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Cost Management: The Story of Anything Inc.



Once upon a time there was a company called Anything Inc. One day Anything Inc. introduced a new product into the market, a $300 Zigmo. The unit was targeted toward the low end of the Zigmo market where prices ranged from $200 to $600. Zigmos were doing extremely well and sales were projected at 1,000,000 units per year for at least the next three years. Costs were estimated as follows:

1. Direct Material = $150
2. Direct Labor = $ 15
3. Manufacturing OH = $ 45
4. General, Selling, & Admin. = $ 75
5. Profit = $ 15
Selling Price = $300


A year went by and everything seemed to be going well. Actual sales were 1,003,112 units. A review meeting was held to evaluate the year’s performance and discuss strategy for the one ahead. It was at this meeting that the first shock was felt.

It all began when Mr. Ido Makitall, the manufacturing manager, turned to Mr. Bill Dollar, the CFO, and requested additional funding for process improvements. Mr. Dollar’s reply caught everyone by surprise. ‘‘I’m sorry,’’ he said, ‘‘We have no money.’’

Minor pandemonium broke out. ‘‘What do you mean by no money?’’ screamed Ms. Mee Bie Cheep, the purchasing manager. ‘‘We came in 3.3 percent below budget in our department, something we worked very hard toward. That’s $5 straight to the bottom line.’’

‘‘Our conversion costs were just $2 per unit over budget, well within a reasonable limit considering the rate of inflation last year,’’ said Mr. Makitall. ‘‘We too came in on budget,’’ Ms. Rhea Design, the R&D manager, added. All eyes turned to Mr. Ican Sell, the marketing manager, who looked very sheepish. ‘‘We were $15 per unit over budget,’’ he said with a tone of sadness. ‘‘Our customer service costs were $25 per unit. We budgeted only for $10 per unit.’’ Needless to say, all present thought the same thing, what in the world had happened? As if reading their minds, Mr. Sell continued, ‘‘All our estimates were based on projected sales of 1,000,000 units. In order for us to reach those targets, our sales people were forced to give our corporate customers some very special warranty provisions.’’

‘‘And what might those be?’’ inquired Mr. Makitall. ‘‘We gave them a one-year warranty,’’ Sell replied. ‘‘Surely that couldn’t have cost us $15,000,000 more,’’ said Ms. Cheep. ‘‘Absolutely not,’’ returned Mr. Sell, ‘‘but we agreed to give them a forty-eight hour turnaround. The number of calls we’ve received this past year was more than we had anticipated.’’

One could almost hear the silence. Five minutes went by. ‘‘Well,’’ stated Mr. Dollar, breaking the awkwardness of the moment. ‘‘Let’s not cry over spilt milk. What are we going to do about it?’’

‘‘How about an AIM & DRIVE session on the cost of Customer Service?’’ suggested Ms. Cheep. They all looked at one another. A unanimous affirmative nod said it all.
And so it was that the Zigmo team began its quest for data on the cost of customer service for goods under warranty. A summary of the various activities and costs associated with Customer Service follows:


1. Calls to Customer Service (Anything Inc.)

A twenty-four-hour customer service desk had been established for all products manufactured by Anything Inc. All calls regarding the Zigmo were directed to this Help Desk. These calls ranged from basic inquiries to complex problems with the unit. Since operators at the service desk were not technically qualified, they were only able to assist callers who had informational questions. All problems relating to the unit were transferred to the Technical Service Center at Fixit, Inc., a subcontractor. In the past twelve months, 300,000 calls were received by the Help Desk, of which 200,000 were transferred to Fixit, Inc. The average call to the Help Desk lasted two minutes. The Customer Service Department billed the Zigmo product line at the rate of $0.50 per minute, according to the newly installed activity based costing (ABC) system.


