Fine Foods, Inc.
Jessica Beck Cochran
Derrick Payne
Dary Phanthavong
Kolby Wright
Background of Fine Foods, Inc.

Producer of a wide range of food products

Most products are packaged for end-consumption and sold
through supermarkets, convenience shops, and other
similar outlets.

Items are sold in different sizes: individual, half-gallon,
or in bulk

Products are pre-packaged goods and are not fresh
products.
Organization of the Fine Foods, Inc.

Owned by Great Plains Capital

Great Plains gives Fine Foods control over management, product selection,
performance evaluation, etc.

Strategic Management Units, based on the markets served
SMU1
•
Supermarkets
SMU2
•
Institutional customers
•
Special Orders
SMU3
•
Governmental
organizations
Production Process
Raw
Materials
Prep
Preliminary
Cooking
Additional
Ingredients
Added
Final
Cooking
Processing
and
Packaging
Shipped to
the
Customer
Meet Kay Smith

Manager of SMU2

Believes that her unit is being allocated too much
product cost due to Special Orders.

Unit morale is low due to low performance
evaluations based on operating profit.
What’s the issue? ….. SPECIAL ORDERS

Constitute 2% of total revenues for Fine Foods

Almost all special orders are for product MP and are to a food
distributor in Mexico.

MP is shipped unbranded for sale in Mexico and is frozen in 10-pound
packages

Product MP can be frozen for up to a year and is flexible to meet
special orders  large inventory
Product MP

Cost allocation of MP is currently negatively affecting SMU2 and its operating
profit

MP sales are a significant portion of SMU2’s total sales, as opposed to the
other units

Comes from the same raw materials as many other the other products

Direct Costs include raw materials, packaging materials, and direct labor
salaries

Variable Costs include electricity, steam, water, and warehouse costs

Fine Foods, Inc. uses activity based costing to allocate fixed production costs

Steam boilers, building maintenance, vehicles, and sanitation costs are
allocated based on net or gross weight
Product MP (cont.)

Remaining overhead is allocated by a fixed percentage, weight, labor time,
and/or production time

Special Orders – total monthly freight out is allocated by the weight of the
product shipped
SMU1 and SMU2

Media and Sales promotion costs are currently allocated to product groups
and individual products based on weight of products sold

Sales and Marketing costs are allocated based on sales volume

Majority of fixed costs are allocated based on weight

This is a problem for SMU2 because of product MP

MP is a very dense, bulky and heavy product, resulting in its receiving of a
majority of fixed costs

These costs are excessive and reflect negatively on SMU2’s operating profit
Proposed Recommendations

Find a cost driver besides weight

For example: time and miles traveled would more accurately reflect costs for
steam boilers and vehicles

Allocate a portion of fixed costs to other units

SMU3 could be included in the allocation of sales and marketing costs, as well
as media and sales promotion costs

This would increase my contribution margin to a more accurate number while
minimally affecting the other units’ profits
Current Benefits of Special Orders

Creates a steady work flow

SMU2 only accepts special orders when the contribution
margin (CM1) is positive
 CM1
includes Variable Manufacturing Cost, Fixed
Manufacturing Costs, and Freight Out

Accepted at idle times in business
Recommended Changes for Special
Orders

Reconsider whether these sales are really special
orders

Remove Fixed Manufacturing Costs from CM1
 Would

allow for more Special Orders
Remove freight out from the price of MP
 Cost
of MP will decrease
Performance Evaluation

Responsibility centers:
 Cost
centers
 Revenue
centers
 Profit
centers
Performance Evaluation

Contribution margin= sales price – variable costs per unit

Operating profit= operating revenues - operating costs

Return on Investment (ROI)= After-tax income
Divisional assets
Performance Evaluation

Residual Income=
After-tax income – (cost of capital X divisional assets)

Economic Value Added (EVA®)= adjusted annual after-tax
income – adjusted total annual cost of capital
Performance Evaluation

Agency costs- cost created conflict exists between individual/department
intentions and what is best for the company

Agency costs for Fine Foods?
Performance Evaluation at Fine Foods

Departmental level (SMU)

Operating Profit
Contribution Margin 1
Gross Sales
(Standard discounts)
(Activity discounts)
(Special discount activities for customers)
Net Sales
(Variable manufacturing cost)
(Fixed manufacturing cost)
(Freight out)
Contribution Margin 1
Contribution Margin 2
Contribution Margin 1
(Media)
(Sales promotion)
Contribution Margin 2
Contribution Margin 3
Contribution Margin 2
(Marketing and sales)
Contribution Margin 3
Contribution Margin 4
Contribution Margin 3
(Top management)
(Business administration)
(Information systems)
(Human resources)
(Supply chain)
(Production)
(External logistics for finished goods)
(Mark up- Manufacture expenditures)
(Other fixed costs)
Contribution Margin 4
Operating Profit
Contribution Margin 4
(Structural costs)
(Total depreciation)
Operating Profit
Issues with Operating Profit Calculation
 Fixed
costs?
 Period
costs?
Recommendations

Add nonfinancial measurements

Replace operating profit
 CM1
 ROI
or Residual Income
Conclusions

Performance evaluation can cause agency costs

For Fine Foods, performance evaluation measurements led
to unfair cost allocation