Revenues, Sales Variances, and Customer-Profitability Analysis

1
Revenues, Sales Variances, and Customer-Profitabil
ity Analysis

• Chapter 16

2
Introduction

• Companies that prosper make revenue planning and
  revenue analysis top priorities for their
  managers.
• This chapter examines revenue allocation issues
  and sales variances.
• It also explores topics related to customer
  revenues and customer costs.

3
Learning Objective 2

• Allocate the revenues of a bundled
  package to the individual products in that
  package

4
Revenue Allocation Methods

• Sedona Languages Institute buys English language
  software programs locally and then sells them in
  Mexico and Central America.
• Sedona sells the following programs Grammar,
  Translation, and Composition
• These programs are offered stand-alone or in
  a bundle.

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Revenue Allocation Methods

• Stand-alone Price
  Grammar 255 Translation 85
  Composition 185
• Purchasing these software programs cost Sedona
  the following
  Grammar 180 Translation 45
  Composition 95

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Revenue Allocation Methods

• Bundle (Suites) Price
  Grammar
  Translation 290 Grammar Composition 350
  Grammar Translation
  Composition 410

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Revenues and Bundled Products

• What businesses provides bundled products?
• Banks provide
• Checking
• Safety deposit boxes
• Investment advisory

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Revenues and Bundled Products

• Hotels provide
• Lodging
• Food and beverage services
• Recreational activities
• Tours provide
• Transportation
• Lodging
• Guides

9
Revenue Allocation Methods

• The two main revenue allocation methods are
• The stand-alone method
• The incremental method

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Stand-Alone Revenue Allocation Method

• The stand-alone revenue allocation method uses
  product-specific information on the bundle of
  products as the weights to allocate the bundled
  revenues to the individual products.
• The term stand-alone refers to the product as
  a separate (non-suite) item.

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Stand-Alone Revenue Allocation Method

• There are four types of weights for the
  stand-alone revenue allocation method.
• Selling prices
• Unit costs
• Physical units
• Stand-alone product revenues

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Stand-Alone Revenue Allocation Method

• Consider the Grammar and Translation suite, which
  sells for 290 per day.
• How much weight should Sedona Languages Institute
  assign to each item?

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Stand-Alone Revenue Allocation Method

• Selling prices The individual selling prices
  are 255 for Grammar and 85 for Translation.
  Grammar 255
  340 0.75
  0.75 290 217.50
  Translation 85 340 0.25
  0.25 290 72.50

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Stand-Alone Revenue Allocation Method

• Unit costs This method uses the costs of the
  individual products to determine the weights for
  the revenue allocations.
• Grammar 180 225 0.80
  0.80 290 232
  Translation 45 225 0.20
  0.20 290 58

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Stand-Alone Revenue Allocation Method

• Physical units This method gives each product
  unit in the suite the same weight when allocating
  suite revenue to individual products.
• With two products in the suite, each product is
  allocated 50 of suite revenues.
  1 (1 1) 0.50
  0.50 290 145

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Stand-Alone Revenue Allocation Method

• Stand-alone product revenues This method
  captures the quantity of each product sold as
  well as their selling prices.
• Assume that the stand-alone revenues in 2001 are
  Grammar 734,400, Translation 81,600, and
  Composition 133,200.
• What are the weights for the Grammar and
  Translation suite?

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Stand-Alone Revenue Allocation Method

• Grammar 734,400/816,000 0.90
  0.90 290 261
  Translation 81,600/816,000
  0.10 0.10 290 29

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Stand-Alone Revenue Allocation Method

• Revenue Allocation
  Weights Grammar Translation
  Selling prices 217.50 72.50
  Unit costs 232.00
  58.00 Physical units 145.00
  145.00 Stand-alone
  product revenues
  261.00 29.00

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Stand-Alone Revenue Allocation Method

• The selling price and stand-alone product revenue
  weights have the advantage that they
  frequently are a good indicator of the minimum
  benefits customers receive from those products.

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Incremental Revenue Allocation Method

• The incremental revenue allocation method ranks
  the individual products in a bundle according to
  criteria determined by management.
• This ranking is used to allocate the bundled
  revenues to the individual products.

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Incremental Revenue Allocation Method

• The first-ranked product is termed the primary
  product in the bundle.
• The second-ranked product is termed the first
  incremental product.
• The third-ranked product in the second
  incremental product, and so on.

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Incremental Revenue Allocation Method

• Assume that Grammar is designated as the primary
  product.
• If the suite selling price exceeds the
  stand-alone price of the primary product, the
  primary product is allocated 100 of its
  stand-alone revenue.

