1. Why would any customer, let alone large advertising agencies and departmental stores, go to Colorscope rather than go to large printers listed in Exhibit 3?

Before desktop publishing became popular, Colorscope had a competitive advantage through its expensive proprietary computer equipment that could produce complicated print special effects. Colorscope had also been able to build strong relationships with valuable customers through the years and had a good reputation for providing high quality work in its field.

Another reason why Colorscope could compete with the large printers was the high fragmentation of the pre-press industry. This was due to the fact that most pre-press companies focused on just a few print products (e.g. catalogs, newspapers or coupons) and had strong specialized expertise in these. Because of that, Colorscope could provide higher quality than the large printers in the fields where it had specialized. Before the dawn of desktop publishing, which led to commoditization of the services, competition was more based on quality than on price.

As a small agency, it is also probable that Colorscope could be more flexible in meeting specific demand and provide more tailored services to the few customers it served, compared to the large printers which would have a bigger and more bureaucratic organization.

3. What you have done above is a “full-cost” analysis. This is in contrast to a “direct-cost” analysis that ignores overhead costs. Is full cost the right metric for job profitability and customer profitability? What assumptions are we making about the variability of overhead costs when we do a “full-cost” analysis?

By allocating the overhead costs to jobs and customers there is an implicit assumption that these are variable with the cost driver. In reality, some of the overhead costs are fixed, at least in the short run.

One benefit of using full cost is that the price charged for jobs needs to recover all costs in order for Colorscope to be profitable in the long run. As overhead costs are incurred to support customer/job activities there is also a benefits received relationship. Finally, revealing the full overhead costs can motivate job representatives to examine how overhead costs are planned and controlled. Even though these costs are fixed in the short run, it is likely that they can be managed in the long run. However, using full cost might give misleading information for short run decisions. Jobs or customers that are unprofitable in a full-cost analysis might still be profitable if we make a distinction between avoidable and unavoidable overhead costs. Pricing based on full cost might also lead to the downward demand spiral. E.g. in the short run, Colorscope’s cost for rent and depreciation is likely to be unavoidable. As long as the customer is profitable before rent and depreciation is allocated, it therefore makes sense to keep/accept the customer. However in the long-run, the company can scale down equipment and floor space and therefore these costs will still be relevant for long-run decisions.

Allocating all of the overhead costs might also be irrelevant for motivation and control purposes. Overhead costs that are not controllable by the job representative will be irrelevant for evaluating their job management performance.

In reality, we have to use different cost analyses for different purposes. For evaluation of long-run profitability and long-run decisions, full cost is relevant, but for short run decisions it makes more sense to use a direct-cost analysis.