Colorscope, Inc.

(Abridged)
Introduction
Andrew Cha, the founder of Colorscope, Inc., a small, vibrant firm in the graphic arts industry, had seen
his business change dramatically over the years. The rapid development of such technologies as desktop
publishing and the World Wide Web as well as the consolidation of several major players within the
industry had radically altered his company’s relative positioning on the competitive landscape. Preparing
to celebrate the company’s thirty-seventh anniversary in March 2013, Cha pondered the issues involved
in moving Colorscope ahead.

Company History
Born in Anhui, China in 1938, Andrew Cha immigrated to the United States in 1967 to seek a better life.
Cha worked as a cook and busboy in a downtown Chinese restaurant in Los Angeles, but he eventually
found jobs that took advantage of his artistic skills in draftmanship and photography. A succession of
promotions in one graphic arts company convinced him that he had the skills to start his own business.
On March 1, 1976, Cha founded Colorscope as a special-effects photography laboratory serving local
advertising agencies in southern California.

As Cha’s reputation grew, so did the business. Sales increased steadily over the years. The company
served agency giants such as Saatchi & Saatchi, Grey Advertising, and J. Walter Thompson and large
retailing and entertainment companies such as The Walt Disney Company and R. H. Macy & Co. To
improve service to these customers, Cha invested in expensive proprietary computer equipment to
continue providing ever more complicated print special effects.

While serving his existing base of high-margin clients, Cha ignored certain trends in the business,
particularly the price pressures brought on by cheaper PC- and Mac-based microcomputers. These
computers were equipped with increasingly sophisticated page layout and color correction software, so
small ad agencies and print shops began to take pieces of business away from larger graphic art
companies like Colorscope. Cha, however, had felt protected from the trend by the strong personal
relationships he had built with key clients over his career.

Market pressures, however, forced Cha to reduce his own basic prices. This, however, proved to be
insufficient. Later, his largest account, representing about 80% of his business, announced that it was
purchasing its own graphic design and production equipment, replacing Colorscope with an internal
group. To rebuild the business, Cha had to reevaluate the industry, his company’s position in the pre-
press segment, its pricing policy, and its operations.

The Pre-press Production Process

Although technology dramatically changed the means by which production was conducted as well the
corresponding values to each phase, the basic process for print material, known in the industry as pre-
press or color separations, remained essentially the same. A content provider, such as a magazine or
direct mail cataloger, designed and laid out a “book” or “project” for distribution (1 week processing
time). Once the book’s layout was approved, a photographer captured and developed the images,
received approvals from the client, and sent them to the pre-press house or “color separator,” in this case
Colorscope (1 week processing time). Once in production, images were processed or digitized via laser
scanner and compiled with text and other graphics to form a master file for the printer (2 weeks
processing time).
During this process, the magazine or direct mail client saw iterations, or proofs, of their “book” with
digital and conventional proofing devices. At these intervals, the clients could ask for changes, ranging
from simple price and copy adjustments to sophisticated special effects, adjusting colors or clearing
blemishes in products and people. A very important qualitative component of the separator’s task was to
understand the product’s desired “look and “feel” and translate the direction the client desired into the
actual images on each page. Typically, the pre-press house charged a base rate for digitizing, assembling,
and proofing each page, with an additional fee for the special effects. When the “books” were ultimately
produced on paper, the images were filed and stored in the separator’s database for future use.

After the client approved the project, Colorscope sent the “master book,” or file, to the printer
electronically. At this point, the separator had converted all of the client’s information, digital text,
graphics, and photographs (described in a postscript or dpi format) into a printer-acceptable (line screen)
format. Printing took about 1 week.

Industry Dynamics
For the individual pre-press firm the market had drastically changed. Thus Colorscope’s previous
position as a high quality, high service player appeared unsustainable in a marketplace full of service
providers that claimed the same quality at lower prices. While in the past prosperous relationships could
last several years, with customers consistently able and willing to pay for top quality separations, current
technology blurred the clear distinctions in quality of the actual output. As more pre-press houses bought
desktop equipment and lowered their prices, customers in the catalog arena defected to even lower-cost
providers. Given that the basic scanning and proofing functions of a pre-press house could be easily
replicated on a smaller scale with minimal investment,1 and given the significant overcapacity in the
industry, Cha knew that the downward pressure on prices was likely to continue.

Work Flow Organization at Colorscope

A “job” at Colorscope began when the customer placed an order. Customer Service representatives
interacted with the customer on the phone and recorded the job specification details. Each order was
“owned” by a particular representative, who, based on the specifications, did a “job preparation.” A
separate “job bag” was opened for each set of four pages for the order. The template of the job was
created by physically cutting and pasting text, graphics, and photographs; extensive markings on the
template specified the changes in font, color, shading, and layout. The next step in the production process
was scanning, whereby the pictures were digitized and output as a computer file. Colorscope had three
laser scanners.

The following step was assembly, performed on nine high-end Macintosh computers, each with
oversized computer terminals. The computers were networked and hooked up to the scanners, output
devices, and a powerful file server that contained archives of optical images. Operators worked on the
computers composing the “job” with scanned images and text input from the keyboard. At this stage the
operators changed colors and shades of the scanned picture to the exact specifications the customer
demanded. Once a job was fully assembled, it was output on one of two high-end output devices. The
output was a large sheet of four-color film that was then developed.

The “job” then flowed to Quality Control (QC) for proofing, where an employee compared the hardcopy
output with customer specifications. Reworks were initiated at this stage. QC might, for instance, require
the job to be rescanned if it determined that the original scanning was flawed. Then the rescanned image
would then have to be reassembled, re-output, and pass QC all over again. Once a job passed QC, it was
shipped to the customer’s printer either on a computer disk or, more usually, on film.
Colorscope’s operators were cross-trained and could work on any stage of the production process. Work
flow and production procedures were standardized but not documented. Colorscope relied instead on
the institutional knowledge of its employees and frequent supervision by Andy Cha to maintain and
improve operational efficiency.

