Case 2: Modern Office Machines.

Modern Office Machines is a manufacturer of small office equipment. Its product line

includes electric pencil sharpeners, disk holders, tape dispensers, hole punchers, computer

stands, and a range of desktop accessories. The electric pencil sharpener is one of its bestknown

products. Until recently, the company had a dominant share of the pencil sharpener

market, as much as a 30 percent share of total sales in the United States.

Because of recent competition from Far East manufacturers, who sold their pencil

sharpeners for lower prices while offering comparative quality, Modern has lost sales and

market share. This year only 10 percent of pencil sharpener sales were of Moderns brand.

Initially, Modern had responded to competition by lowering prices and squeezing margins.

Since this approach hasnt proven satisfactory, the company has decided to try a different

approach of designing products to a tight cost target.Target Costing

Modern established a team that included representatives from engineering, accounting,

and production. The team was responsible for redesigning Moderns pencil sharpener

and improving its production process to achieve a 25 percent reduction in costs over the

next 2 years. Since the current manufacturing cost is $16, this means a cost reduction of $4

for manufacturing.

The team members reviewed the design and production of the pencil sharpener at one

of its meetings. They found that the sharpener is made from stainless steel casing. The

shell is divided into two parts: a base and a top. The motor, blades, and bin drawer are

attached to the base using 12 screws and washers. The top is then attached to the base using

another 4 screws. All parts are assembled by hand. The motor and bin drawer are purchased

from an outside supplier. The blades are manufactured by a blade machine. At standard,

the assembly takes 30 minutes per pencil sharpener.

The team also met with the marketing group and reviewed that groups research on

customers expectations about features and price. Their research indicates that there are

three features a customer desires in an electric pencil sharpener: speed of sharpening, ease

of cleaning scrapings, and appearance. Using a 5-point scale, with 5 representing high

importance, the marketing group found that customers rated speed of sharpening a 4, ease

of cleaning scrapings a 4, and appearance a 2.

Moderns engineers familiar with pencil sharpeners functioning felt that four components

could address these features: motor, blade assembly, drawer, and outer casing. Motor

and blade assembly contribute 75 percent and 25 percent respectively to the speed of sharpening.

The design of the drawer is 100 percent responsible for ease of cleaning scrapings,

while the appearance is 100 percent determined by the casing. They proposed a solution

which would use a cheaper, less powerful motor (saving $3.00/motor) and a less-expensive

plastic bin drawer (saving $1.00/drawer) to meet the 25 percent cost-reduction target.

The accountant on the cost-planning team collected information about the current

actual cost of producing each of the components and other costs. Her cost data is summarized

in Table attached

Currently Moderns pencil sharpener sells for $27.00. This yields a return on sales

of 7.4 percent. In general, the small office machinery industry gets a 15 percent return on

sales. To respond to competitive pressure in past years, Modern had dropped its price

from $29.40 to $27. Modern would like to capture its lost market share and go back to

its 15 percent return on sales. However, analysis of competitors prices and market

response to those prices indicates that a price of $23.50 would stimulate sales and restore

market position.

Target Costing

Required:

a. Evaluate the cost-planning efforts of Modern in light of what you have studied about

target costing. Is their approach consistent with target costing?

b. How would you change their process to be consistent with target costing?

c. Compute a target cost for the pencil sharpener. Assume that a 15 percent return on

sales is required.

d. Compute a value index for the pencil sharpeners various components.

e. Which components should be targeted for cost reduction? Should any components be

targeted for increased spending?

f. What target cost would you establish for each of the components?

g. In the light of your analysis, what suggestions would you provide for the redesign of

the pencil sharpener

Table 1 Current Actual Cost Component Source Manufacturing costs: Motor Blade assembly Drawer Outer casing Subtotal External supplier Internal External supplier Internal $ 6.40 3.20 2.40 4.00 $16.00 Selling/distribution General and administrative Internal Internal 6.00 3.00 Total cost $25.00