Activity
Resource Usage
Model and
Tactical Decision
Making
Prepared by
Douglas Cloud
Pepperdine University
21-1
Objectives
1. Describe theAfter
tactical
decision-making
model.
studying
this
chapter,ofyou
shouldcosts and
2. Define the concept
relevant
be able to:
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.
21-2
The Tactical DecisionMaking Process
Tactical decision making
consists of choosing among
alternatives with an immediate
or limited end in view.
21-3
The Tactical DecisionMaking 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
21-4
The Tactical DecisionMaking 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.
21-5
The Tactical DecisionMaking 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?
21-6
The Tactical DecisionMaking 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.
21-7
The Tactical DecisionMaking 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.
21-8
The Tactical DecisionMaking 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).
21-9
The Tactical DecisionMaking 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.
21-10
The Tactical DecisionMaking Process—Review
Step 1
Step 2
Continued
Define
Problem
Identify
Alternatives
What to do with small,
ill-shaped apples.
1. Sell to pig farmers.
2. Sell bagged apples
(feasible).
3. Make applesauce
(feasible).
4. Make pie filling.
5. Continue dumping.
21-11
Step 3
Step 4
Continued
Predict
Costs
Compare
Costs
Bagged alternative:
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
Bagged Applesauce
Revenue
$0.26
Cost
0.05
Net benefit $0.21
$0.65
0.40
$0.25
Bagged: Differentiation
Applesauce: Forward
integration
21-12
Step 5
Select
Alternatives
Select bagging
alternative because it is
profitable and is more
consistent with strategic
positioning desired by
producer.
21-13
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.
21-14
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.
21-15
Flexible Resources
Flexible resources can be easily
purchased in the amount needed
and at the time of use… like
electricity.
21-16
Flexible Resources
Flexible Resources
a. Demand Changes
Relevant
b. Demand Constant
Not Relevant
21-17
Committed Resources
Committed resources are
purchased before they are used,
such as salaried employees.
21-18
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)
1. Activity Capacity Reduced
Relevant
2. Activity Capacity Unchanged
Not Relevant
21-19
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.
21-20
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.
21-21
Some Types of Decisions
Illustrated
 Make or Buy
 Keep or Drop
 Special Order
 Sell or Process Further
Important: Short-term Perspective
21-22
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
$4.75. The company normally produces
100,000 units of the part each year.
21-23
ABC Make-or-Buy Analysis
Make
Buy
Using materials
$ 50,000 $
0
Using direct labor
200,000
0
Providing supervision 300,000
240,000
Moving materials
394,000
345,000
Providing power
90,000
0
Inspecting products
301,000
263,000
Setting up equipment
600,000
540,000
Acquiring Part 34B
0
475,000
Total
$1,935,000 $1,863,000
Buy the part!
Differential
Cost
$ 50,000
200,000
60,000
49,000
90,000
38,000
60,000
-475,000
$ 72,000
21-24
Functional Based Make-or-Buy Analysis
Make
Using materials
$ 50,000
Using direct labor
200,000
Providing supervision 300,000
Providing power
90,000
Acquiring Part 34B
0
Total
$640,000
Buy
$
0
0
240,000
0
475,000
$715,000
Differential
Cost
$ 50,000
200,000
60,000
90,000
-475,000
$ -75,000
Make the part!
21-25
Keep-or-Drop Decisions
Seat Covers Floor Mats
Sales
$950,000
Less unit-level variable
expenses:
Direct materials
-300,000
Direct labor
-210,000
Maintenance
-90,000
Power
-35,000
Commission
-30,000
Contribution margin
$ 285,000
Less traceable expenses -405,000
Product margin
$-120,000
Less common expenses
Income before taxes
DROP?
Total
$1,680,000 $2,630,000
-400,000
-700,000
-210,000
-420,000
-90,000
-180,000
-25,000
-60,000
-40,000
-70,000
$ 915,000 $1,200,000
-325,000
-730,000
$ 590,000 $ 470,000
-430,000
$ 40,000
21-26
Keep-or-Drop Decisions
Keep Alternative Drop Alternative
Contribution margin
$285,000
Advertising, direct fixed
-50,000
Supervision, direct fixed
-30,000
Inspecting products, nonunit variable -20,000
Inspecting products, traceable fixed -80,000
Inspecting products, unused capacity -40,000
Material handling, nonunit variables -10,000
Material handling, traceable fixed
-70,000
Customer service, traceable fixed
-45,000
Total
$ -60,000
$
0
0
0
0
0
0
0
0
-15,000
$-15,000
Dropping the product saves $45,000!
21-27
Special-Order Cost
Polarcreme, Inc., an ice-cream
company, is operating at 80
percent of its 20 million halfgallon 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.
21-28
Special-Order Cost
Which costs
are irrelevant?
Variable costs:
Dairy ingredients
Sugar
Flavoring
Direct labor
Packaging
Commissions
Distribution
Other
Total unit-level costs
$0.70
0.10
0.15
0.25
0.20
0.02
0.03
0.05
$1.50
$1.45
21-29
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).
21-30
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).
21-31
Sell or Process Further
Differential Amount
Sell Process Further to Process Further
Revenues
Processing costs
Total
$400
---$400
$1,500
1,000
$ 500
$1,100
1,000
$ 100
Decision: Further Process
21-32
End of
Chapter
21-33
21-34