Case

Colorscope, Inc.

Page 1

Analysis
Q1)

What is the external environment that Colorscope currently faces?

A1)

Q2)

Cheaper technology is lowering entry barriers

Better technology is eroding quality-based competitive advantage
Intense competition from:
o Small stand-alones
o Large national chains
o Backward (vertical) integration by large printers
o Intense price pressures, and erosion of rents (high margins)
What has Colorscopes competitive advantage been, and why?

A2)

Reputation for quality poor quality is extremely costly because

o Pre-press is the last stage at which an error can be detected
o Mistakes in advertised price can be expensive for content provider to honor
o Merchandisers take great pride in their catalogs
o Fast turnaround this is very valuable to the content provider because it gives them more
time to decide, for example, how much to discount which items (i.e. it gives them more
time to observe their competitors actions in a fluid environment
Actual costing differs from normal costing in that overhead allocation rate = actual overhead /
actual volume of base
o This is ex post allocation rate if actual overhead will not be known till year-end, then cost
can only be determined then

For Colorscope, we have actual, as opposed to budgeted data, so this is an illustration of actual costing
Q3)

How many overhead cost pools are appropriate for Colorscope?

A3)

Q4)

The 5 departments preparation, scanning, assembly, output and Quality Control

These are the major stages in the production process, and hours are not clocked in these
departments in fixed proportion (Exhibit-9)
How do we determine the amount of overhead in each overhead pool?

A4)

In this case, we have to first allocate overhead to the cost pools (the 5 departments), and then
allocate overhead from the pools to the jobs
Page 2

This is called 2-stage allocation system

2-Stage Cost Allocation System

Begin with first stage allocation

Wages are already tracked by department (Exhibit-11)

Equipment depreciation is also tracked by department
Rent has to be allocated to the departments
o Using floor space as the allocation base makes sense
other overhead has to be allocated to the departments
o We could use labor hours as the allocation base, since this is available

First Stage Allocation

Description
Wages

Preparation

Scanning

Assembly

Output

$8000

$32000

$64000

$10000

Page 3

Quality
Control
$11000

Idle
Space

Total
$125000

Depreciation
Rent
Others
(1)Total Overhead
(2)Labor hour
Overhead rate per labor hour
(1)/(2)
Floor Space in square feet

$500
$2000
$1311
$11811
160

$25000
$2000
$5246
$64246
640

$10000
$8000
$10492
$92492
1280

$14000
$4000
$1639
$29639
200

$500
$1000
$1311
$13811
160

$74

$100

$72

$148

$86

1000

1000

4000

2000

500

$13000

$50000
$30000
$19999
$224999

6500

15000

$13000

Second Stage Allocation

In the second stage, we allocate from the overhead cost pools to each job

Using labor hours seems reasonable

Equipment depreciation is another possibility, since it is similar to machine hours
Which is a better choice?
o Cost of labor far exceeds depreciation, so labor hours will be a more important cost driver
of overhead in this case

We have to calculate allocation rates for each department

Now we can calculate job profitability

This is just revenues total costs = revenues direct costs allocated overhead

Page 4

Job#

Revenue
(1)

Total
Material
Expense
(2)

Gross
Margin
(1)-(2)

