October 5, 2010 The demand for organic items in the US has been growing exponentially in the past decade. Numerous warnings about what we consume are very common; the chemicals, preservatives and other additives are creating health problems worldwide. Thus, a growing niche for all-natural processing is booming. Maple Hill Dairy Farm is a small family-owned business. They take pride in their high quality dairy products they produce. They sell their dairy products in a small store adjacent to the farming operation as well as in several area markets.
Part of their charm is due to the fact that their products are still bottled in glass bottles. However, this is also part of their problem. Maple Hill Dairy is that of a DIFFERENTIATOR. They create and sell high quality products and receive between a 25% to 40% premium over standard market prices. Their net profit of $17,759. 00 for annual operations appears to be low for a dairy operation this size. Laura Ashley, the manager for Maple Hill, requested an analysis to help her determine 2 specific ideas. 1.
The possibility of changing the container and packaging system. Currently, the bottle that they package each of their dairy products in is . 75 cents each. By changing from a glass container to a plastic or paper container, they will save . 50 cents each on direct material costs. There is a risk of losing their “charm” as they look to the possibility of new customers. Also, the bottling operation overhead costs, they estimate, would be half of the cost of that in this analysis. 2. The possibility of expansion. Currently, they are operating at capacity.
An ABC cost analysis reveals that although they are posting an annual profit, two of their products are costing more to produce per unit than they are getting revenue for. Each bottle of chocolate milk that they produce costs an average of $2. 68. They are selling it for $1. 90 – nearly a 41% loss. Each bottle of eggnog that they produce costs an average of $3. 01. They are selling it for $2. 25 – nearly a 34% loss. 2 Their other three products: whole milk, low fat milk and skim milk, have between an 8. 5 and 12. 5% profit margin.
The volume of those items sold is the reason that Maple Hill has been able to post a positive net income. Maple Hill Dairy Farm ABC cost unit analysis Page 2 Based on the information of this analysis, my recommendations are as follows: 1. Change from the glass to the plastic/paper containers. The savings from this change, all else status quo, would bring their margin closer in line to where the losses on the chocolate milk and eggnog would be within 15%. From that single change, the net income alone could increase to $985,790. 2.
By switching to plastic/paper containers, the manufacturing process would also change. Thus the overhead allocations for the “bottling” task would be reduced to half their costs as of this analysis. It is assumed that the change would take 6 months to complete, and it is assumed that they dairy will be able to keep up with production for that transition. Again, a reduction of half of these costs, for half of a year, would again reduce the overhead by 20. 5%. This will also increase warehouse capacity, as there is no more storage for returned glass containers.
This may, however, create an increase of warehousing costs and additional labor as paper and plastic containers will not have the support and the ability to be stacked as glass containers do. 3. A proposed increase in sales price was suggested. At this time, however, by reducing the costs of your product, I suggest none. It may be possible to even reduce your sales price in attempt to gain more customers and earn more market share. The cost of changing from a differentiation strategy to a cost leader strategy always has its unique risks.
This risk is worth taking. 4. The discussion of the expansion of the dairy should be tabled at this time. After the container change, another analysis would be appropriate to see how the bottom line looks. Taking this risk and obtaining additional debt before a significant change is not recommended. Maple Hills can continue to service its customers with a quality dairy product even as the changes are implemented. The ABC cost unit analysis is limited to the information given to us, but we are confident in the results. Sincerely, Marci M. Ridley