Gibson Agency Case Study Recommendation

Please look over the case study below. Already finished 90% of the assignment but just needed to add some other considerations or recommendations which was part 4. If you could please skim through the draft that I had and add 2 paragraphs for the last portion

1. Calculate and present the budgeted profit for each of Gibson’s clients for each of the years 2016 through 2019, using the current costing system (i.e., the one described in the case). Note: The only information provided in this case is budgeted information. “Actuals” are not included/available (specifically). This is because, in this case, we are trying to avoid complicating the issue via inevitable differences between what is budgeted and what actually is realized.
2. Based on what you calculate as the profit for each year, you will find the detail that Billy Gibson sees and has created his concern regarding client profitability. In particular, Billy sees that there are unprofitable clients. What recommendation would you make to Billy about his plans to eliminate unprofitable clients? Provide an analysis that sufficiently and convincingly supports your recommendation.
3. Identify key assumptions that underlie your analysis and discuss the implications of these key assumptions.

Identify and discuss other considerations (e.g., qualitative, strategic, etc.) applicable to the case scenario, as well as other recommendations that you would make to Billy.

Already finished most of the work but just need help with part 4 which is to provide other considerations/recommendations for this case.

Gibson Agency
Gibson Agency (GA) is located about 60 miles west of Madison, Wisconsin, in a predominantly
rural area. Area businesses include farms, a clothing company, big-box stores (e.g., Wal-Mart,
Menards, etc.), several supermarkets, and a thriving artist community. In 2009, Bill Gibson,
Founder and CEO of the company, decided that the area was a good place to locate a technical
support center. He believed that operating in a rural, lower cost area would enable the firm to
achieve low costs without sacrificing quality, while bringing employment opportunities to people
in this area.
GA’s strategy is to provide superior technical support services on behalf of a limited number of
clients. The typical GA client is a small- to medium-size firm that has a relatively sophisticated
product that requires skilled technical support. GA only supports U.S. and Canada based
customers and will not accept clients that want international support for their customers.
Many firms require the services of a technical support center, but choose to outsource to firms
like GA. The key motivation for doing so is economies of scale. More specifically, many firms
do not have a critical mass of calls and other connections to customers to justify the expense of
operating their own in-house technical support center. Further, professional technical support
centers can often leverage existing expertise to provide a high level of service to end-consumers.
Operations
To the uninitiated, a technical support center is a simple environment consisting of
communication technology (e.g., telephones, software that allows “virtual chat”, etc.), and the
individuals that manage these communications.
In practice, however, they are often highly sophisticated environments requiring considerable
computer support. When a GA operator answers the phone or engages via virtual chat, the entire
process is recorded for quality assurance purposes and, when appropriate, the engagement is
used to provide training for new hires.
The operator keeps detailed notes of the interaction with the client’s customer on GA’s computer
system and makes recommendations on how to cure the problem that the customer is
experiencing. If the customer subsequently calls back or engages in a follow-up virtual chat, the
case number assigned at the beginning of the first engagement allows another operator to access
the event log and quickly come up to speed by reading the documentation of the customer’s
previous connections. The event log is designed to ensure that the customer is not forced to
repeat the same story as provided earlier, or, even worse, repeat a series of corrective steps that
have already proven to be ineffective.
The computer system is more than just a sophisticated note-taker. It also provides the operator
with specific guidance on how to resolve the problem that the customer has encountered. For
example, if the customer is having trouble with setting up his or her electronic equipment, the
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computer system provides the operator with a step-by-step procedure designed to enable the
customer to achieve a successful setup. These computerized problem-solving systems allow
relatively inexperienced and less-skilled operators to provide effective support to clients’
customers.
About 10% of GA’s operators are relatively more knowledgeable and act as supervisors.
Supervisors are primarily responsible for solving problems that are either undocumented or too
complex for the computer system to handle.
When an undocumented problem is encountered, it is flagged in the computer system and the
Solutions Development Group is automatically notified. This group is responsible for reviewing
the event log and writing up a formal step-by-step procedure to resolve the problem. When that
problem is encountered again, any operator can access the step-by-step procedure to quickly
resolve an instance of that problem.