Prep

Scanning

Assembly

Output

Quality
Control

Net Profit

61001

$9,600

$5,400

$4,200

296

3212

3035

1186

604

-$4,133

61002

$9,600

$3,500

$6,100

222

2409

2746

1186

690

-$1,153

61003

$23,000

$4,500

$18,500

518

4015

5420

2372

690

$5,485

61101

$12,000

$1,800

$10,200

296

1606

2168

593

345

$5,192

61102

$11,000

$1,500

$9,500

296

1606

2023

593

345

$4,637

61201

$11,000

$1,500

$9,500

296

1606

2312

593

518

$4,175

61202

$23,000

$3,300

$19,700

518

3212

4191

1186

431

$10,162

61203

$22,000

$3,400

$18,600

444

3413

4625

1186

518

$8,415

61204

$20,000

$3,200

$16,800

444

3011

4191

1186

690

$7,277

61301

$50,000

$13,000

$37,000

1110

13049

18065

4744

2588

-$2,556

61401

$7,800

$1,800

$6,000

370

1405

2312

593

345

$974

61402

$8,000

$3,100

$4,900

296

1907

2312

1186

604

-$1,405

61403

$8,000

$3,900

$4,100

296

2008

2457

593

259

-$1,512

61404

$9,000

$2,100

$6,900

296

2208

2601

593

431

$770

61405

$9,800

$2,000

$7,800

296

2008

2601

593

345

$1,957

61501

$11,000

$2,200

$8,800

296

2108

2818

593

345

$2,640

61502

$11,000

$3,600

$7,400

296

2008

2890

1186

604

$416

61601

$20,000

$3,300

$16,700

518

2610

4336

1186

777

$7,274

61602

$2,000

$600

$1,400

148

502

723

148

86

-$207

61603

$1,400

$1,000

$400

148

502

795

297

86

-$1,428

61701

$8,000

$2,100

$5,900

296

2008

2818

593

259

-$73

61702

$10,000

$2,500

$7,500

296

2008

2963

593

431

$1,209

61801

$4,000

$1,600

$2,400

74

502

795

297

86

$646

61901

$2,000

$1,700

$300

148

502

867

148

86

-$1,452

61902

$12,000

$2,200

$9,800

370

1907

3035

593

431

$3,464

62001

$0

$200

-$200

74

100

145

148

86

-$753

Total

8658

61430

83244

24165

12683

$50,021

Idle
Time

3182

2811

9249

5485

1122

-$21,849

Total

$28,172

Unused
Floor
Space

$13,000

Net
Profit

$15,172

Page 5

Examine job profitability whale curve

The output from an ABC customer analysis is often portrayed as a whale curve

A plot of cumulative profitability versus the number of customers

Customers are ranked, on the horizontal axis from most profitable to least profitable (or most
unprofitable)

What is the cost of rework?

Rework due to change in specifications by customer

Job#
61001
61002
61301
61502
61801
61901

Material
Expense
for
rework
$2,700
$1,100
$1,000
$1,500
$1,000
$1,000

Prep

Scanning

Assembly

Output

Quality
Control

Total
Hours

Total Cost

0
0
2
1
0
1

16
8
5
4
1
1

10
6
10
8
3
4

4
4
2
1
1
0

2
3
2
0
0
0

32
21
21
14
5
6

$5,784
$3,182
$2,888
$2,724
$1,464
$1,488

Quality Control initiated rework of house errors

Job#
61301
61402
61403
61603

Material
Expense
for error
correction
$1,000
$1,000
$1,000
$500

Prep

Scanning

Assembly

Output

Quality
Control

Total
Hours

Total Cost

1
0
0
1

3
9
10
3

4
16
14
3

1
2
2
1

1
2
1
0

10
29
27
8

$1,922
$3,520
$3,390
$1,264

Page 6

Cost per Page

Job#

Pages

Net
Profit

Profits/
Page
(1)

Revenue

Revenue/
Page
(2)

Cost/Page
(2)-(1)

61001
61002
61003
61101
61102
61201
61202
61203
61204
61301
61401
61402
61403
61404
61405
61501
61502
61601
61602
61603
61701
61702
61801
61901
61902
62001
Total

16
16
32
16
16
16
32
32
32
128
16
16
16
16
16
16
16
32
4
4
16
16
4
4
16
1
545

-$4,133
-$1,153
$5,485
$5,192
$4,637
$4,175
$10,162
$8,415
$7,277
-$2,556
$974
-$1,405
-$1,512
$770
$1,957
$2,640
$416
$7,274
-$207
-$1,428
-$73
$1,209
$646
-$1,452
$3,464
-$753
$50,021

-$258
-$72
$171
$325
$290
$261
$318
$263
$227
-$20
$61
-$88
-$95
$48
$122
$165
$26
$227
-$52
-$357
-$5
$76
$162
-$363
$216
-$753
$896

$9,600
$9,600
$23,000
$12,000
$11,000
$11,000
$23,000
$22,000
$20,000
$50,000
$7,800
$8,000
$8,000
$9,000
$9,800
$11,000
$11,000
$20,000
$2,000
$1,400
$8,000
$10,000
$4,000
$2,000
$12,000
$0
$315,200

$600
$600
$719
$750
$688
$688
$719
$688
$625
$391
$488
$500
$500
$563
$613
$688
$688
$625
$500
$350
$500
$625
$1,000
$500
$750
$0
$15,353

$858
$672
$547
$425
$398
$427
$401
$425
$398
$411
$427
$588
$595
$514
$490
$523
$661
$398
$552
$707
$505
$549
$838
$863
$534
$753
$14,457

Customer
Rework/
Page
(3)

House
Rework/
Page
(4)

$362
$199

$23

$220
$212

$170

$316

$366
$372

$1,491

What should Colorscope do about the cost/quality tradeoff?

Price customer initiated rework

Restructure production sequence:
prep -> scanning -> QC -> assembly -> output -> QC
Short term: cost can be bear by the company
Long term: customer initiated rework should be charged
In house errors should be reduced
Identify error at the scanning stage itself so it can be checked earlier
Share rework cost with the customer

Page 7

$15

$763

Profit
before
Rework
(1)+(3)+(4)
$103
$127
$171
$325
$290
$261
$318
$263
$227
$18
$61
$132
$117
$48
$122
$165
$196
$227
-$52
-$41
-$5
$76
$528
$9
$216
-$753
$3,150

Cost
per
page of
rework
not
there

$12,966