Reference no: EM131451615

Shatin Dairy Farm

Shatin Dairy Farm is a small, family-owned business that started its operations in 1996 with the goal of using all natural processes to create high quality dairy products. The company produces several different products sold in health food markets and some of the larger supermarkets in the area as well as in the Shatin Country Store, a small retail store located next to the farm. Shatins' products are well-known for their quality and have gained a strong brand-loyalty throughout the region in which Shatin operates. A key competitive factor for Shatin is that is uses only glass bottles in the packaging of its products, which appeals to many of its targeted customers.

Shatin's sales have grown rapidly in recent years, but production is currently limited by the number and size of the facilities on site that can only accommodate 300 animals (of which 130 cows are part of the milking herd). As a result, Shatin is considering expanding its operations to allow it to meet the increasing demand for its products. In order to expand, Shatin would have to buy additional land, build more barns and enlarge the milking facility. Shatin's manager, Laura Ashley, is concerned about the potentially large financial outlays that Shatin would incur with expansion and she feels that she should examine whether or not current operations are efficient and cost effective before expanding.

Laura is also considering the possibility of packaging the farm's product in plastic and paper containers instead of glass bottles.   She expects that this would attract new customers, and in addition, it would reduce costs significantly.  The direct cost of packaging the product (now $.75 per bottle) would be about one-third the current cost, and the cost of the bottling equipment for filling the plastic or paper containers would fall to one-half the cost of the current equipment within 6 months time.   All other costs would remain the same. Also, Laura thinks the sales of the farm's products would grow even faster with the broadened product line - the brand reputation of the farm's products could be leveraged to bring in new customers and the use of plastic or paper containers would enable the farm to attract new supermarkets and other retailers that do not presently handle bottles. Laura thinks that the supermarket customers would be willing to pay at least $.40 per quart more for Shatin products relative to other store brands.

Laura subscribes to the relevant trade journals in dairy farming, and has excerpted the following information from a recent issue of one of her journals.   It shows the buying criteria of a sample of supermarket customers who were purchasing milk in plastic and paper containers (1 = most important, and 5 = least important).  The current supermarket prices for these products in Shatin's area are $1.25 per quart for each product except eggnog which sells for $1.80. Supermarkets mark up the price of milk by about 40% from dairy cost, so the price received by the dairy is somewhat less.

Attribute Importance Ranking, by Product

Background about Shatin's Operations -

The main processes involved in milk production are as follows:

1. Milking: An employee begins by sanitizing the cows.  Once this is done, the employee attaches the cows to an electronic milking machine. The machine automatically provides information on the number of gallons produced by each cow and pumps the milk into a holding tank before the next process begins. This is a very time- consuming and labor-intensive process because the milking pen currently accommodates 12 cows at a time. The rest of the cows are kept in the milking barn until it is their turn to be milked. Milking the entire milking herd takes between three and four hours per day.

2. Separating: In this process, a machine sorts the cream from the milk.  The cream is then stored in a vat until it is made into butter or is added back to the milk to create either, low-fat, chocolate, or whole milk or eggnog.

3. Pasteurizing: Pasteurizing is the process by which any bacteria in the milk are killed.  Milk runs through hot plates, bringing it to a temperature of 175 F degrees. Then, the milk is run through cold plates to bring it to the optimal storage temperature of 38 F degrees.

4. Homogenizing: After pasteurization, the milk is homogenized by breaking up fat molecules in the milk by running the milk through a high pressure system. This process is done for cosmetic purposes to create a rich, creamy finished product. This step is the last step in the production process for whole milk, skim milk, and low- fat milk.  These three types of milk are then stored in separate holding tanks until the bottling process begins.

5. Mixing:  This process is only completed for chocolate milk and eggnog.  In this process, sugar and other ingredients are added and mixed into the milk to create the finished product.

6. Bottling: Bottling is a very costly process for Shatin. Shatin uses glass bottles to package its milk products, which requires more filling time than paper or plastic containers. Before the bottles can be filled, employees must sterilize and sanitize the glass bottles. The clean bottles are then placed on a conveyer belt to be filled. The filling of the bottles is completed by a machine that fills each bottle and also places plastic caps on the bottles. An employee removes the filled bottles from the conveyor belt and places them into crates.

7. Warehousing: When the crates are filled, an employee moves them to the refrigeration room in the warehouse. They are stored in the room until they are shipped. In addition to the refrigeration room, the warehouse also holds new and returned glass bottles as well as ingredients like sugar that are added to the milk in the mixing process.

The products produced by Shatin and current prices received by Shatin are as follows:

• Whole Milk, $1.90 per quart
• Low-Fat Milk, $1.90
• Skim Milk, $1.90
• Chocolate Milk, $1.90
• Eggnog, $2.25

Bottles are produced in one size - quarts. Selected data for the most recent year are as follows:

Shatin's Accounting System

Shatin has a conventional accounting system which keeps track of overhead costs in four categories: bottling equipment, facilities, processing, and general and administrative. There are sub-accounts in each of these accounts except for bottling equipment.  The accounts, sub-accounts and costs for the most recent operating year are shown in Table 1. These costs are often called resource costs, and are labeled as such in the OROS software system. Shatin grows on site most of the feed needed at the dairy farm. The cost of producing the feed and some additional feed purchased during the year is included under labor and materials for other processing costs.

Table 1: Overhead (Resource) Costs for Shatin Dairy Farm

In addition to the overhead costs, Shatin has direct costs for bottles and other materials. These materials are purchased from a variety of suppliers. Each glass bottle costs Shatin $.75, including both purchase and recycling cost. Other ingredients include cocoa, sugar, and spices. Cocoa, used in the production of chocolate milk, costs $.05 per bottle. Sugar, used in both chocolate milk and eggnog, costs $.05 per bottle.  Spices, used to make eggnog, cost $.08 per bottle. In total, 65,700 ounces of sugar and cocoa were used in the production of chocolate milk, and 76,650 ounces of sugar and spice were used in the production of eggnog.

Laura has heard from a local vendor that information from an activity-based costing would be helpful to Laura in improving Shatin's operations. With some guidance from a cost consultant recommended by the vendor, the following production activities were identified

• Milking
• Separating, pasteurizing, and homogenizing
• Mixing
• Bottling
• Warehousing
• General and Administrative (G&A)
• Receiving and Inspecting
• Cleaning and Repairs

Overhead (Resource)-consumption Cost Drivers -

Laura has further analyzed the cost structure, to determine how the overhead (resource) costs could be allocated to the eight activities identified above. On the advice of the cost consultant, she determined that all costs in the general and administrative account could be allocated to the general and administrative activity. Moreover, most (90%) of the costs in the bottling machine account could be allocated to the bottling activity, and the remainder to the receiving and inspecting activity. Determining how the other processing costs could be related to the activities is not as simple, but after some careful study the following estimates were made for the other processing costs account:

The other facilities cost account includes the costs of maintaining the warehouse and milking barn, and is allocated to the activities on the basis of square feet.      Square feet are therefore the resource-consumption cost driver for the other facilities cost account, which is one of Shatin's overhead (resource) accounts.

Activity-consumption Cost Drivers

After some additional study, it was decided that the best way to allocate the costs of each activity to the products was to use the following activity-consumption drivers:

Required -

1. Assess the competitive environment of Shatin Dairy Farm and determine what you think is or should be Shatin's competitive strategy, and explain why.

2. Determine the unit costs for each of the five products given the available information.

3. How could you improve on these calculations?

I need this done in British english.