1. Why was Dakota's pricing system inadequate for its current operating environment?

Currently, DOP's pricing system is pricing products by adding markup twice, which is marking up the purchased product cost by around 15% to cover the cost of warehousing, distribution, and freight. Then add another markup to cover the approximate cost, for general and selling expenses, plus an allowance for profit.

We found that the existing pricing system is inadequate regarding to following points:

The current pricing system use cost-plus method, it determines the mark-ups at the start of each year, based on actual expenses in prior years, the general industry condition and competitive trends. Costs continue to rise for customers at normal circumstances which may due to various external reasons like inflations, economic situations etc. The current costing system could not cope with the highly competitive market, and the inflation will make the costs keep increasing to a level that the selling price might not able to cover it. It is because the selling price in based on actual expenses in previous years, while the expenses would still go up with the general inflation.

They only charge a small price premium (up to additional 2% markup) to the new desk top delivery. The new service did attract new customers but the inadequate mark-up of 2% for desktop delivery could not cover the costs of providing the service. If clients utilizing desktop delivery place smaller orders it has a negative effect on profit because costs are not covered.

Actual prices were adjusted based on long-term relationships and competitive situations, but were independent of the specific level of service provided to that customer (except for desk top deliveries), which means it takes no consideration to the difference between order with small size or larger size. Therefore, it is possible that costs will be understated or overstated in some cases.

Also, from the policy of customers pricing, we think that it is time-consuming on deciding prices and will cause inefficiencies, with inaccurate results.

The company introduce online order method, EDI (Electronic data interchange) an order data will be recorded electronically when customer making the order. Therefore the staffs don’t have to enter those data manually. So EDI orders require less labour hours than the manual orders therefore cost less money. However, the current pricing system makes no difference between the manual orders and EDI orders.In conclusion, we think this pricing system is suitable for companies, who produce homogenous product, and the production operations are high labor intensive and overhead costs are a relative small part of total costs. However, DOP provides a diverse product line and use both commercial freight and its own trucks to do the delivery. We recommend that introduce an activity based cost system would be more appropriate for DOP's business as it will help Dakota distinguish the real cost driver and trace the cost of each product and service to different customers more accurate, and makes good use of the investigation done by the directors.