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Fine Foods, Inc.

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.

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Fine Foods, Inc.

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  1. Fine Foods, Inc. Jessica Beck Cochran Derrick Payne Dary Phanthavong Kolby Wright

  2. 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.

  3. 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

  4. Production Process

  5. 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.

  6. 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

  7. 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

  8. 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

  9. 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

  10. 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

  11. 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

  12. 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

  13. Performance Evaluation • Responsibility centers: • Cost centers • Revenue centers • Profit centers

  14. 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

  15. 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

  16. Performance Evaluation • Agency costs- cost created conflict exists between individual/department intentions and what is best for the company • Agency costs for Fine Foods?

  17. Performance Evaluation at Fine Foods • Departmental level (SMU) • Operating Profit

  18. Contribution Margin 1

  19. Contribution Margin 2

  20. Contribution Margin 3

  21. Contribution Margin 4

  22. Operating Profit

  23. Issues with Operating Profit Calculation • Fixed costs? • Period costs?

  24. Recommendations • Add nonfinancial measurements • Replace operating profit • CM1 • ROI or Residual Income

  25. Conclusions • Performance evaluation can cause agency costs • For Fine Foods, performance evaluation measurements led to unfair cost allocation

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