Do you know how to find the cost pools for the Pelarsen Windows: Humans v. Robots?

ISSN 1940-204X Pelarsen Windows: Humans v. Robots1 Shahid Ansari Babson College Paul Mulligan Babson College Alfred J. Nanni, Jr. Babson College Humans v. Robots The company used economic profit as a key measure of plant performance. Economic profit was equal to accounting profit minus a capital charge equal to the company's weighted average cost of capital times the net assets of a business unit (see Exhibit #1G). With the construction and housing market slump in 2007, he did not expect things to get much better in 2008. He knew the senior management of Pelarsen Windows would be meeting in early 2008 and that one of the agenda items would be the fate of the Texas plant, and, therefore, his future as a plant manager. This had not helped employee morale in his plant. It was clear to Niedermeyer that a plan for near-term return to profitability and a viable long-term plan for future growth were critical if he and his plant wanted to remain a part of the Pelarsen family. When it came to the performance assessment of his plant, Niedermeyer felt that he was not on a level playing field. He had seen a recent industry report stating that \"the major disadvantage of this industry's cost structure was that purchasing and labor costs are very high in relation to the revenues received. This can only be overcome by investing in the most modern plant and equipment available while closing down inefficient facilities, and expanding operations to logging, sawmilling and plywood/veneer manufacturing.\" (IBIS World Industry Report, October 23, 2007) Doug Niedermeyer looked at his watch and sighed. It had been a long and stressful day and it was not over yet. It was only 6:15; he was at the cocktail reception for the plant managers with a dinner and an after-dinner pep talk by Ingrid Pelarsen, CEO of Pelarsen Windows, still to follow. All of this was part of the annual ritual known as the plant performance review, and Doug Niedermeyer had not looked forward to being here this year. In preparation for his meeting, Doug had been thinking about the latest fiscal year financial results for his Texas plant. Despite an increase in annual window sales, his plant had reported an accounting loss of $1.2 million. On top of this, a capital charge of $5.1 million assessed to his plant had left him with a whopping loss of nearly $6.34 million. He believed the loss would have been larger had he not successfully lobbied the national sales office to send more of the high margin architectural window business his way.He believed that getting more architectural window demand into his plant would be critical to improving financial performance. This year he was hoping to keep his production volume of the standard windows at the same level as last year (270,000 windows), but increase his share of architectural windows from 25,000 windows to 50,000. He had asked his plant controller to give him a projected income statement for that scenario. According to those projections, that demand mix would allow him to show an accounting profit of $3.94 million (see Exhibit #1), allowing him to argue that he had improved his controllable profit since the capital charge was beyond his control as it was levied on the asset base that he had inherited from his predecessors. IMA ED U C ATIONAL C ASE JOU RNAL This case is designed for classroom use only. The operating details presented here are fabricated from the generic features of the window building industry for teaching purposes only. They do not reflect actual operations or data of any real company. 1 \u0007 1 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Niedermeyer's arch-rival was Eric Stratton, plant manager of Pelarsen's state-of-the-art manufacturing facility in Portland, Oregon. Stratton's plant was one of the most profitable plants in the Pelarsen plant network. In Niedermeyer's eyes, Eric received preferential treatment from company management and, thus, received most of the high margin business from the national marketing office. It should be no surprise to anyone that Eric's plant had higher economic profit than Doug's. Fortified by two martinis, and finding Ingrid Pelarsen alone in a corner, Doug mustered his courage and walked over to her to air his grievances. \"Ingrid, this may not be the best time to discuss this, but you need to know just how hard it is for plant managers like me who rely on humans to compete with the fancy robots in Eric's plant. His plant has state-of-the-art equipment. His robotic forming machines can do precise arches and other shapes in a fraction of the time it takes our people on the manual steam presses to shape wood for architectural windows. It is no surprise that our national marketing staff channels most of the more complex high margin architectural window business to his plant and sends our plant mostly lower-priced standard windows. I make $162 in contribution margin on each complex architectural window, while I make a fraction of that amount$24on a standard window. Now I may not have a fancy MBA degree like Eric, but I speak for all of the old-timers who grew up with this business who know that with better equipment and higher margin products our plants would look a lot better too. I have a proposal for modifying the allocation of standard and architectural window orders between my plant and Eric's. We handle most of the west and southwest demand, and I believe that both plants can perform well with a more equitable distribution of demand.