x2.5) $0.98
delivery
Pick Pack $734.000 697.500(310.000x2.5x0.9) $1.05
Data Entry $612.000 775.000 (310.000x2.5) $0.79
Desk Top Delivery $250.000 8.500 $29.41

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 Total $5708.000

Customer A Customer B
Overhead
XActivity Allocation
Number of
Total Cost
Number of
Total Cost
service used service used
Storage 4,43 350 1.550,50 700 3.101,00
Requisition Handling 5,81 364 2.114,84 790 4.589,90
Basic Warehouse Stock
0,98 910 891,80 2500
Delivery 2.450,00
Pick Pack 1,05 910 955,50 2500 2.625,00
Data Entry 0,79 910 718,90 2500 1.975,00
Desk Top Delivery 29,41 0 0,00 26 764,66
Total     6.231,54   15.505,56

XActivity Current Customer A Customer B

Sales $79,320 $79,320 $79,320
       
Product Cost $50,000 $50,000 $50,000
Distribution/Services (32.2%) $16,100    
ABC   $10,432 $27,846
       
Return on Sales ($) $13,220 $18,888 $1,474
Return on Sales (%) 16.7% 23.4% 1.9%

4. What inference do you draw about the profitability of these two customers?

If we analyze the customer profitability based on the result of the numbers from ABC system, we will
find out that Customer A is more profitable than Customer B.
However, if we move our focus from “internal” to “customer”, we will see that Customer B utilizes far
more services and has the potential to earn Allied much greater revenue. . The fact that we are billing
them wrong is our own fault. B type customers are quite dependent on our firm. On the contrary, the
level of services used by A is low, and there is a risk that they can drop out easily.
Our strategy would be to maintain the level of B type customers’ usage and increase their level
of pay. In addition, maintain the level of pay for A type customers and increase their usage. Using the

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traditional system, A type customers are subsidizing B type customers while B type customers are
exploiting the firm.
They used more service than customer A. The fact that Allied was billing them wrong is Allied’s own
fault.

5. Should TFC implement SBP pricing system?

o Yes, TFC should implement SBP pricing system. With using SBP, TFC can increase their
profitability and no longer exploited by the customer. But it will not guarantee that it
will improve the profitability of the division. ABC make situation better or not depends
on how we analyze data from the system. Not all customers are profitable but very
often without ABC, it is difficult to know who the profitable ones are.
o We believe the gradual implementation of the SBP system could cost Allied a
percentage of its customer base and subsequent revenue. A steady slow
implementation of this pricing system will give Allied the chance to look at the current
numbers and asses accurately whether or not the new system is profitable. If under the
SBP system companies choose to discontinue a specific service, variable costs for the
service will no longer be incurred.
o Implementing SBP system will cause resistance in the organization, especially from
salespeople. We can pursuade and give explanation about the purposes and benefits of
implementing this new system. ABC system will help management to analyze the
profitability of each customer, and hopefully it will restore the profitability of the
company. Allied needs to offer some benefit, such as modified compensation plan
focused on growing customer revenue and profitability to help encourage sales
behavior.
o We believe that TFC can significantly improving profit by concentrating on individual
account management. This can be done with the help of Services Based Pricing (SBP)
scheme in identifying service costs, and then calculating contribution for each account
and then ranking the accounts in order to identify the profitable ones.
o However, don’t drop out the bottom 20 customers, because the total cost is still the
same. Do not see the unit cost. The unit cost is unitized fixed cost. If TFC drop out the
bottom 20 customers, unit cost will go up because the total cost is spread on the
remaining customers. This will cause some of the remaining customers to look
unprofitable. So, if TFC drop these customers, the unit cost will be higher.
o TFC should charge its customers based on their service usage. We suggest TFC used cost
plus pricing strategy. It means that the customers should be charged based on the cost
of products plus service charge (based on SBP schemes) plus mark-up. So, it will be fair
for customers that have the same sales but different level of services to be charged
differently, based on the services they used.

6. What managerial advice do you have for Allied about the Total Forms Control (TFC) business? How
does Exhibit 1 relate to this business?

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 Value chain is the flow of activities from basic material to the end user which each activity adds
value to the previous one. The key is providing additional value for customer in each step of the
value chain.

The Industry Chain

Cust. Purch.
Trees Pulp Paper Forms mn TFC manager Cust recieving User

The TFC Chain

Storage& Requisit Stock Order Desk Freigh

inventory ioning selection& entry- top t
financing pick-pack billing delivery

The process of value chain in Allied starts from natural resources like papers and pulps then
manufacture produce standard computer printout paper and fax paper to custom-designed forms
tailored to meet the exact business needs of the client. From the forms manufacturing, the products
move to forms sales. Allied expanded its business by making warehouse and distribution network.
For customer who face problem with inventory, Allied build TFC to facilitate it. TFC itself had a value
chain starting from storage and inventory financing, requisitioning, stock selection and pick-pack,
order entry billing, desk top delivery, and freight.
Allied has no uniqueness on its product. Its competitive advantage is on its TFC services. Through the
whole value chain, customers can strategically source many distinct product categories with one
order, one delivery, one invoice, and one remittance, all conducted by one salesperson.
My recommendation for TFC:
 Implement Customer Profiling Program
o Initiate Just In Time Inventory (JIT) System with Allied (for 179 customers that represent 72%
of sales)
o Incorporate purchase history into requisition process and establish autofill order process
o Introduce customer needs assessment and cross-sell initiative
o Reduce pick-pack orders: work with Allied to reconfigure cartons to meet top 40 accounts’
buying patterns
 Company Optimization
o Centralize data entry into single location

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o Build a staffing model designed to reduce headcount, possibly by consolidating warehouses
o Modify compensation plan to help encourage sales behavior focused on growing customer
revenue and profitability