Activity Based Costing of Columbo Yogurt - Case Study Example

Colombo Frozen Yogurt Activity-Based Costing Applied to Marketing Costs Contents Introduction The focus of this paper is to take a new look at the income generated by Columbo Yogurt within the General Mills structure. This paper will argue two main points: (1) that the overall profitability of the Columbo Yogurt business is lower than originally projected, and (2) the profitability of the two business lines is significantly different than that indicated by a traditional allocation based on sales percentages. The use of ABC (Activity-Based Costing) indicates a far different and, in the author’s opinion, more accurate accounting for the actual contribution and net income figures as provided in the case. Competitive Environment Colombo participates in a market which is significantly different than General Mills’ core retail business. Whereas GMI participates in the supermarket and grocery retail market, Colombo sells to yogurt shops. As we will see from the financial analysis in this case, Colombo’s sales are relatively low in yogurt shops (although no data is given on competitors, one is left to assume that other frozen yogurt competitors, such as TCBY, have significantly greater sales in company-owned and –franchised shops). As shown in the case, there are two major current retail outlets for Colombo’s products. The impulse buyer at the convenience store may view the Colombo product as additional revenue, increasing his/her average revenue per customer or per transaction. One assumes that frozen yogurt is an “oh, by the way” sale, in which the customer may have entered the store intending to buy something else, sees the Colombo machine and/or promotion, and asks for a frozen yogurt. One can imagine a setting where impulse buying of frozen yogurt is a significant portion of a convenience store’s sales. This could include a convenience store near a resort, near the beach, or in a vacation area where ice cream and frozen yogurt can be popular. In these cases, it may make sense for the proprietor and workers in small convenience stores to invest the time to learn how to use the machine, and take up valuable space near the cash register in order to sell the product. In many cases, however, the convenience store retailer has neither the time nor the imagination to learn and market frozen yogurt as a convenience item. It takes much more effort (capital equipment, learning process, cleaning and maintenance, proper pouring of the product) to serve a frozen yogurt than it does to sell sun tan lotion or cigarettes, for example. Thus, on a cost per minute or cost per square foot basis, it may make little sense for most store owners to push this product category. Yogurt shops, on the other hand, rely primarily on Colombo and competing products for their livelihood. These companies are looking for brand image, merchandising assistance, and ways to increase their business. To the extent that General Mills can assist these retailers, they have the opportunity to sell major amounts of product through relatively few outlets. The author will argue that those sales are significantly more profitable than those to convenience store retailers. Fit in General Mills’ Strategy General Mill’s take on Colombo is that they could expand their offerings in this segment of the retail convenience grocery market. Since their sales reps are already selling other GM products to these outlets, it requires a simple addition of a few lines to the order form—or so the thinking went for the acquisition. In fact, the reality of strategic fit is significantly different. The sales rep needs to feel comfortable selling the system. He/she takes a significant amount of time to ensure that the store owner/purchaser knows how to use the frozen yogurt machine. Sales reps who have large dollar goals may look upon the Colombo product category in a similar way to the convenience store owner: for most applications, the amount of effort involved may not be justified by the potential payback. General Mill’s efforts in the yogurt shops appear to be nonexistent. The sales reps confess that 99% of their time is spent in convenience stores. Given that they have no other products to sell to yogurt shops, it may be difficult to justify additional sales calls to meet with unfamiliar customers. Although the case doesn’t mention sales trends, one is left to wonder whether the existing yogurt shop customers were acquired before General Mills bought Colombo, and whether the business is declining as more focused competitors aim at yogurt shops in a more targeted way. As a multi-billion dollar (sales) company, General Mills understands mass marketing to retailers. They regard their key competitors as the leaders in the American grocery business, such as Post, Kellogg’s and P&G. The net contribution made by a niche, specialty business like Colombo may not hit the ‘relevance’ factor, as even large swings in sales and profitability may not have any impact on General Mills’ overall financial results. ABC Analysis of New Segment Profitability The case gives a sales-weighted income statement. Since the majority of sales are to the ‘impulse’ market, the majority of costs are allocated in that direction: Although the sales price to each segment per case is the same, the actual pricing differs by the amount of price promotions and merchandising allowances applicable in each case. The following analysis reallocates the merchandising cost according to the actual use of merchandising material. Since the yogurt shops took only 90 of 3,450 merchandising stands, and because each merchandising stand costs $50, the bulk has been reallocated to the impulse segment. The amount of merchandising expense therefore drops from $345 to $45 to reflect the actual cost. An allocation according to case sales was applied to SG&A. The sales reps were remarkably honest in their 60-day diaries by saying that they only spend 1% of their time in yogurt shops (as related to this business segment, which means that they spend considerably less than 1% of their total time there). Since the sales reps’ time is paid for directly (salaries and commissions) and indirectly (management expenses, overhead, benefits, other expenses), it makes more sense to allocate according to actual time spent in each distribution segment, as follows: Thus the amount of SG&A charged to the yogurt shop end of the business drops from $237 to $39. Note that the overall amount of SG&A charged has been increased, as sales reps claim to be spending a good deal more time than is justified by sales results in selling Colombo products to impulse locations. The standard General Mills formula, which works well for goods similar to cereal and packaged items, breaks down when applied to a sales rep-intensive product in a new category. Thus, this author recommends an ABC-motivated change to increase the overall SG&A costs to reflect the greater amount of time required from $1,725 to $3,900. Shipping and packaging are significantly different for the two segments. Because the impulse stores buy in less than pallet amounts, their cost of shipping and packaging are significantly higher than for the yogurt shop segment, as follows: By taking the actual cost of shipping and packing, the costs per unit sold for the Yogurt Shops drops significantly. Although the nominal pricing per case is the same for both segments at $19.90 per case, it appears that the yogurt shops take little advantage of the pricing promotions. This author therefore applied the entire $4,500 to the impulse category, as the sales reps appeared to spend their time there, and therefore were more likely to use price promotions to push their product. It also appears that the yogurt shop customer is less sensitive to pricing, and therefore these promotions are not required. Recommended Changes for General Mills General Mills needs to revise their assumptions about why they bought the business, and how the business should be run going forward. The initial assumption at the time of acquisition was that the business would slot in well in its existing sales force and with its current customers. The reality is that the entire business loses money in the grocery segment. Success in groceries may require more resources than General Mills is willing to invest in that segment. Although the bulk of their frozen yogurt sales are in the ‘impulse’ segment, ABC analysis indicates that GM is losing money (-1% of sales) in that segment. On the other hand, ABC analysis demonstrates that General Mills is making substantial net income on its yogurt shop segment: Although the case gives no information about the overall size of the frozen yogurt market, it appears that additional investment in this end of the business could result in substantial increases in profitability. General Mills should probably abandon its low-volume impulse customers at a graduated rate as it increases efforts in its yogurt shop section. An alternative is for General Mills to consider selling Colombo, as it is not a fit with the rest of its business strategies and operational capabilities. Read More