Casemix Company, founded by Mr Appliance, specialized primarily in the manufacture of high-quality coffee makers. Their prices were slightly higher than those of their competitors, but the Casemix coffee makers were more reliable and attractive. However, the coffee- maker market went into decline when expresso-machines became more popular. In response, the Casemix Company decided to widen its range of products and look for new development opportunities. A consulting company was asked to help Casemix define its new strategy and it gave the following recommendations: Since your business is based on small domestic appliances, you could use this experience to develop similar products, close to what you already know, using key success factors that you have already mastered. That is why the Casemix Company launched a new hair-dryer line, and a food-processor line. As mentioned by the consulting company, there were significant manufacturing synergies. Actually, the three product lines use the same machines and the same manpower. In contrast, the Casemix Company had to make a considerable effort to market the new products. The Casemix coffeemaker was sold to only one retailer. The hairdryers and the food-processors require a larger market. In order to guarantee outlets for its new products, the Casemix Company signed agreements with other retailers Fabrication of the components was outsourced, and these components were assembled on a newly modernized production line at the Casemix factory. Items were produced and delivered to customers on demand. In 20n, coffeemakers only represent 19% of the sales. For this product, the Casemix Company maintains its niche strategy. It has only one customer. The manufacturing has a single production launch every month. The coffeemakers are manufactured with four outsourced components. The hair-dryer market is very competitive. The hair-dryer companies drive down each other's prices and the Casemix Company has to follow suit. The manufacturing of a hair-dryer requires 5 components and there are 5 production launches every month. Food-processors are more complicated to manufacture, requiring a higher number of components. The company produces different food-processor models which are not all sold i to the same clients. Ten production launches have to be completed each month. This marketi seems to be less competitive. Thus, the Casemix Company was able to increase the price of its food processors without experiencing a decrease in its orders. In appendix 1, you will find more information about these 3 products and the company's overhead costs. Casemix managers are particularly concerned about the hair-dryer market. Their competitors regularly lower their prices forcing Casemix to adjust their own. Are the competitors selling at a loss? Is the Casemix Company less competitive even with modernized equipment? Was the hair-dryer line a good strategy for the company? M Appliance, the CEO, decides to organize a meeting with his managers, Mr. A (controller), Mr 8 (production manager), and Mr. C (sales manager) to address these questions. Mr. "wonder how our competitors manage to keep lowering their hair dryer prices! We have a modern, efficient, production line and I don't think that their productivity could be any higher than ours" Mr. C "This is all the more surprising because with mony competitors in this market, we will never be able to reach a monopoly or oligopoly situation. Even if the price war kills off a few companies, there will still be too many left. Anyway, nobody is interested in selling at a loss! So, why do our competitors continue to lower their prices?" Mr. A: "Our competitors may make different hypotheses about indirect costs, or they may ollocate them to their products differently. Or else, they forget that the selling price is supposed to enable the company to make a profit!" Mr. Appliance: "Yes, I remember that you proposed a new method of allocating our indirect costs, last month. I told you that we would see: changing methods is always costly. I worry about creating discontinuity with our historical data." Mr. A: "That is right, the good point about our present system is that it is simple. We calculate the direct cost (direct material and direct labor) for each product. The overhead costs are allocated to the products according to the number of labor hours. (See appendix 2). Is this system still appropriate today? In the last few years, our overhead costs have been increasing. We automated our production equipment, which increased our depreciation costs. Moreover, new product models have been introduced more frequently and we have hod increased spending on sales promotion. This is why we need to reconsider our cost calculation system. Firstly, some costs that are considered to be indirect costs ore direct. That is the case for machine set-up labor costs which correspond to the costs of labor hours required to set up machines before each production launch. I would recommend taking the production preparation