2. Calls to Fixit, Inc.’s Technical Service Center (TSC)

In keeping with the company’s strategy of focusing on its core competency and outsourcing all other activities, Anything Inc. had recently spun off one of its repair centers, Fixit, Inc. Most of the technicians of Fixit, Inc. had previously worked for Anything Inc. and had been thoroughly trained on the Zigmo. Of the 200,000 telephone calls that were received by Fixit, Inc.’s TSC in the past twelve months, 136,000 were solved by the Fixit technicians. Only 1,000 of these required parts (the rest were minor problems that the customer could handle). When required, spare parts were ordered from Fixit’s Regional Service Center (RSC) and shipped to the customer either from inventory or after procuring them in the market. The old parts that were replaced were shipped (collect) to the RSC by the customer. These were then disassembled, sorted, and stored at the RSC if they were capable of being reused. If not, the parts were scrapped. An average call to the Fixit Technical Center lasted four minutes, for which Anything Inc. was billed at the rate of $150 per hour ($2.50 per minute). For the 1,000 calls that needed parts, Fixit billed an average of $70 per order. This $70 charge included $40 for parts based on an average of two parts per job, at $20 per part. Freight for sending back the old parts and shipping the replacement ones was budgeted at $10 for each shipment of two parts weighing approximately 0.8 kg each. The shipping rate was negotiated at $6.25 per kg. Fixit was charged $10 for disposing the replaced parts.


3. Field Service

Of the 200,000 calls that were transferred to Fixit, as mentioned earlier, 136,000 were solved over the phone. The balance of 64,000 that could not be solved, either because of a complex problem or because of the type of customer involved, were transferred to a field service representative. The field service rep would visit the customer and attempt to solve the problem at the customer’s location. Such service calls averaged two hours each and were billed at a fully loaded rate of $150 per hour. While it certainly did not take two hours to solve most problems, one field rep had remarked that half the time was spent getting to the customer, waiting in lobbies while security experienced their ‘‘power trips’’ before letting the rep into the offices or plants, and filling in tons of paperwork.
The field service technicians were able to solve 90 percent of the problems at the customers’ sites. Of these, 2,800 required parts (charged out at the same $70 as before). This worked out to $196,000 per year (2,800 x $70).


4. Replacement and Repairs

For the 10 percent (6,400) of field service repairs that could not be solved by the technician, the customers were provided with a replacement unit. The charge to the warranty budget was a full sale price of $300. The old units were shipped back to the Regional Service Center at Fixit Inc. at an average freight cost of $20 per unit. In the past year, 70 percent (4,480 defective units) were repaired at an average cost of $85 each. The $85 repair charge was based on an estimate of 18 minutes of labor per repair at $150 per hour, plus $40 for parts. After repairs, the units were ‘‘fed into the pipeline’’ to be used for future replacements. The transfer price resulted in ‘‘revenue’’ of $225 per unit to the RSC. Thus the net cost for every replaced unit was $180 ($300 charge for a new unit, plus $20 to ship the old unit back, plus $85 to repair the old unit, minus $225 revenue for ‘‘selling’’ the repaired unit back to inventory).


5. Dismantling and Scrapping

As can be seen in the section above, 4,480 of the 6,400 returned units were repaired and fed into the pipeline. The remaining 1,920 irreparable units were dismantled, sorted, and after salvaging some parts, the rest were scrapped. This dismantling activity was charged out at $10 per unit. Therefore the cost for each of the 1,920 such units would be $330 ($300 charge for the new unit replaced, plus $20 to ship the old unit back, plus $10 to dismantle the old unit). Bill Dollar calculated the total cost of the entire process to be around $23.2 million (see Figure 3-1). In order to bring the project cost down by $15 million something dramatic would need to be done. Will the team at Anything Inc. live happily ever after? Let’s go through the rest of the story and see for ourselves.

Resources: Supplychain Cost Management, The AIM & DRIVE® Process for
Achieving Extraordinary Results
, by : Jimmy Anklesaria

What did we learn from the story?

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