1. Activity Resource Usage Model and Tactical Decision Making
Prepared by
Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Objectives
After studying this chapter, you should be able to:
1. Describe the tactical decision-making model.
2. Define the concept of relevant costs and revenues.
3. Explain how the activity resource usage model is used in assessing relevancy.
4. Apply the tactical decision-making concepts in a variety of business situations.

3. The Tactical Decision-Making Process
Tactical decision making consists of choosing among alternatives with an immediate or limited end in view.

4. The Tactical Decision-Making Process
1. Recognize and define the problem.
2. Identify alternatives as possible solutions to the problem, and eliminate alternatives that are not feasible.
3. Identify the predicted costs and benefits associated with each feasible alternative. Eliminate the costs and benefits that are not relevant to the decision.
Continued

5. The Tactical Decision-Making Process
4. Compare the relevant costs and benefits for each alternative, and then relate each alternative to the overall strategic goals of the firm and other important qualitative factors.
5. Select the alternative with the greatest benefit which also supports the organization’s strategic objectives.

6. The Tactical Decision-Making Process—Example
Step 1: Define the Problem
Each year 25 percent of the harvest by an apple processor is small and odd-shaped. These apples cannot be sold in the normal distribution channels and have simply been dumped in the orchards for fertilizer. What should the firm do with these apples?

7. The Tactical Decision-Making Process—Example
Step 2: Identify Feasible Alternatives
1. Sell the applies to pig farmers.
2. Bag the applies in five-pound bags and sell them to local supermarkets as seconds.
3. Rent a local canning facility and convert the apples to applesauce.
4. Rent a local canning facility and convert the applies to pie filling.
5. Continue with the current dumping practice.

8. The Tactical Decision-Making Process—Example
Step 3: Predicting Costs and Benefits and Eliminating Irrelevant Costs
Labor and materials (bags and ties) for the bagging option would cost $0.05 per pound. A five-pound bag of apple could be sold for $1.30 to local supermarkets.
Making applesauce would cost $0.40 per pound for rent, labor, apples, cans, and other materials. It takes six pounds of apples to produce five, 16-ounce cans of applesauce. Each can sells for $0.78.

9. The Tactical Decision-Making Process—Example
Step 4: Comparing Relevant Costs and Relating to Strategic Goals.
The bagging alternative costs $0.25 to produce a five-pound bag ($0.05 x 5 pounds). The revenue is $1.30 per bag, or $0.26 per pound. The net benefit is $0.21 per pound ($0.26 – $0.05).
The net benefit of converting the apples into applesauce is $0.25 per pound ($0.65 – $0.40).

10. The Tactical Decision-Making Process—Example
Step 5: Select Best Alternative.
Since the apple producer is reluctant to follow a forward integration strategy, the bagging alternative should be chosen.

11. The Tactical Decision-Making Process—Review
Step 1
Define Problem
What to do with small, ill-shaped apples.
Step 2
Identify Alternatives
1. Sell to pig farmers.
2. Sell bagged apples (feasible).
3. Make applesauce (feasible).
4. Make pie filling.
5. Continue dumping.
Continued

12. Predict Costs Compare Costs Bagged alternative: Step 3
a. Revenue $1.30 per bag ($0.26 per pound)
b. Cost $0.05 per pound
Applesauce alternative:
a. Revenue: $0.78 per can ($0.65 per pound)
b. Cost: $0.40 per pound
Step 4
Compare Costs
Bagged Applesauce
Revenue $0.26 $0.65
Cost
Net benefit $0.21 $0.25
Bagged: Differentiation
Applesauce: Forward integration
Continued

13. Step 5
Select Alternatives
Select bagging alternative because it is profitable and is more consistent with strategic positioning desired by producer.

14. Relevant Costs Defined
Relevant costs are future costs that differ across alternatives. A cost must not only be a future cost but must also differ between alternatives.

15. Irrelevant Cost Illustrated
Sunk costs are past costs.
Example: The original cost of a building is a sunk cost when you are trying to decide whether or not to sell the business five years later.

16. Flexible Resources
Flexible resources can be easily purchased in the amount needed and at the time of use… like electricity.

17. Flexible Resources Flexible Resources a. Demand Changes Relevant
b. Demand Constant Not Relevant

18. Committed Resources
Committed resources are purchased before they are used, such as salaried employees.

19. Supply – Demand = Unused Capacity
Committed Resources
Committed Resources
Supply – Demand = Unused Capacity
a. Demand Increase < Unused Capacity Not relevant
b. Demand Increase > Unused Capacity Relevant
c. Demand Decease (Permanent)
Activity Capacity Reduced Relevant
Activity Capacity Unchanged Not Relevant

20. Committed Resources—Example
A company has five manufacturing engineers who supply a capacity of 10,000 engineering hours (2,000 hours each). The cost of this activity capacity is $250,000, or $25 per hour. The firm expects to use 9,000 hours. If the firm decides to reject a special order requiring 500 hours, the cost of engineering would be irrelevant.

