reichard

reichard - Transcript

Reich 1

REICHARD MASCHINEN
From the case Throw away all the steel inventory now cost 93 000 because plastic is better for the customer and more profitable The extra profit from plastic will make up the loss 93 000 in only 16 months Price Cost Profit Plastic 325 67 258 Steel 325 264 61 Difference

197

P S

Volume per year 35 000 690 wk x 50 wks Profit Difference per year 350 x 197 69 000 93 000 Loss 69 000 year 1 1 3 years to recover the loss Is this good thinking

Reich 2

The Options
1 Steel only business as usual 2 Both ASAP pricing 3 Plastic only after September Sell steel from inventory only until plastic is available 4 Convert raw steel to rings this summer Buy no more steel Steel plastic both available for the next 1 to 2 years pricing 5 Stop producing rings now buy plastic rings for resale Or tell customer they can try experimental plastic rings if they want to accept the risks warranty is void We can recommend a plastic parts supplier

Reich 3

TABLE 1 Relevant Costs per 100 units
STEEL RINGS
25 450 Rings in stock 0 0 0 0 0 Summer Production next 34 500 rings 0 14 11 0 25 Future Rings Full Cost Variable Cost 77 77 47 47 37 37 103 0 264 161

Raw Materials Direct Labor Variable OH Fixed OH Total PLASTIC RINGS Raw Materials Direct Labor Variable OH Fixed OH Total

Full Cost 4 16 12 34 66

Variable Cost 4 16 12 0 32

Notes
1 Assume that the make work projects in the Summer have zero real value to the company 2 The variable overhead is 40 of the departmental overhead or 8 x direct labor

Reich 4

Product Profitability at current prices
Short Run
I The finished rings on hand 100 of Sales Contribution II Steel rings produced this summer vs Plastic 325 25 300 340 32 308 308 4 77 S 4XP Even if use full value for labor S 325 84 241 3XP

NEXT ONE TO TWO YEARS
88 week supply of steel rings

Reich 5

III Contribution Basis
Steel Plastic 325 161 340 32 308 4 S 2XP 164 308 77

IV Profit Basis with allocated fixed overhead
Steel Plastic 325 264 340 67 273 4 P S But 63 273 68

Fixed Overhead Absorbed
S 36 000 x 103 37 000 P 9 000 x 35 3 000

Reich 6

Table 2 Comparison of Incremental Profitability per 100 rings
STEEL RINGS
25 450 Rings in stock 325 0 325 x4 1300 Next 34 500 Rings 325 14 11 25 300 x4 1200 Future Rings Contribution 325 77 47 37 161 164 x4 656 Full Cost 325 77 47 37 103 265 61 x4 244

Revenue RM Labor OH Variable Fixed

Profit

PLASTIC RINGS
Revenue RM DL OH Variable Fixed Profit 340 4 16 12 32 308 340 4 16 12 34 67 273

Reich 7

What If Selling Prices Change
Steel long run can t fall much because cost sets a minimum at 264 Since P lasts 4x longer will P price rise Probably No because P cost is low full cost 67 P price could fall to 100 or even lower 90 80 Even at 100 steel from summer production is still more profitable Steel 100 25 75 S 4 x P

Plastic 100 32 68 4 17 But no new steel material will be purchased

Reich 8

Beyond 2 years only plastic is likely to survive
Lower Cost Longer life Easier to handle Cheaper to ship But switching barriers may slow down the conversion rate or even lead some customers to stay with steel

But annual profit will then be much lower Now Steel 325 161 36 000 x 164 59 000 contribution to fixed overhead and profit Future 80 32 Plastic 9 000 x 48 4 000 contribution to fixed overhead and profit

How long can we afford to stay with a more profitable but less desirable to the customer product AFFORD Financially Strategically Ethically

Reich 9

An average customer spends about 6 50 per month on rings to keep a 6 000 machine running Rings usage Life Annual usage Cost 2 to 6 average 4 2 months 4 x 6 24 3 25 x 24 77 Per month cost 6 50 At same price plastic cost is 1 50 month BARRIER TO SWITCHING Save 5 month at what risk

Reich 10

Table 3 Annual Contribution of Plastic and Steel Rings In the Future Plastic
Sales Price Variable Costs Material Direct Labor Overhead 40 Contribution Unit Sales Annual Contribution Notes 1 The firm currently sells 35 880 rings per year 690 x 52 2 If all sales switch to plastic rings the steady state volume would be 8 970 1 4 x 35 880 80 4 16 12 32 48 8 9702 4 000

Now Steel
325 77 47 37 161 164 35 8801 59 000

Reich 11

Table 4 Make Rings A low value replacement part vs Buy Rings
How would you think about this problem We sell 36 000 Rings year we have 10 SOM per the case World Market 360 000 rings per year With Plastic 90 000 360 000 4 Plastic Price within 1 year 80 or less The cost leader is now likely to be a plastics company and cost will be key to price World Market 90 000 x 80 100 72 000 Tiny We sell 112 000 in steel rings now Leave this business to the plastics companies small firms We can buy easily Is this good thinking

Reich 12

What if we make the additional 34 500 steel rings this summer and then demand slackens at prices above 100 Can we unload the steel rings We sell 36 000 rings year 1 24 machine 1 500 machines in use 2 10 year normal life 150 replacement machines sold per year 3 With 10 SOM there are 15 000 machines out there 4 3 4 annual growth new annual sales 450 to 600 machines 5 Our share 45 to 60 6 We sell about 200 machines year 150 50 Offer as an introductory special 100 steel rings for 100 with a new machine Use up 40 000 steel rings in two years

Reich 13

The Classic Pricing Triangle

Product Cost


PRICE

Value to The Customer

Competitors Price Steel Rings Plastic Rings As A New Product Plastic Rings Long Term

Reich 14

Fixed Costs
Unitizing fixed costs is clearly suspect because The resulting per unit amount is only accurate at one particular volume It may confuse people by making a fixed cost appear to be a variable cost It involves arbitrary allocation rules that cannot be verified It distorts C V P relationships calculated using product cost numbers Economic theory suggests that fixed costs are irrelevant for short run decisions anyway

On the other hand

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Economic theory suggests the fixed costs are relevant in the long
run and many decisions are more LR than SR there are very few pure SR decisions

Fixed costs must be covered by the products in aggregate so why not charge each product for a fair share Whereas full cost distorts the SR perspective marginal cost distorts the LR view which is the bigger sin Business history reveals as many sins by taking an incremental view as by taking an accounting view

Full Cost Variable Unitized Share of Fixed Cost

Forces Pulling in Different Directions
Finance Steel

Reich 16

Rings Rings
Manufacturing Buy not Make Marketing Plastic

How to decide the right course of action