\" Ingrid Pelarsen listened quietly as she sipped on her glass of tonic water. When Niedermeyer was finished talking, she took her last sip from the glass, set it on the table, and began talking. \"Doug, I hear you, and if it makes you feel any better, I also hear the same thing from other plant managers who are managing older plants and equipment -which of course is the majority of our 15 plants. I understand the need for modernizing our older plants. However, I am not convinced that we cannot squeeze more profitability from our older assets. For example, we have a wide disparity in product quality and working capital management across plants even though we use the same suppliers, dealers, and sales channels for the windows. I wonder how much profit we leave on the table through inefficient management practices. Before we invest capital, we need to get a clearer picture of what the appropriate mix of technology is across our whole IMA ED U C ATIONAL C ASE JOU RNAL company. Not to mention that a housing downturn is not the ideal time to be advocating for capital investments. We simply don't have the capital required to modernize your plant at this time.\" Ingrid went on to explain that she had put together a small team that included members from sales, manufacturing, and the controller's office to study these issues and make appropriate recommendations. She had assigned John Blutarsky, Pelarsen's brilliant but mercurial Special Projects manager, to head the team. Ingrid explained, \"Blutarsky's team is currently documenting our existing operations. They are looking at what we produce, how we produce it, who we sell it to, how we manage working capital, and what it costs us to produce these products across our various plants. Their study is specifically comparing your plant in Texas with Eric's plant in Oregon. I will give your proposal to John and have him include this in his team's analysis. In a few weeks they should be able to finalize their recommendations. I hope I can give you better answers at that time.\" Company Background and History Pelarsen Windows was founded by Gunnar Pelarsen, the grandfather of the current CEO, Ingrid Pelarsen, in 1922. An immigrant carpenter from Sweden, Gunnar Pelarsen started his business in Minnesota near the Canadian border. This location provided him with a steady supply of high quality wood, which was the primary source of differentiation at the time. Glass was considered an undifferentiated commodity in the early 1900s. Like other industries at the time, window manufacturing was largely a craft industry. Carpenters handcrafted windows with simple tools in modest workshops or on-location at construction sites. However, like many industries, window manufacturing had begun the transition from craft to mass production. Gunnar Pelarsen was a leader in streamlining the window manufacturing process by standardizing frame sizes and components. This standardization allowed Pelarsen Windows to manufacture and assemble windows in larger volumes at a remote location, rather than producing windows at the construction site. In the 1930s, Pelarsen built its first large scale manufacturing plant that produced windows that were completely assembled off site. The 1950s saw the introduction of insulated glass to provide protection against condensation and frost. This innovation transformed the glass component of the window from commodity to differentiator. The company also experienced phenomenal growth during this period, driven largely by the construction 2 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 boom that followed the end of World War II. In 1966, Gunnar Pelarsen retired and turned over the reins of the business to his only son, Johann Pelarsen. Under Johann's management, the company solidified its leadership of the windows market by continuing to capture market share and by introducing new innovations in both window design and production methods. With the increased emphasis on energy efficiency, Pelarsen introduced new advances in insulation, light sensitive windows that enhanced solar heating and cooling, and new glass attachment techniques to increase the R-value (a measure of energy efficiency) of the windows. Pelarsen was also the first window producer to introduce robotics and computer-aided manufacturing into its (newer) window manufacturing plants. By the end of the century when Johann Pelarsen turned over the day-to-day operations of the company to his only daughter, Ingrid, the company had over 10,000 employees. With revenues of $2.4 billion and a market share of nearly 34% of the $7.1 billion U.S. wood window market, the company was one of the largest window manufacturers in the U.S. By 2007, the company was manufacturing nearly four million windows at 15 plant locations in North America. Plant management typically consisted of a plant manager, a sales manager, a production manager, and a controller. To meet the needs of this diverse customer base, the company developed a network of 15 plants that were spread over the continental United States. The degree of plant automation varied, and this was generally a function of plant age. Older plants, such as Doug Niedermeyer's plant in Texas, were built before the 1970s and utilized older production machines and used a mix of skilled and unskilled workers. The per-line production capacity of these older plants was typically lower than the newer modern plants that had more up-to-date equipment. However, many of the older plants were quite large and had multiple production lines. For example, Stratton's Oregon plant had a single production line while Niedermeyer's plant in Texas had five parallel, identical production lines, so his total plant capacity was five times the capacity of one of Stratton's single production lines. There was a perception that the automation and highcapacity lines of the newer plants encouraged national sales people to direct most of the large, national account orders to plants like Eric's. However, Blutarsky's analysis indicated that having modern facilities did not guarantee national account business for either standard or architectural windows. The account representatives at the national sales office often sought the older plants for their custom orders, believing that the skilled laborers in these plants were more capable of producing a high quality custom product. These older plants also had multiple production lines, which meant