Case Study (70 marks)

Somerset Corporation makes a high-end computer monitor. The company produces no defective units but it wants to reduce direct materials usage per unit in 2019. Manufacturing conversion costs in each year depend on production capacity defined in terms of units that can be produced. Selling and customer-service costs depend on the number of customers that the customer and service functions are designed to support. The industry market size for high-end computer monitors increased 5% from 2018 to 2019.

Somerset Corporation presents the following data for the years 2018 and 2019:

20182019

Units produced and sold6,0006,500

Selling price$420$440

Direct materials (pounds)16,00016,375

Direct materials costs per pound$40$44

Manufacturing capacity (units)10,00010,000

Conversion costs$1,000,000$1,100,000

Conversion costs per unit of capacity$100$110

Selling and customer-service capacity (customers)6058

Total selling and customer-service costs$360,000$362,500

Selling and customer-service capacity cost per customer $6,000$6,250

Based on the case information provided:

a.Comment on whether Somerset Company is adopting a cost leadership or product differentiation strategy, clearly explaining the terms 'cost leadership' and 'product differentiation'. Provide evidence of how you arrived at the conclusion. (7 marks)

b.Calculate operating income of Somerset Corporation for 2018 and 2019. (5 marks)

c.Calculate the revenue effect and cost effect (variable and fixed costs effects) of the growth component, and the net effect on operating income as a result of the growth component. Comment on what these components indicate. (8 marks)

d.Calculate the revenue effect and cost effect (variable and fixed costs effects) of the price-recovery component, and the net effect on operating income as a result of the price-recovery component. Comment on what these components indicate. (8 marks)

e.Calculate the net effect on operating income as a result of the productivity component (variable and fixed costs effects). Comment on what these components indicates.

(5 marks)

f.Show the change in operating income of Somerset Corporation from 2018 to 2019, incorporating the effects of the growth, price-recovery and productivity components. Analyse and discuss the effects of the three components in the change in operating income from 2018 to 2019. Is your conclusion in (a) above, supported by the computations and analyses you have derived in (c), (d) and (e). Explain clearly the components that supported your decision, or why it was not supported. (12 marks)

g.Discuss how strong and collaborative relationships with suppliers and customers can enhance business performance, including the financial and non-financial performance of businesses (you may want to utilise the four perspectives of the Balanced Scorecard to assist in your discussion). In addition, explain how an improvement in employee retention (a learning and growth perspective measure) could flow through each of the balanced scorecard perspectives to result in improved financial performance. (25 marks)