labor costs out of the total overhead and allocate them to each product line. After all, we already have all the information required to determine the exact amount of production preparation labor costs per each product line. Secondly, we do need to define a more rigorous method to allocate indirect costs." Mr. Appliance: "I do agree with you. I am starting to realize that our product costs depend on the cost allocation bases we use for overheads. This is very worrying! And yet, we do need reliable information to determine our selling prices and to identify our most profitable products so that we can develop them." Mr. B: "I'm not a cost specialist but I think that, when determining the product cost, we should identify the costs of the resources used to make it. A few days ago, I learnt about a new method at a seminar at ESCP. I don't remember all the details, but the general idea was that activities create costs. For me, as a production manager, this idea of activity is particularly relevant. Activity is real. For example, in the factory, we have "components reception and handling", "packing and dispatching", "maintenance", etc. We could allocate the cost of each activity directly to the product according to its consumption." 28 Mr. A: "Yes, I am familiar with the ABC concept. I've read many articles about activity-based costing in financial magazines. How about if we try out this new approach on our pricing/costing problem? I propose that we have another meeting to identify activities and their cost drivers." Mr. A, Mr. B, Mr. C. and Mr. Appliance think separately about the project and meet again to exchange opinions. After a long discussion and after collecting some operational information (number of orders, time spent, number of production cycles), they come along with the information displayed in appendices 3 and 4. Questions Using the data in the appendices, calculate the full product cost of each product using the activity-based costing method. What do you think of the results you obtain? What are your recommendations? APPENDIX 1: PRODUCT AND INDIRECT COST FIGURES Number of Units produced/month Machine set-ups/month Coffee Maker Hair dryer 7.000 15 000 1 5 Customer deliveries/month Food-processor 4 400 10 22 1 7 Suppliers contacted/month 2 2 4 New products launched on the market 1 2 3 Customers visited/month 1 4 10 Types of components 10 4 5 Total component cost/unit 8 10 (11 Labor hours/unit 0.5 1 0.8 Machine hours/unit 0.5 05 0.2 Labor hours per machine set-up 70 98 110 Notes: 1. All products manufactured each month are packed and sold that same month. 2. The labor cost per hour is 12. Monthly overhead costs Buying and handling costs 220,000 Machine set-up labor costs 19,920 Indirect production costs 180,000 Maintenance costs 45,600 Packaging and transportation costs 120,000 Sales costs 120,000 Total 705,520 30 APPENDIX 2: PRODUCT COSTS ACCORDING TO THE PRESENT COSTING SYSTEM Allocation of indirect costs: Total number of labor hours: 0.5 x 7,000+1 x 15,000 +0.8 x 4,400 22,020 hours Monthly overhead costs Buying and handling costs 220,000 Machine set-up labor costs 19,920 Indirect production costs 180,000 Maintenance costs 45,600 Packaging and transportation costs 120,000 Sales costs 120,000 Total 705,520 Indirect costs per labor hour 705,520/22,020 32.041 For each product, we calculate the following full product cost per unit (in ): Per unit Component cost Direct labor cost Overhead cost Full product cost Selling price Profit Coffee maker Hair Dryer Food processor 8 10 11 6 0.5 x 32.04 16.02 12 1 x 32.04 32.04 9.6 0.8 x 32.04 25.63 30.02 54.04 46.23 41 58 75 10.98 3.96 28.77 APPENDIX 3: ACTIVITIES AND COST DRIVERS Activities Cost driver Purchasing and logistic department Contacting suppliers and placing number of suppliers contacted orders Handling of components for production line preparation number of types of components handled per machine set-up multiplied by the number of machine set-ups Production Planning and monitoring production Manufacturing the product Maintaining the equipment Product packaging Delivering product to clients department Maintenance department Delivery department Product promotion Customer service department Client follow-up number of machine set-ups number of machine hours. number of machine hours number of products packed number of deliveries number of new products launched on the market number of customers visited each month APPENDIX 4: TOTAL COST PER ACTIVITY Note: Managers from different departments were interviewed and operational data was gathered. This information was analyzed to determine the amount of resources consumed by each activity per month. Activities Contacting suppliers and placing orders Handling of components for production line preparation Planning and monitoring production Manufacturing the product Maintaining the equipment Product packaging Delivering product to clients Product promotion Client follow-up Cost (in euros) 40,000 100,000 80,000 180,000 45,600 20,000 100,000 30,000 90,000 32