Activity-based budgeting, Balanced Scorecard, and strategy Sippican Corporation (B)12

Refer to Case 5-36, the Sippican Corporation (A) case, which required time-driven ABC analysis. Sippican's senior executive committee met to consider the implications from its time-driven ABC model. Frankly all had been shocked to learn that their apparently highest margin product line, flow controllers, could actually be losing money because of its many shipments, short production runs, and heavy use of engineering time. The team contemplated action steps to restore profitability.

After some deliberation, the executive team crafted a new strategy that involved the following principles:

Improve Revenue Quality: Product Focus and Menu-Based Pricing

??? Focus on core products: valves and pumps.

??? Increase market share in valves by offering discounts for large orders.

??? Reduce discounting for pumps, especially in small order sizes.

??? Aggressively raise prices for small orders of flow controllers.

Productivity

??? Reduce set-up times.

Based on the new strategy, Peggy Knight developed the forecasted monthly sales and production plan shown in Exhibit 5-12. She wondered whether the shift in product mix, new pricing model, and forecasted productivity improvement in setup times would be sufficient to restore Sippican's historic margins. Sippican's machines were leased monthly and had staggered expiration times; Knight believed she could, on short notice, make 10% to 15% adjustments up or down to accommodate changes in demand for machine capacity. Also, Knight felt that she had some flexibility with the size and composition of the labor force as well. The company had recently hired quite a few production employees on short-term contracts to meet the expanded demand for the newly introduced flow controller line.

Required

(a) Estimate the resource demands from Knight's forecasted sales production plan in Exhibit 5-12.

(b) Prepare a pro forma product line income statement based on the new plan.

(c) Comment on the magnitude of the change in profit with the new plan in relation to the change in production and sales under the previous plan.

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VALVES PUMPS FLOW CONTROLLERS TOTAL Forecasted price $75 $80 $110 10,000 12,000 Forecasted sales (units) 2,500 24,500 Number of production 40 40 50 130 runs Number of shipments 40 70 100 210 1,000 10,800 Total direct labor hours 3,800 6,000 Setup labor hours per run Total setup hours 4.0 4.8 9.6 832 160 192 480 6,192 Machine hours: run + 5,160 1,230 12,582 setup Engineering hours 240 700 60 400 Source: Robert S. Kaplan.