The Future
Cha realized that Colorscope had to capitalize on its biggest assets, its employees, who were all well
trained and worked effectively as a team to meet deadlines. The short-term strategy was to increase
marketing efforts to drum up new business for the lean months that preceded the huge rush of orders to
do pre-press for catalogs in the fall season before holiday shopping started. Exhibit 1 gives details of jobs
completed in June 2012 and revenue generated from each customer. Revenue per page, however, was
unlikely to improve due to competitive pressures. Cost containment and improving operational efficiency
were therefore critical, particularly in reducing the amount of rework. This effort required the
cooperation of its workers, and Cha was considering sharing the gains of such improvement with its
employees. With this objective in mind, Colorscope began tracking hours spent on rework, which was
broken down into hours spent on rework initiated by customer due to change in specifications, and
rework caused by errors in-house. Colorscope compensated its line workers on an hourly wage basis. To
keep track of hours worked, employees logged the hours spent on various jobs into a centralized
computer from remote terminals. (Exhibit 2 gives the hours spent at different workstations by different
jobs in June 2012.) So tracking rework hours was fairly straightforward; employees recorded both types of
rework hours separately for each job. (Exhibit 3 gives the rework hours recorded during June 2012.)

Another area for improvement was product pricing. At present, Colorscope quoted more or less the same
per-page price for different customers, plus additional charges for special effects. Yet different customers
placed different demands on organizational resources, and this was not appropriately reflected in the
price charged. However, Colorscope could not afford expensive accounting systems or to hire consultants
to design a state-of-the-art activity-based cost system. Exhibit 4 gives selected financial information, while
Exhibit 5 gives materials expense, broken down by jobs, for the month of June 2012.

Assignment Questions

1. Set up a two-stage cost system to calculate the profitability of different jobs. You will have to
choose first stage drivers to allocate the cost of resources to cost pools. Then choose second stage drivers
to allocate the costs in various cost pools to jobs. Compute the cost driver rates. Calculate profitability of
all jobs by allocating costs to jobs using the cost-driver rates that you estimated. It might be useful to
diagram this system before you start calculating the cost pools and cost-driver rates.

2. Assignment question 1 is a full cost analysis. Is full cost the right metric for job profitability, or
should we only allocate direct costs of jobs? What assumptions are we making about the variability of
overhead costs when we do a “full-cost” analysis?

3. What is the financial consequence of rework? What should Colorscope do about rework? How?

4. Should Colorscope change its incentive system?

5. How can Colorscope improve its operations and profitability?

Exhibit 1 Jobs completed in June 2012*

Job # Pages Revenue

601 32 $ 19200

602 32 23,000
603 32 23,000

604 112 76,000

605 128 50,000

606 48 26,600
607 32 16,000

608 16 11,000
609 16 11,000
610 32 20,000
611 8 3,400

612 32 18,000

613 8 6,000

614 17 12,000

Total 545 $315,200

Source: Company documents

Exhibit 2 Hours clocked at different workstations in June 2012*

Job Quality
JOB # Preparation Scanning Assembly Output Control Total
601 7 56 80 16 15 174

602 7 40 75 16 8 146
603 8 32 58 8 8 58114

604 23 112 212 28 25 400

605 15 130 250 32 30 457

606 13 56 104 12 13 198
607 8 39 66 12 10 135

608 4 21 39 4 4 72
609 4 20 40 8 7 79
610 7 26 60 8 9 110
611 4 10 21 3 2 40

612 8 40 80 8 8 144

613 3 10 23 3 2 41

614 6 20 44 5 6 81

Idle Time 43 28 128 37 13 249

Capacity 160 640 1280 200 160 2440

Hours clocked in different work stations include rework hours given in Exhibit 3.

Source: Company documents

Exhibit 3 Rework hours*

Rework due to change in specifications by customer

Job Quality
JOB # Preparation Scanning Assembly Output Control Total
601 0 24 16 8 5 53

605 2 5 10 2 2 21
609 1 4 8 1 0 14
613 1 2 7 1 0 11

Total 4 35 41 12 7 99

Quality Control initiated rework of house errors

Quality
JOB # Job Preparation Scanning Assembly Output Control Total
605 1 3 4 1 1 10
607 0 19 30 4 3 56

611 1 3 3 1 0 8
Total 2 25 37 6 4 74

In all four jobs that were subsequently reworked because Quality Control initiated rework, the original
defects were introduced in the scanning stage of the operation. However, when a job is rescanned,
assembly, output, and quality control all have to be redone.

Exhibit 4 Selected Financial Information for June 2012*

Job Quality
Description Preparation Scanning Assembly Output Control Idle Total
Wages $8,000 $32,000 $64,000 $10,000 $11,000 $125,000
Depreciation $500 $25,000 $10,000 $14,000 $500 $50,000
Rent $30,000
Others $20,000
Total Overhead $225,000

Floor Space in
sq. ft. 1000 1000 4000 2000 500 15,000
6,500

Source: Company documents.

Exhibit 5 Materials expense in June 2012

Total Materials Customer Correction of house

Job # expense2 initiated rework error
601 $ 8,900 $3,800

602 4,500
603 3,300

604 13,400

605 13,000 1,000 $1,000

606 5,900
607 7,000 2,000
1,000

608 2200
609 3,600 1,500
610 3,300
611 1,600 500

612 4,600

613 3,300 2,000

614 2,400

Total $75,000 $8,300 $3,500

Source: Company documents.