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Incremental Revenue Allocation Method

• 
  Revenue
  Remaining to be
  Revenue Allocated to Product
  Allocated Other Products Grammar 255
  35 (290 255) Translation 35
  -0- Total revenue
  allocated 290

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Learning Objective 3

• Provide additional information about the
  sales-volume variance by calculating the
  sales-mix and sales-quantity variances

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Sales-Volume Variance Components

• The following information relates to Sedona
  Languages Institute budget for the year 2001.
• Product Grammar Trans.
  Comp.
  Selling price
  per unit 259 87 185
  Variable
  cost 189 50 95
  Contribution
  margin per unit 70 37 90

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Sales-Volume Variance Components

• Product Grammar Trans.
  Comp.
• Contr. margin 70 37 90
• No. of units 3,185 980 735
• Total 222,950 36,260 66,150
• Sales mix
• based on units 65 20
  15
• Total budgeted contribution margin 325,360

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Sales-Volume Variance Components

• The following are the actual results for Sedona
  Languages for the year 2001.
• Product Grammar Trans. Comp.
  Selling price/unit 255 85 185
  Variable cost 180
  45 95 Contribution
  margin
  per unit 75 40 90

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Sales-Volume Variance Components

• Product Grammar Trans.
  Comp.
• Contr. margin 75 40 90
• No. of units 2,880 990 630
• Total 216,000 39,600 56,700
• Sales mix
• based on units 64 22
  14
• Total actual contribution margin 312,300

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Market-Share Variance

• Assume that Sedona Languages Institute derives
  its total unit sales budget for 2001 from a
  management estimate of a 20 market share and a
  total industry sales forecast by Desert Services
  of 24,500 units in the region.
• In 2001, Desert Services reported actual industry
  sales of 28,125 units.

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Market-Share Variance

• What is Sedonas actual market share?
• 4,500 28,125 0.16
• Budgeted total contribution margin is 325,360.
• Budgeted number of units is 4,900.
• What is the budgeted average contribution margin
  per unit?
• 325,360 4,900 66.40

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Summary of Variances
Static-Budget Variance 13,060 U
Level 1
Flexible-Budget Variance 17,370 F
Sales-Volume Variance 30,430 U
Level 2
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Summary of Variances
Sales-Volume Variance 30,430 U
Level 2
Sales-Mix Variance 3,870 U
Sales-Quantity Variance 26,560 U
Level 3
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Summary of Variances
Sales-Quantity Variance 26,560 U
Level 3
Market-Share Variance 74,700 U
Market-Size Variance 48,140 F
Level 4
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Learning Objective 6

• Discuss why revenues can differ across customers
  purchasing the same product

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Customer Revenues and Customer Costs

• An analysis of customer differences on both
  revenues and costs can provide important insight
  into why differences in customer profitability
  exists.

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Customer Revenue Analysis

• During the first six months of 2002, Sedona
  Languages Institute expanded its market and sold
  200 composition programs to two new customers in
  Colombia.
• Customer A is in Bogota and customer B is in
  Barranquilla.

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Customer Revenue Analysis

• Customer
  
  A B Programs
  sold 140 60 List selling
  price 185 185 Invoice price 175
  180 Total revenues 24,500 10,800
• What explanation(s) can be given for these
  revenue differences?

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Customer Revenue Analysis

• Two variables explain revenue differences between
  these two customers
• The volume of programs purchased
• The magnitude of price discounting
• Price discounting is the reduction of selling
  prices below listed levels in order to encourage
  increases in customer purchases.

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Customer Cost Analysis

• Assume that Sedona Languages Institute has an
  activity-based costing system that focuses on
  customers rather than products.
• Activity Area Cost Driver and Rate
  Order taking 80 per purchase order
  Set-up 100 per batch

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Customer Cost Analysis

• Customer
  A
  B Number of
  Purchase orders 7
  2 Batches 7 2
• What is the cost of servicing each customer?

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Customer Cost Analysis

• Customer A
  Ordering 7 80/order 560
  Set-up 7 100/batch
  700 Total 1,260
• Sedona can use this information to persuade this
  customer to reduce usage of the ordering and
  set-up cost drivers.

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Customer Cost Analysis

• Customer B
  Ordering 2 80/order 160
  Set-up 2 100/batch 200
  Total 360

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Learning Objective 7

• Prepare a customer-profitability report

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Customer-Profitability Profiles

• Managers find customer profitability analysis
  useful for several reasons
• It highlights how vital a small set of customers
  is to total profitability.
• When a customer is ranked in the marginal
  category, managers can focus on ways to make
  future business with this customer more
  profitable.

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Customer-Profitability Profiles

• Which customer is more profitable, A or B?
• A
  B Revenues 24,500 10,800
  Cost of good sold
  (95 per unit) 13,300
  5,700 Contribution margin 11,200 5,100
  Other expenses 1,260 360 Operating
  income 9,940 4,740

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Customer-Profitability Profiles

• Customer A seems to be more profitable.
• However, customer B has a higher gross profit
  percentage.
• Customer A has a gross profit of 40.6 (9,940
  24,500).
• Customer B has a gross profit of 43.9 (4,740
  10,800).

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Customer-Profitability Profiles

• Customer profitability reports often
  highlight that a small percentage of
  customers contribute a large percentage
  of operating income.
• It is important that companies devote
  sufficient resources to maintaining and expanding
  relationships with these key contributors to
  profitability.

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Learning Objective 8

• Apply the concept of cost hierarchy to customer
  costing

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Cost Hierarchy

• Customer cost hierarchies are being used by
  companies such as General Motors to highlight how
  some costs can be reliably assigned to individual
  customers while other costs can be reliably
  assigned only to distribution channels or
  to corporate- wide efforts.

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Cost Hierarchy

• General Motors uses a seven level cost hierarchy
  to analyze profitability.
• The aim of this cost hierarchy is to assign
  costs to the lowest level of the hierarchy at
  which they can be identified.

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Cost Hierarchy

• Enterprise-related activities
• Market-related activities
• Channel-related activities
• Customer-related activities
• Order-related activities
• Parts-related activities
• Direct materials

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End of Chapter 16