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write in oun words Traditional volume-based cost allocation systems that use only drivers that vary directly with the volume of products produced—such as direct labor dollars, direct labor hours, or machine hours—are likely to systematically distort product costs because they break the link between the cause for the costs and the basis for assignment of the costs to the individual products. Costs may vary not only with respect to volume of production, but also, for example, with batch-related activities (e.g., changeovers, setups, and inspection of the first item of production run) and the number of products (e.g., scheduling materials receipts and improving products). Also, cost distortions tend to be greater with greater differences between relative proportions of indirect resources used by cost objects because traditional cost assignments based on volume-related measures do not accurately reflect these differences.
5-4 Companies producing a varied and complex mix of products require many more resources to support their highly varied mix, and therefore have higher costs. Examples of the greater resources required include a much larger production support staff to schedule machine and production runs; perform changeovers and setups between production runs; inspect items at the beginning of each production run; move materials; ship and expedite orders; develop new and improve existing products; negotiate with vendors; schedule materials receipts; order, receive, and inspect incoming materials and parts; and update and maintain the much larger computer-based information system.
5-10 Service organizations are often ideally suited for activity-based costing because virtually all of the costs for a service company are indirect and appear to be fixed. The large component of apparently fixed costs in service companies arises because, unlike manufacturing companies, service companies have virtually no material costs—the prime source of short-term variable costs. Service companies must supply virtually all of their resources in advance to provide the capacity to perform work for customers during each period. Fluctuations during the period of demand by individual products and customers for the activities performed by these resources do not influence short-term spending to supply the resources.
5-11 As mentioned in 5-10, virtually all the costs for a service company are indirect and appear to be fixed. Service companies have few or no direct materials and many of their personnel provide indirect, not direct, support to products and customers. Consequently, service companies do not have direct, traceable costs to serve as convenient allocation bases.
Unlike physical products, services cannot be inventoried for future sales. Service companies must supply virtually all their resources in advance to provide the capacity to perform work for customers during each period, and demand often fluctuates. For some service industries, the increase in spending resulting from an incremental transaction or customer is essentially zero. Therefore, service companies making decisions about products and customers based on short-term variable costs might provide a full range of all products and services to customers at prices near zero, leading to little recovery of the costs of all the committed resources supplied in order to deliver services to customers. It can be difficult to identify and measure the outputs for a service organization. The variation in demand for organizational resources is much more customer-driven in service organizations than in manufacturing organizations. A service company can determine and control the efficiency of its internal activities, but customers determine the quantity of demands for these operating activities. For example, customers may vary greatly in the number of transactions and the balances in their checking accounts. Service companies must focus on customer costs and customer profitability; measuring revenues and costs at the customer level provides service companies with far more relevant and useful information than at the product level. Finally, a customer may have multiple relationships with a service company. Therefore, the cost system should provide information that supports determining profitability of the entire relationship with the customer. Customer costs and customer profitability are discussed in more detail in Chapter 6.
5-12 Individuals may feel vulnerable facing uncertainty about what the activity-based cost analysis may show, or they may feel threatened by the suggestion that their work could be improved. For example, the analysis might reveal that products or customers thought to be very profitable are actually unprofitable, or that some processes are inefficient. Individuals may be concerned that they will then be judged as poor managers, even though they were making decisions that others would agree were good decisions based on the cost system in place.
6-1 Nonfinancial measures such as customer satisfaction and customer loyalty are important in managing relationships with customers, but an excessive focus on improving customer performance with only these metrics can lead to deteriorating financial performance. To balance the pressure to meet and exceed customer expectations, companies should also be measuring the cost to serve each customer and the profits earned, customer by customer.
6-3 Companies should not necessarily avoid high cost-to-serve customers. The high cost of serving such customers can be caused by their unpredictable order patterns, small order quantities for customized products, nonstandard logistics and delivery requirements, and large demands on technical and sales personnel. Activity-based pricing may be used to ensure that companies charge prices that are high enough to cover the high costs of serving such customers. Customers may, in response, change their behavior to become lower cost-to-serve customers. Companies may also improve the process used to produce, sell, deliver, and service customers in order to improve customer profitability.
6-6 Service companies, even more so than manufacturing companies, must focus on customer costs and profitability sales because the variation in demand for organizational resources is much more customer driven than in manufacturing organizations. A manufacturing company producing standard products can calculate the cost of producing the products without regard to how their customers use them. In this sense, the manufacturing costs are customer independent. Of course, the costs of marketing, selling, order handling, delivery, and service of the products might be customer specific. For service companies, in contrast, customer behavior determines the quantity of demands for organizational resources that produce and deliver the service to customers.
6-13 Loyal customers are valuable for several reasons. Three reasons are required in this question; the chapter lists the following five reasons:
1. Loyal customers have a greater likelihood to repurchase, and the costs to retain them are generally much lower than the cost to acquire an entirely new customer.
2. Loyal customers can persuade others, through word of mouth, to become new customers; they can become references for potential future customers.
3. Loyal customers are less likely to defect when a competitor offers a similar product at the same or slightly lower price.
4. Loyal customers are often willing to pay a price premium to retain a known and trusted relationship with a key supplier.
5. Loyal customers are willing to collaborate with the supplier to improve performance and develop new products.
6-14 Customer retention rate, though a traditional customer loyalty metric, is a poor indicator of a customer’s loyalty. This is because customers often remain with their current supplier because of inertia, high switching costs, or the current lack of an alternative supplier.