The Solutions Development Group is also responsible for working with GA’s clients to develop
the initial response protocols for each product and to provide clients with feedback about each
problem encountered so that future products and updates can be designed to avoid repeating the
problem. This feedback is often critical to the GA’s clients. GA prides itself on the speed and
accuracy of the feedback that it provides, and suggests to clients that this feedback loop is a
significant part of the value inherent to GA’s services.
Client Staffing Protocols
GA clients are either electronic equipment manufacturers or software houses. All of the client
firms sign long-term contracts with GA. The average contract is for three years and reflects the
high initial investment that both firms have to make in developing the problem resolution
software and training GA operators. It is usual for a satisfied customer to renew the contract as
changing technical support centers is a difficult and expensive undertaking.
The firm’s employment manual describes the rationale for the limited number of clients.
According to Billy Gibson, “We choose to limit ourselves to a small number of clients (six or
less) because it allows us to provide highly personalized service while still reaping economies of
scale. We train operators to support two clients at a time. This policy allows us to better handle
the peaks of service that vary by client and to have spare capacity when operators are ill or on
medical leave.”
Training and Overtime
Training is an ongoing activity at GA. Every time a client introduces a new product or upgrades
an existing one, new software has to be developed and the operators trained on its use. Training
usually begins with the client engineers’ demonstrating the new product and explaining its
features to members of the Solutions Development Group and a select number of operators.
Then, the operators and engineers discuss likely problems that clients’ customers might
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encounter. Finally, the operators practice on the problem resolution software to ensure that they
know how to respond to the problems they are likely to encounter. Training consumes about 5%
of an operator’s time. Operator training that is specific to a client is tracked separately and
directly charged to clients. In contrast, the salaries of the training staff are indirectly assigned to
clients.
The center is open from 8 am in the morning (U.S. Eastern) until 11 pm (U.S. Eastern ) six days
a week; it is closed on Sundays. Since GA only supports U.S. and Canada-based customers, it
avoids the need to operate overnight. From time to time operators are asked to work overtime.
Most operators want to work some overtime to increase their take-home pay. Overtime is paid at
150% of normal pay and the average operator works approximately 10 hours of overtime per
week. The advantage of overtime to GA is the ability to absorb extra workloads without having
to hire additional employees. For example, when a client introduces a new product, the operators
who support that client have to work long hours as they both support the existing products and
train up on the new one. Overtime expenses are indirectly assigned to clients.
Organization Structure
GA is organized around function (Exhibit 2). The operations manager is responsible for
scheduling operator time and interfacing with the training and Solutions Development Group
departments. The training manager is responsible for ensuring that all operators are adequately
trained and that the training staff is up to date on clients’ products’ features. There are also
separate managers for the Solutions Development Group and Facilities. Finally, a CFO covers
the accounting, finance, and information needs for the firm.
All upper managers and department heads report directly to the CEO, and are responsible for
hiring and evaluating the individuals that report to them (i.e., department employees, assistants,
etc.).
Budgetary Process
The first step in the budgetary process consists of estimating the total number of hours of
operator time expected to be dedicated to each client in the coming year. This estimate
encompasses the time each employee is expected to be spent both (1) engaged with clients’
customers (i.e., on calls, engaged in virtual chats, etc.) and (2) being trained on client-specific
software.
The budget is based on the actual time spent on each client in the previous year, adjusted for
expected changes in the workloads for the coming year. For example, if 50 full-time-equivalents
(FTE) were consumed by a client in 2xx1 and the client had predicted that the number of
customer-engagements for 2xx2 would increase by 10%, the budgetary process assigns 55 FTE
to the client for 2xx2.
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The firm has a standardized chart of accounts that defines each of the firm’s direct and indirect
cost categories (see Exhibit 3). At the end of each year, the CFO and her staff estimate the
expected level of expenses associated with each indirect account for the coming year. Again,
these estimates are largely determined by the actual amounts spent in the prior year, as well as
expected changes in the coming year.
The CFO and her staff work closely with department managers to develop the budget. For
example, support staff wages is captured in account number 2100. Since every department in the
firm employs individuals that provide staff support, the CFO and her team talk to all of the
department managers to develop estimates for this account (see Exhibit 4).
Once the total costs of all of the indirect accounts are estimated, the total anticipated overhead
for the coming year is determined (see Exhibit 5). The estimate for operator hours is also
developed as part of this budgeting process (see Exhibit 6).
Cost System
GA had used the same cost system since its founding. Per the CFO:
“My previous position was with a manufacturing firm. I originally thought that this company
would need a totally different approach to costing, but I was wrong. I essentially took the
system that we used and applied it here to generate fully-absorbed client costs.
The only real differences are in the nature of the costs and the fact that we have no direct
material content to our products.
Oh yes, and of course here we determine the cost of clients, not products.”
The budgeted operators’ costs for customer engagements and training are directly assigned to
each client. All other costs are indirectly assigned in proportion to operator hours.
The CFO explained why operator hours is used instead of operator dollars:
“Operators are paid based upon their level of experience, with an experienced operator
making about 25% more than a new hire. However, we do not assign operators to clients
based upon their level of experience. Consequently, we do not want to charge one client
more than another simply because more experienced operators are currently assigned to that
client.”
To determine the overhead rate for the year, the total amount of budgeted indirect costs is
divided by the total estimated operator hours. The overhead rate is based on the prior year’s
actuals. So, for 2019, the estimated overhead rate used was $60.24 per operator hour.
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The full cost of each client is determined by summing the cost of the operators’ wages dedicated
to that client (which includes an allowance for down time) and the operators’ hours multiplied by
the overhead rate.
During the year, GA records the actual time spent on each client. The computer system tracks
time spent on each customer-engagement, by operator, by client. It also tracks operator down
time (i.e., the time not spent engaged with clients’ customers), and training time by client.
The down time is analyzed weekly to fine-tune operator assignments to increase efficiency. For
example, if over a period of several weeks a client’s engagements are only sufficient to keep 40
FTE busy and 45 FTE are currently assigned, then five FTE would be reassigned to other clients.
It is usually possible to adjust operator levels to match demand to a fairly accurate degree.
Consequently, in normal periods, down time is relatively limited and deemed acceptable (i.e.,
approximately 10% of total available time).
The actual cost of the indirect expenses are accumulated monthly and compared to the budget.
Any account category that shows excess spending compared to the budget is subjected to
managerial review. For example, if supplies are running above expectations, management would
request the CFO and her team to analyze the expenditures on supplies for the last few months to
understand why they are higher than expected. Whenever possible, corrective action is taken to
bring spending back into line.
The budget is not restated during the year even if conditions change quite significantly. The CFO
commented:
“We want the annual budget to really mean something. If we allowed people to change it at
will, it would lose a lot of its authority. We compute variances monthly and expect our
managers to find ways keep spending to their previously agreed budgetary levels.”1
Fee Structure
The firm’s fee structure is based upon the number of operator hours expended on the client over
the year. Each client contract is negotiated separately.
From GA’s perspective the primary objective is to generate an acceptable return for GA
shareholders by charging an hourly fee that sufficiently exceeds the fully absorbed hourly cost.
Since all operator hours have the same reported cost, the differences in hourly fees reflects the
intensity of the negotiations with the client and not specific differences in the level of resources
dedicated to each client.
1
Please note that the information presented in Exhibits 5 and 6 is budgeted information. The scope of this case does
not include variance analysis (i..e, the investigation of differences between actual and budgeted amounts), and thus,
actuals for each year are not provided for brevity, complexity-avoidance, etc. However, budgets for a given year are
largely influenced by “actuals” from the previous year, and thus, the trends established by the information in
Exhibits 5 and 6 reflect the general trend of the company over the presented time period.
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Clients are billed monthly and the fees are based solely upon the number of FTE dedicated to the
client. If the FTE dedicated to a client changed during a month, the total fee is adjusted
appropriately, as influenced by the number of hours spent by operators on behalf of that client.
At the end of the year, GA provides each client with a report that documents the total level of
down-time and training for all operators that were dedicated to that client. The training time
reported is specific to each client, but since each operator serviced two clients at a time, the
downtime was assigned equally to each client the operator was responsible for.
In 2017, two of the five client contracts that were currently in force, Peripheral and Virtual
Lights, Inc. came up for renewal. Unfortunately, one of the firms decided to go in-house and
open their own technical support center. Gibson commented,
“It was a serious blow to the firm when we lost Virtual Lights, Inc. We spent six months
looking for a replacement client before we laid off some of our operators. Now two years
later, we still have not found a replacement for them.”
In 2018, the P.R. Industries contract came up for renewal and, after rather unexpectedly
strenuous negotiations; a new hourly rate was established. This rate, while higher than the
previous one, generated lower profit than in the first year of the original P.R. Industries contract.
Gibson commented, “We tried to increase the fees for P.R. Industries so that it generated the
same profit percentage as the original contract, but they really pushed back and in the end we
were forced to accept a lower profitability rate.”
At the end of 2019, two more clients, ATP Company and Diff Engine Partners were scheduled to
come up for renewal. They were both happy with the level of service that they were receiving,
but were waiting to review GA’s latest fee structure. The CFO of ATP Company, in particular,
had warned GA that they would seek other bids to ensure that GA’s prices were competitive.
Diff Engine Partners Software seemed less concerned as long as the fees were “reasonable.”
Gibson commented:
“I am really concerned about this fee issue.
It seems that some clients are just not right for us. It’s not easy to get them to budge on fees,
and it costs a lot to provide technical support services for that client.
Plus, we would get a boost to profitability if we got rid of clients that are losing us money.”
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Exhibit 1
Client List
Client Name
Status
Peripheral
Current
P.R. Industries
ATP Company
Diff Engine
Partners
Virtual Lights,
Inc.
Description
Develops accounting packages for medical offices.
Tracks billing and insurance co-payments by health
plan. Major selling point: comprehensiveness of
package.
Current
Manufactures high-end gaming systems. Major selling
point: extremely fast video processing speed.
Current
Manufactures high-speed networks for small
businesses and schools. Major selling point: network
stability.
Current
Develops animation software for commercial use.
Major selling point: ease of use.
Did not renew Manufactures digital video recorders and provides
contract at
download service for major cable and satellite systems
end of 2017 in the US. Major selling point: very high storage
capacities.
7
Exhibit 2
Organization Chart
CEO
Executive
Assistant
CFO
Finance and
Accounting
Staff
Operator
Department
Secretarial
Assistant
Training
Department
Secretarial
Assistant
Operator Staff
Solutions Dev
Group
Secretarial
Assistant
Training Staff
Facilities
Support Staff
Programmer
Staff
8
Exhibit 3
Chart of Accounts
Account Number
Name
1000
Operator Wages
1050
Operator Training
Wages
2000
Operator Benefits
2010
2020
Operator Overtime
Unused Operator
Time
2100
Support staff wages
2105
Support staff benefits
3000
Managerial Salaries
3005
Managerial Benefits
4010
5010
Depreciation and
Property Taxes
Communications
6010
6020
Utilities
Miscellaneous
Description
The wages of all operators. These costs are
assigned directly to each client.
The wages of all operators while training for
specific clients. These costs are assigned
directly to each client.
The benefits such as health care and retirement
that are paid to the operators.
Overtime paid to operators
Operator time that cannot be assigned to a
client because the operator is excess to current
requirements.
Wages of support staff such as secretarial and
buildings and grounds.
The benefits such as health care and retirement
that are paid to the support staff.
The salaries of the management team. Includes
all individuals above the supervisor level,
including the manager of the Solutions
Development Group. Also includes all training
and finance department salaries.
The benefits such as healthcare and retirement
that are paid to the management team.