that a customer order might 'get to the line' faster at one of these plants. In contrast, the high single line capacity of the modern, automated plants sometimes encouraged national sales associates to place large standard orders at these plants. Kate Dubinsky, Pelarsen's leading national sales associate, commented on plant performance. \"The older, traditional plants are my first choice for small orders and custom products. They have the craftspeople required to get the custom product right the first time and they treat the small orders with higher priority, both of which should lead to a higher level of customer satisfaction. However, when I have a large order, I tend to seek out the more modern plants, as they're more likely to deliver the needed volume in a timely fashion. The older plants will dedicate one line to that order and they just don't have the capacity to deliver on time. Utilizing the high capacity at plants like Eric's for these large orders means that my large orders get delivered fast once they hit the line.\" Each plant produced a different mix of products based on its location and the type of orders sent to it by the national sales office. Doug Niedermeyer's plant was located near Houston, Texas. The Houston market Customers and Product Mix Blutarsky's team began its work by reviewing the customers and markets served by Pelarsen Windows. The company produced wood windows for the new home construction market and for the replacement window market. Sales were primarily to home building firms and home construction material suppliers. One distinguishing feature of the customers mix was that it contained small local contractors and retailers as well as large \"national\" accounts, such as the national home builder Toll Brothers Construction and major building suppliers such as Home Depot and Lowe's. Pelarsen maintained two distinct sales organizations. One group of salespeople was assigned to offices at the plant. These sales people were responsible for local sales to smaller contractors and independent retail outlets. All orders secured by these salespeople were filled by the local plant. A national sales staff, based at Pelarsen headquarters, handled large national accounts and building supply chains like Home Depot. National account representatives negotiated deals with major national accounts and then allocated the business to the Pelarsen plant with the available capacity, geographical proximity, or other factors needed to fulfill the order. IMA ED U C ATIONAL C ASE JOU RNAL 3 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 was primarily dominated by large demand volume from medium-priced tract homes that offer a limited number of standard layouts and minimal options for customization by the home purchaser. These homes use the basic standard windows with rectangular design. Eric Stratton's plant was located in Portland, Oregon and catered largely to the highend housing markets on the West Coast. Stratton's plant produced architectural windows in a variety of shapes and styles to meet demand of the home buyers in this market. As indicated above, the national sales staff often routed architectural windows to Texas if that plant had capacity or if the customer was located close to it. After completing the customers, markets, and product mix, Blutarsky and his team turned next to look at the production and cost systems. following forecast for west/southwest window demand for the upcoming year: 400,000 standard windows and 230,000 architectural windows. Niedermeyer proposed the following allocation between his plant and Eric Stratton's: Table #1: Niedermeyer's Proposed Allocation of 2008 Forecasted Demand Niedermeyer's Stratton's Total Demand Texas Plant Oregon Plant by Window Type Standard Window 130,000 400,000 50,000 180,000 230,000 Total plant production 320,000 310,000 Niedermeyer believed that this was a reasonable demand allocation proposal. Each plant would have approximately the same total demand (320,000 v. 310,000) and he was only asking for about 22% of the architectural window demand. He believed that acquiring a little over 20% of the more expensive architectural window demand would be enough to bring his plant to a more profitable position. Ideally, he'd like to have more architectural demand, but he sensed that his proposal would be rejected without consideration if he asked for too much. Historically, he currently received a small percent (less than 12%) of architectural window orders, and had one line dedicated to architectural windows and the remaining four lines dedicated to standard window production. He knew that architectural windows required longer processing times. The question that he had not addressed was whether he would continue to dedicate one production line to architectural or shift to two lines of architectural production, leaving only three lines to handle the standard windows under the new allocation plan. He hoped that Blutarsky could assist with this decision. Niedermeyer hoped that Blutarsky's analysis would also address some logistics issues related to production at the Texas plant. Historical data suggested that Niedermeyers's plant had different lead times for standard and architectural windows. He wasn't sure why this was happening, since his five production lines were identical. He knew that architectural orders would sometimes be delayed in process due to unavailability of required hardware components. He had also heard through the company grapevine that Stratton's lead time for standard windows was less than half that of the Texas plant, and Stratton's lead time for architectural windows was approximately one-fourth that of the Texas plant. He knew that he would have to close this lead time gap if he was to secure a larger proportion of the architectural production. Products and Production Process The basic material used to produce windows is wood and glass, complemented by various metal hardware components for locking, movement, and installation. