Question:
Dude Skis sells to Stuffy Skis, which is a high-end retailer of the most expensive all-mountain skis, as well as Warehouse Sports, which retails the lowest-cost skis through many outlets to beginner skiers. The skis that Dude sells to Stuffy have thehighest margins, and Stuffy requires little administrative support. Warehouse buys in massive volume, but only buys low-margin items, and returns 20% of its purchases under various pretexts in order to clear out its inventory at the end of the season. Dude's management wants to know how much it earns from each customer, and whether it should drop either one. Dude's cost accountant constructs the following table:
|
Stuffy Customer
|
Warehouse Customer
|
|
Revenue
|
$520,000
|
$2,780,000
|
|
Direct costs Materials
|
210,000
|
1,390,000
|
|
Direct labor
|
100,000
|
550,000
|
|
Customer service cost
|
0
|
130,000
|
|
Sales returns cost
|
0
|
600,000
|
|
Total direct costs
|
310,000
|
2,670,000
|
|
Contribution margin ($)
|
$210,000
|
$110,000
|
|
Contribution margin (%)
|
40%
|
4%
|
In the table, there is no customer service cost at all for Stuffy Skis, since no customer service positions would be eliminated if Dude were to drop Stuffy as a customer. On the other hand, there are four customer service employees assigned to the Warehouse Sports account who would be laid off if Dude were to drop that account.
The analysis reveals that Stuffy Skis produces far more contribution margin than Warehouse Sports, despite much lower revenues. However, this does not mean that Dude should eliminate Warehouse as a customer, since it still produces $110,000 of contribution margin. If Dude has a considerable amount of overhead to cover, it may be quite necessary to continue dealing with Warehouse Sports in order to retain the associated amount of contribution margin.