Mark-Wright Inc. (MWI) is a specialty frozen food processor located in the midwestern states. Since its founding in 1982, MWI has enjoyed a loyal local clientele willing to pay premium prices for the high-quality frozen foods prepared from special recipes. In the last two years, MWI has experienced rapid sales growth in its operating region and has had many inquiries about supplying its products on a national basis. To meet this growth, MWI expanded its processing capabilities, which resulted in increased production and distribution costs. Furthermore, MWI has been encountering pricing pressure from competitors outside its normal marketing region.
Because MWI desires to continue its expansion, Jim Condon, CEO, has engaged a consulting firm to assist the company in determining its best course of action. The consulting firm concluded that, although premium pricing is sustainable in some areas, MWI must make some price concessions if sales growth is to be achieved. Also, to maintain profit margins, the company must reduce and control its costs. The consulting firm recommended using a standard cost system that would facilitate a flexible budgeting system to better accommodate the changes in demand that can be expected when serving an expanding market area.
Jim met with his management team and explained the consulting firm's recommendations. He then assigned the team the task of establishing standard costs. After discussing the situation with their respective staffs, the management team met to review the matter. Jane Morgan, purchasing manager, noted that meeting expanded production would necessitate obtaining basic food supplies from sources other than MWI's traditional ones. This would entail increased raw materials and shipping costs and could result in supplies of lower quality. Consequently, the processing department would have to make up these increased costs if current cost levels are to be maintained or reduced.
Alan Chen, processing manager, countered that the need to accelerate processing cycles to increase production, coupled with the possibility of receiving lower-grade supplies, could result in a slip in quality and a higher product rejection rate. Under these circumstances, per-unit labor utilization cannot be maintained or reduced, and forecasting future unit labor content becomes very difficult.
Tina Lopez, production engineer, advised that failure to properly maintain and thoroughly clean the equipment at prescribed daily intervals could affect the quality and unique taste of the frozen food products. Jack Reid, vice president of sales, stated that if quality could not be maintained, MWI could not expect to increase sales to the levels projected. When the management team reported these problems to Jim, he said that if agreement could not be reached on appropriate standards, he would arrange to have the consulting firm set the standards, and everyone would have to live with the results.
1. With respect to a standard cost system, list:
a. Its major advantages.
b. Its disadvantages.
2. Identify those who should participate in setting standards and describe the benefits of their participation.
3. Explain the general features and characteristics associated with the introduction and operation of a standard cost system that make it an effective tool for cost control.
4. What could the consequences be if Jim Condon, CEO, has the outside consulting firm set MWI's standards?