Strategic Change at Kemps LLC
Kemps, headquartered in Minneapolis, is a full-line dairy, that produces milk, yogurt, sour cream, cottage cheese, and ice cream products. Its customers are retailers and distributors as large as SuperValu and Target and as small as convenience stores. Kemps markets its products under its own branded portfolio along with products sold through private label and copacking contracts. Like most dairies, Kemps was experiencing consolidation in its customer base. It decided to shift from its former customer relationship strategy—willing to do whatever the customer asked—to a lower-total-cost strategy. The new approach clearly required an accurate understanding of cost by product and customer that Jim Green, Kemp’s CEO, would use to instill a “low total cost” culture throughout the organization.
As a critical component of the cost-to-serve model, Kemps implemented a time-driven ABC system so it could track the costs of changeovers in producing and packaging all its products and the costs of picking, loading, and delivering products to its diverse customer base. The model captured differences in how the company entered orders from customers (customer phone call, salesperson call, fax, truck-driver entry, EDI, or Internet), how it packaged orders (full stacks of six cases, individual cases, or partial break-pack cases for small orders), how it delivered orders (commercial carriers or its own fleet, including route miles), and time spent by the driver at each customer location. The extra time for changeovers to clean out allergens (such as nuts, eggs, soy, or wheat) used in certain ice cream products could now be accurately assigned to those products. The model also captured the extra packaging costs for special promotions and customer-specific labels and promotions.
The company soon learned it was losing money with one of its customers, a chain of specialty high-end shops, because of the low volume and high variety of products ordered and the small just-in-time deliveries the chain requested. Kemp’s vice president of sales called on the customer, explained the situation, and offered three options: accept a price increase and a minimum order size; eliminate its private-label ice cream, replacing it with Kemp’s standard branded product that was already being produced in efficient, high volumes; or find another ice cream supplier. When the customer inquired why Kemps was making the change, the VP responded that after 25 years, Kemps only now understood its true manufacturing costs and the impact of specialty production on its margins. The customer accepted a price increase of 13%, agreed to the elimination of two low-volume products, and agreed to accept full rather than partial truckload orders, thereby eliminating internal storage charges for Kemps. The changes produced immediate benefits of $150,000 per year, transforming this unprofitable customer into a profitable one.
Kemps also used its time-driven ABC model proactively to become the leading dairy supplier to a national customer. Kemps demonstrated that it could identify the specific manufacturing, distribution, and order handling costs associated with serving this customer on the basis of actual order characteristics: DSD (direct store delivery) or shipments to distribution centers, gallon versus pint deliveries, and volume and mix of products. The time-driven ABC model facilitated an open, trusting relationship between supplier and customer that differentiated Kemps from its competitors.
Kemps also became aware that some of its smaller convenience store customers had been overordering and returning product when the date code expired. To avoid the high cost of these rebates and returns, Kemps offered these retailers a 2% discount if they would manage their own inventories without the return option. In this way, Kemps eliminated 95% of out-of-code returns, generating a net saving of $120,000 per year.
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The Bottom Line
Over the past seven years, we and our colleagues at Acorn Systems have successfully helped more than 100 clients introduce time-driven ABC into their processes. Most have reported substantial improvements in profitability that they attribute to the information generated by the new approach. Take the case of Banta Foods, a Midwest food distributor with revenues of $155 million from 17,000 SKUs and 5,000 customers. It operated on a razor-thin net margin of about 1%. Historically, its profit drivers were increasing the number of orders taken per day, increasing aggregate revenues, and controlling aggregate expenses.
Banta’s time-driven ABC system, which was fully implemented within 16 weeks, revealed much more granularity in its expense structure by tying costs to products, orders, customers, and territories. Managers learned that a $1,000 order, previously considered the smallest size to break even, could either be quite profitable or a loss depending on the distance to the customer, the location of the product in the warehouse, the size of the order, the frequency of delivery, the type of service, and the credit rating of the customer—all of which were incorporated in the algorithms in its new time-driven ABC system.
Based on the data in its ABC model, Banta instituted a nonnegotiable minimum order size, reduced the inventory of unprofitable products, promoted sales of high-profit products, negotiated with customers either to reduce the demand for high-cost services or to reprice them, and offered incentives to its salespeople to increase the net profits of their customers. It also renegotiated with vendors to recoup the cost of processing customer rebates. The general manager of sales used the information to transform his sales representatives from order takers to consultants, helping them to create customers and territories that were more profitable for Banta. He reports, “Salespeople can now increase their gross profits not by simply adding points to their margin but by knowing which items to sell.”
By accurately projecting the cost and profits of proposed business, Banta has been able to take on new business that has increased revenues by 35% and generated immediate profit improvements of 43%, with a further 25% yet to come through from future opportunities. (See the exhibit “Profitable Decisions at Banta Foods.”) Its performance has led to the distinction of being named “Innovator of the Year” by the industry journal, Institutional Distributor.
Profitable Decisions at Banta Foods
Over the past 15 years, activity-based costing has enabled managers to see that not all revenue is good revenue and not all customers are profitable customers. Unfortunately, the difficulties of implementing and maintaining traditional ABC systems have prevented them from being adopted on any significant scale. Time-driven ABC has overcome these difficulties, offering a transparent, scalable methodology that is easy to implement and update. It draws on existing databases to incorporate specific features for particular orders, processes, suppliers, and customers. Activity-based costing is no longer a complex, expensive financial-systems implementation; the time-driven ABC innovation provides managers with meaningful cost and profitability information, quickly and inexpensively.