The depreciation charge for all building and
equipment, plus property taxes for the building
Includes costs of the telephone lines and high
speed internet connections.
Includes costs of electricity and gas.
Includes consulting and other infrequent
expenses.
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Exhibit 4
Sample Account Breakdown
Support Staff Wages – Account 2100
2019 Budget
SDG – Support
CEO – Executive Assistant
Operator – Secretarial
Training – Secretarial
Finance – Secretarial
SDG – Secretarial
Facilities – Support
$ 1,270
110
75
25
53
35
42
Total
$ 1,610
10
Exhibit 5
2016 – 2019 Budgets ($000s)
Account
2016
2017
2018
2019
Revenue
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
$
2,140
2,536
5,084
3,867
4,626
$ 2,273
2,797
5,690
4,588
4,027
$ 2,452
2,778
5,946
5,209
–
$ 2,547
3,063
6,381
5,719
–
Total Revenue
$
18,253
$ 19,375
$ 16,385
$ 17,710
635
665
1,625
1,014
1,225
675
734
1,820
1,204
1,067
705
729
1,902
1,367
–
732
788
2,040
1,500
–
5,164
$ 5,500
$ 4,703
$ 5,060
1,754
796
1,540
675
1,510
512
2,664
545
305
51
1,833
805
1,698
708
1,732
640
2,749
562
324
54
1,532
701
510
1,587
668
1,745
670
2,780
478
321
46
1,690
789
1,610
684
1,979
725
2,865
560
323
58
Operator Wages (includes training)
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
Total Operator Wages
$
Overhead
Operator Benefits
Operator Overtime
Unused Operator Time
Support Staff Wages
Support Staff Benefits
Managerial Salaries
Managerial Benefits
Depreciation and Property Taxes
Communications
Utilities
Miscellaneous
Total Overhead
$
10,352
$ 11,105
$ 11,038
$ 11,283
Profit
$
2,737
$ 2,770
$
$ 1,367
644
11
Exhibit 6
Budgeted Operator Hours (000s)
2016
2017
2018
2019
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
23.5
24.6
60.2
37.5
45.4
25.0
27.2
67.3
44.5
39.5
26.1
27.0
70.4
50.6
–
27.1
29.2
75.5
55.5
–
Total Hours
191.2
203.5
174.1
187.3
12
2016
2017
2018
2019
Revenue
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
2.140
2.536
5.084
3.867
4.626
2.273
2.797
5.690
4.588
4.027
2.452
2.778
5.946
5.209
–
2.547
3.063
6.381
5.719
–
Total
18.253
19.375
16.385
17.710
Wages
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
635
665
1.625
1.014
1.225
675
734
1.820
1.204
1.067
705
729
1.902
1.367
–
732
788
2.040
1.500
–
Total
5.164
5.500
4.703
5.060
OH
Operator Benefits
Operator Overtime
Unused Operator Time
Support staff wages
Support staff benefits
Managerial salaries
Managerial benefits
Depreciation and property taxes
Communications
Utilities
Miscellaneous
1.754
796
1.540
675
1.510
512
2.664
545
305
51
1.833
805
1.698
708
1.732
640
2.749
562
324
54
1.532
701
510
1.587
668
1.745
670
2.780
478
321
46
1.690
789
1.610
684
1.979
725
2.865
560
323
58
Total
10.352
11.105
11.038
11.283
Profit
2.737
2.770
644
1.367
2016
Peripheral
P.R. Industries
ATP Company
Diff Engine Partners
Virtual Lights, Inc.
2017
2018
2019
23,5
24,6
60,2
37,5
45,4
25,0
27,2
67,3
44,5
39,5
26,1
27,0
70,4
50,6
–
27,1
29,2
75,5
55,5
–
191,2
203,5
174,1
187,3
(all numbers are presented in 1,000s of hours)
Current Costing System
Utilizing the cost accounting system outlined in the case study, we conducted a comprehensive
analysis of Gibson Agency’s four key clients: Diff Engine Partners, P.R. Industries, Peripheral,
and ATP Company. The focus of our assessment was on calculating the budgeted profits for each
client from 2016 to 2019 by deducting the total client cost from the respective client revenue.