21. Committed Resources—Example
The firm can purchase a component that will drop the demand from engineering hours from 9,000 to 7,000. Since engineering activity capacity is acquired in chunks of 2,000, the company can lay off one engineer or reassign the engineer to another plant.

22. Some Types of Decisions Illustrated
Make or Buy
Keep or Drop
Special Order
Sell or Process Further
Important: Short-term Perspective

23. Make or Buy
Talmage Company produces a mechanical part used in one of its engines. (Talmage produces engines for snowblowers.) An outside supplier has offered to sell a part (Part 34B) for $ The company normally produces 100,000 units of the part each year.

24. ABC Make-or-Buy Analysis
Differential Make Buy Cost
Using materials $ , $ $ 50,000
Using direct labor 200, ,000
Providing supervision 300, ,000 60,000
Moving materials 394, ,000 49,000
Providing power 90, ,000
Inspecting products , , ,000
Setting up equipment 600, ,000 60,000
Acquiring Part 34B , ,000
Total $1,935,000 $1,863,000 $ 72,000
Buy the part!

25. Functional Based Make-or-Buy Analysis
Differential Make Buy Cost
Using materials $ 50,000 $ $ 50,000
Using direct labor 200, ,000
Providing supervision 300, ,000 60,000
Providing power 90, ,000
Acquiring Part 34B , ,000
Total $640,000 $715,000 $ -75,000
Make the part!

26. Keep-or-Drop Decisions
Seat Covers Floor Mats Total
Sales $950,000 $1,680,000 $2,630,000
Less unit-level variable expenses:
Direct materials -300, , ,000
Direct labor -210, , ,000
Maintenance -90, , ,000
Power -35, , ,000
Commission , , ,000
Contribution margin $ 285,000 $ 915,000 $1,200,000
Less traceable expenses , , ,000
Product margin $-120,000 $ 590,000 $ 470,000
Less common expenses ,000
Income before taxes $ ,000
DROP?

27. Keep-or-Drop Decisions
Keep Alternative Drop Alternative
Contribution margin $285,000 $
Advertising, direct fixed -50,000 0
Supervision, direct fixed -30,000 0
Inspecting products, nonunit variable -20,000 0
Inspecting products, traceable fixed -80,000 0
Inspecting products, unused capacity -40,000 0
Material handling, nonunit variables -10,000 0
Material handling, traceable fixed -70,000 0
Customer service, traceable fixed , ,000
Total $ -60,000 $-15,000
Dropping the product saves $45,000!

28. Special-Order Cost
Polarcreme, Inc., an ice-cream company, is operating at 80 percent of its 20 million half-gallon capacity. A distributor from another geographically area offered to buy 2 million units of premium ice cream at $1.75 per unit. They have agreed to provide their own label and pay transportation costs. This sale would avoid a sales commission.

29. Which costs are irrelevant?
Special-Order Cost
Variable costs:
Dairy ingredients $0.70
Sugar 0.10
Flavoring 0.15
Direct labor 0.25
Packaging 0.20
Commissions 0.02
Distribution 0.03
Other
Total unit-level costs $1.50
Which costs are irrelevant?
$1.45

30. Special-Order Cost
The nonunit-level variable costs will also be incurred, producing a total increment cost of $304,000 or $0.152 per unit (for an order of 2 million units). Revenue per unit of $1.75, less the unit-level variable cost ($1.45) plus the nonunit-level variable cost ($0.152) provides a net benefit of $0.148 per unit. Thus Polarcreme’s profit would increase by $296,000 ($0.148 x 2,000,000).

31. Sell or Process Further
Joint products have common processes and costs of production up to a split-off point.
The point of separation is called the split-off point.
Assume that the hot sauce sells for $1.50 per bottle. Also, assume that the additional processing costs amount to $1,000. The total revenue at split-off for Grade A tomatoes are $400 ($0.40 x 1,000 pounds). If the Grade A tomatoes are processed into hot sauce, the total revenues are $1,500 ($1.50 per bottle).

32. Decision: Further Process
Sell or Process Further
Differential Amount
Sell Process Further to Process Further
Revenues $400 $1,500 $1,100
Processing costs , ,000
Total $400 $ $ 100
Decision: Further Process

33. End of
Chapter