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Medium Profitability Cost Accounting Pricing Strategy

Juice Producer

#Food & Beverage #Manufacturing
ProHub Comment

This is a classic profitability paradox case where growing sales mask deteriorating profitability due to faulty cost allocation. The core issue is that plastic gallons—which cost more to produce and package—were not priced high enough on a per-ounce basis to cover their incremental costs, and all overhead was averaged across both product lines, further misallocating costs to the cheaper carton product.

Estimated Time 15 minutes
Difficulty Medium
Source Harvard
50 / 100
A major producer of juice is in the business of processing and packaging fruit juice for retail outlets. Traditionally, the producer has packaged the juice in 18-ounce carton containers. Recently, in response to demand from the market, the producer purchased a machine that packages the juice in plastic gallons (36 ounces). Over the next couple of years, sales continued to grow on average of 20% per year. Yet, as sales continued to increase, profits steadily decreased. The owner cannot understand why. He hires you to help out.

Clarifying Information

  1. Looking at the revenue side, how much did the producer charge for the 18 oz. carton? $2.00 per container.
  2. For the 36 oz. plastic gallons? For twice the size, the producer figured he would provide an incentive to buy by selling them at $3.50 per gallon.
  3. How was the cost of the new equipment accounted for in the price? The producer ended up raising prices across the board by $.50 on all packages, both cartons and gallons, selling at $2.50 and $4.00, respectively.
  4. What about cost of packaging? Does it cost the same to package the juice in cartons as it does in gallons? Well, I guess not. Plastic is more expensive than the paper carton we have traditionally used. Also, we had to hire more experienced labor to operate the machine because it is a little more complicated than the carton machine. We figured that because the demand was higher for the gallons – we would cover our costs through increased volume.
  5. What about overhead costs? All costs for the factory are added together and divided by the number of units produced.
  6. Let’s try to understand the trend in sales. What percentage of gallons versus cartons is sold? The more our customers notice the gallons, the more they like them. As the overall volume is increasing, plastic gallons have comprised 60% of the sales. The owner has been very pleased about that.
  7. It seems to me that it costs more to package in the gallons, yet the price is not higher on a per ounce basis. In fact, it’s lower. Have you done any proper cost allocation to determine which type of product should carry which costs? No, we haven’t.