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 best- known 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 Modern's brand. Initially, Modern had responded to competition by lowering prices and squeezing margins. Since this approach hasn't proven satisfactory, the company has decided to try a different approach of designing products to a tight cost target.

Modern established a team that included representatives from engineering, account- ing, and production. The team was responsible for redesigning Modern's 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 pur- chased from an outside supplier. The blades are manufactured by a blade machine. At stan- dard, the assembly takes 30 minutes per pencil sharpener.

The team also met with the marketing group and reviewed that group's 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.

Modern's engineers familiar with pencil sharpeners' functioning felt that four compo- nents 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 sharp- ening. 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 summa- rized in Table 1 below.

Table 1

Component Source Current Accrual Cost

manufacturing costs:

Motor External supplier $6.40

Blade assembly Internal 3.20

drawer External Supplier 2.40

outer casing Internal 4.00

Subtotal $16

Selling/distribution Internal 6.00

General and administrative Internal 3.00

Total cost $25.00

Currently Modern's 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:

1. Evaluate the cost-planning efforts of Modern in light of what you have studied about target costing. Is their approach consistent with target costing?

(I am asking for a paragraph that explains what the question wants: like if the approach they used alines with target costing and if not what did they do, and what can they do to improve)