Case 13

Dream Beauty



Overview

Dream Beauty is a case setting to apply the concepts of segmental costing and margin, activity
based costing, and the strategic profit model. The case provides revenue and cost data for three
distribution channels and limited individual accounts. The specific answers are provided in the
accompanying Powerpoint presentation. This is the used as a basis for class discussion to
illustrate segmental costing and profitability analysis.

Solutions to Questions

Slide 2 provides a segmental profitability summary for Retail, Convenience stores (C-
Stores), and Mass Merchants. All costs are assigned based on percent of revenue thus resulting
in an equal contribution of all segments. This is clearly inappropriate as the activities to serve
each segment are quite different.

Slide 3 uses more appropriate drivers for assigning costs. COGS are assigned based on
percentage of revenue. Ordering and delivery costs are assigned based on the number of orders.
Packaging costs are assigned based on the number of packages. Labeling cost is assigned only
to the mass merchants since that is the only segment that uses it. The resulting segmental
contribution reveals a very different story as the C-Store segment is clearly loosing money while
the retail and mass merchant segment is very profitable. The major reason is that C-Stores
require substantially more orders and resulting deliveries. Another cost category that could be
included is inventory carrying cost. However, it has not been included here since it is difficult to
assign specific products to segments.

Since the C-Store segment is not profitable, there obviously needs to be some action taken
to remedy the situation. The alternatives could include dropping the segment from service,
increasing the price, or investigating the segment further to determine if it is a generic problem or
if it can be isolated to specific accounts. Slide 4 summarizes the gross margin (Sales COGS)
for each C-Store. At the gross margin level, all the stores appear to be profitable. However,
when the ordering, packaging, and delivery costs are assigned based on the number of orders and
packages (Slide 5), it becomes clear that there are four profitable accounts and nine accounts that
have a negative contribution (Slide 6). This demonstrates how logistics cost can influence
account profitability. This obvious point is that there needs to be some action with the
unprofitable accounts in the C-Store segment to either increase their revenue, decrease the cost of
serving them, or stop serving them. Slide 7 summarizes these options.

While Slide 3 provides an accurate assessment of segmental profitability, it does not
reflect the differences in the asset requirements to achieve such profitability. Slides 8-10 provide
a strategic profit model summary for each of the segments. The operating costs are taken from
the previous analyses. The strategic profit model (discussed in Chapter Eighteen) includes the
relevant assets for each segment. The specific assets include the inventory (based on the turns
for each segment), accounts receivable (based on days of receivables), and other fixed assets such
as the labeler. Since the labeler is only used for the mass merchant segment, it is only included
as an asset for the segment. The strategic profit analysis has also assigned inventory carrying
cost (at 20% annually) to the operating costs for each segment. The point needs to be made that
these return-on-assets appear to be extremely high because there is no overhead assigned to each
segment. A review of the return-on-assets demonstrates that while the mass merchants had the
highest profit contribution, it does not provide the highest return-on-assets due to the labeler.
This illustrates how logistics assets including inventory, accounts receivable, and equipment can
impact the return-on-assets for key segments.