Ahmad, General Manager of Mawred Office Supplies (HOS) was concerned about the financial results for calendar year 2000. Despite a sales increase from the prior year, the company had just suffered the first loss in its history (see summary income statement in Exhibit 1). Mawred Office Supplies was a regional distributor of office supplies to institutions and commercial businesses. It offered a comprehensive product line ranging from simple writing implements (such as pens, pencils, and markers) and fasteners to specialty paper for modern high-speed copiers and printers. HOS had an excellent reputation for customer service and responsiveness. HOS operated several distribution centers in which personnel unloaded truckload shipments of products from manufacturers, and moved the cartons into designated storage locations until customers requested the items. Each day, after customer orders had been received, HOS personnel drove forklift trucks around the warehouse to accumulate the cartons of items and prepared them for shipment. Typically, HOS shipped products to its customers using commercial truckers. Recently, HOS had attracted new business by offering a “desk top” option by delivering the packages of supplies directly to individual locations at the customer’s site. Mawred operated a small fleet of trucks and assigned warehouse personnel as drivers to make the desktop deliveries. Mawred charged a small price premium (up to an additional 2% markup) for the convenience and savings such direct delivery orders provided to customers. The company believed that the added price for this service could improve margins in its highly competitive office supplies distribution business. HOS ordered supplies from many different manufacturers. It priced products to its end-use customers by first marking up the purchased product cost by about 15% to cover the cost of warehousing, distribution, and freight. Then it added another markup to cover the approximate cost for general and selling expenses, plus an allowance for profit. The markups were determined at the start of each year, based on actual expenses in prior years and general industry and competitive trends. Actual prices to customers were adjusted based on long-term relationships and competitive situations, but were generally independent of the specific level of service provided to that customer, except for desk top deliveries. Mawred had introduced electronic data interchange (EDI) in 1999, and a new internet site in 2000, which allowed customer orders to arrive automatically so that clerks would not have to enter customer and order data manually. Several customers had switched to this electronic service because of the convenience to them. Yet Mawred’s costs continued to rise. Ahmad was concerned that even after introducing innovations such as desktop delivery and electronic order entry, the company could not earn a profit. He wondered about what actions he should take to regain profitability. Distribution Center: Activity Analysis Ahmad turned to his controller, Mays and director of operations, Tarek for help. Tarek suggested: If we can figure out, without going overboard of course, what exactly goes on in the distribution centers, maybe we can get a clearer picture about what it costs to serve our various customers. Mays and Tarek went into the field to get more specific information. They visited one of Mawred’s distribution facilities. Site manager Ali confirmed, “All we do is store the cartons, process the orders, and ship them to customers.” With Ali’s help, Mays and Tarek identified four primary activities done at the distribution center—process cartons in and out of the facility, the new desk top delivery service, order handling, and data entry. Ali described some details of these activities. The amount of warehouse space we need and the people to move cartons in and out of storage and get them ready for shipment just depends on the number of cartons. All items have about the same inventory turnover so space and handling costs are proportional to the number of cartons that go through the facility. We use commercial freight for normal shipments, and the cost is based more on volume than on anything else. Each carton we ship costs about the same, regardless of the weight or distance. Of course, any carton that we deliver ourselves, through our new desktop delivery service, avoids the commercial shipping charges. 2 The team confirmed the information with the warehouse supervisor who noted: This desktop delivery is a real pain for my people. Sure, we offer the service, and it’s attracted increased business. But I have had to add people since existing personnel already had more than enough to do. Mays and Tarek next checked on the expenses of entering and validating customer order data. The order entry expenses included the data processing system and the data entry operators. They spoke with