(Exhibit 1) Notably, Diff Engine Partners consistently exhibited the highest profit margins
throughout the specified period, establishing itself as the most lucrative client year after year.
Following closely, P.R. Industries consistently secured the position as the second most profitable
client. Peripheral consistently ranked third in terms of profitability. However, our analysis
revealed a concerning trend with ATP Company. Although moderately profitable in 2016 and
2017, ATP Company experienced a notable decline, resulting in negative profits in both 2018
and 2019. This aligns with Mr. Gibson’s reference to “clients that are losing us money.” Despite
ATP Company’s consistent status as the top revenue generator, the associated service costs have
eroded their profitability, making them appear at first glance as less profitable compared to other
clients.
Recommendation Regarding Eliminating Unprofitable Clients
Mr. Gibson has expressed the desire to boost profitability by dropping clients that are not
profitable and we’ve identified that the partnership with ATP Company resulted in a negative
budgeted profit for the year 2019 (Exhibit 1). To understand the potential impact of dropping
ATP as a client in 2019, we looked at the impact of losing Virtual Lights (VL) in 2018 and how
the profit and overhead (OH) costs changed for each remaining client. We looked at which OH
costs were avoidable, and which are not, to better understand what OH costs won’t change if we
drop a client and reduce service activity, versus which costs will change. We looked at the
percentage change in operator hours from 2017-2018 (Exhibit 2), because it is the main cost
driver, which came to about 14%. Then we compared the percentage change for each OH line
item to the 14% to see which costs changed in line with operator hours (avoidable) and which
stayed the same (unavoidable). We also found OH items that changed somewhat (partially
avoidable), which we applied 50% adjustment to account for (Exhibit 3). Next, we looked at the
allocation of operator hours in 2019 and ATP had 40% of the total while the rest of the clients
had 60% (Exhibit 5). Applying the analysis of avoidable and unavoidable OH costs with the
allocation, we were able to determine the OH if ATP was dropped in 2019 (Exhibit 4).
Reallocating the unavoidable costs with the remaining three clients, we determined each client’s
OH costs (Exhibit 5, bottom). Finally, we were able to put it all together and analyze the
scenarios of keeping versus dropping ATP as a client in 2019 by looking at the overall revenue,
direct labor costs and overhead costs as well as the profit (Exhibit 6). By keeping ATP, Gibson is
able to make a much larger overall profit than dropping it completely. As a result of this
thorough financial analysis, it is a better decision to keep ATP as a client.
Key Assumptions
Following are the key assumptions made in the analysis:
No Unused Overhead Costs: It is assumed that all operator hours are variable, and that there will
be no unused operator hours allocated if ATP is dropped. This assumption is made to avoid the
prior mistake of allocating 510 unused operator hours in 2018 when a new client could not be
obtained. The implication of this assumption is that GA will need to lay off some of their
operators by the end of 2019.
Another implication of this assumption in the case of dropping ATP is that other clients, in
particular Diff Engine Partners, will be fine with the increase in OH allocation. Another
alternative is for GA to make appropriate restructuring changes to reduce costs further, such as
reducing support staff.
Partial Managerial Benefits are Avoidable: In 2018, despite GA losing a client, managerial
salaries and benefits did not drop. However, for 2019, it is assumed that this overhead is partially
avoidable. The implication is that if ATP is dropped, managerial staff benefits must be reduced.
It is also assumed that managerial salaries are unavoidable. However, this can change if GA
restructures to reduce managerial staff if ATP is dropped.
Other Considerations/Recommendations
Appendix
Exhibit 1: Budgeted Profits Per Customer
Exhibit 2: Change in Operator Hours
Exhibit 3: Avoidable OH vs Unavoidable OH
Exhibit 4: OH if ATP Company is dropped in 2019
Exhibit 5: Allocation of OH before and after dropping ATP Company
Exhibit 6: Keep/Drop Analysis Worksheet