LO $16-1,$

I thought the Internet would be an ideal way to distribute our products. We've had a lot of success with our direct sales, but now we can reach a much larger audience. The baskets we make and sell appeal to people everywhere. I thought about opening stores in other towns or maybe even franchising, but the Web offers me a way to expand without losing control.

That's why the results for the first quarter of our Web$-$based unit are so disappointing. We expected a small loss, because of marketing and other start$-$up expenses, but I was not prepared for the beating we took.

Maya McCrum,

President and CEO

AGM Enterprises

Organization

AGM Enterprises is a small, family$-$owned and managed company that produces and sells wooden baskets. The company was founded in $1947$ in California by Autumn McCrum as a way of supplementing the family income. The business remained small until $1990,$ when Maya McCrum took it over from her mother. Until that time, all orders were taken by the senior Page $640$Ms$.$ McCrum and all baskets were handmade by her. Ten years ago, Maya moved to a model of having $$dealers$$ take orders and opened a small workshop where part$-$time labor produced the baskets. The dealers were also looking to supplement their incomes and, supplied with a small display inventory, displayed the baskets at home or at parties, and took orders. Order fulfillment was handled directly by AGM Enterprises personnel, who shipped finished baskets directly to customers. Little production inventory was kept.

Last year, Maya McCrum evaluated the costs and benefits of two alternative distribution channels in an attempt to expand the business beyond the West Coast. One alternative was to franchise the business. Maya was concerned that she and the managers of AGM would lose control, especially control over quality, which she felt distinguished AGM baskets. The other alternative was to begin taking orders over the Internet. Maya chose the Internet option. The company added a new managerial position, Chief Technology Officer $($CTO$),$ and established a subsidiary, agm.com, to handle the new business. In an unusual move for the company, Maya went outside the small circle of family and friends and hired as the CTO Mary Brown, who had experience on both the technical and management side of a local Internet start$-$up$.$ Mary was looking for something new where she could be in charge of an entire operation and was excited that she could combine this with her interest in basket weaving. It was agreed that if she could meet or exceed her budget for the first year of operation, she would be given a substantial piece of agm.com.

The executives of AGM Enterprises considered the initial foray into the Internet to be an experiment to see if the $$anonymous$$ approach would be effective in selling baskets. Until this time, AGM considered its network of dealers to be crucial in the growth it had experienced in the last several years. To this end, a separate workshop $($factory$)$ was established in Pennsylvania. One of the reasons for selecting Pennsylvania was the availability of part$-$time labor at lower costs than in California. Another was to attempt to penetrate the East Coast market by locating a workshop there, taking advantage of more immediate access to local market tastes and trends. It was decided that the Pennsylvania operation would produce exclusively for agm.com business and the California workshop would continue to handle the orders from dealers.

Most of the staff functions for agm.com were provided and controlled by AGM Enterprises. Mary and Donna Cunha, the senior vice president of marketing for the parent company, jointly decided the marketing budget. While the budget was decided jointly, media decisions and advertising campaigns were run directly from the parent organization. Personnel and financial services were also centralized.

Mary contracted with a major telecommunications company to provide Web hosting services for the operation. She wanted to go with a telecommunications company rather than a local Internet Service Provider $($ISP$)$ for reasons of reliability. The back office operations $($billing$,$ payroll, etc.$)$ would be maintained on personal computers at the agm.com office.

The Initial Plan

AGM Enterprises $($and agm.com$)$ have a July $1$ fiscal year and the launch of agm.com was designed to coincide with the beginning of fiscal year $1.$ Maya and Mary decided that agm.com would initially offer only one of the company's many baskets for sale. Company managers believed this would simplify production scheduling and help maintain quality control for the workforce. The basket to be offered was the round basket, one of the company's most popular. The standard cost sheet for the basket is shown in Exhibit $16\mathrm{.}16.$

The cost accounting system at AGM Enterprises and the one adopted for agm.com is a full absorption$,$ standard cost system. Overhead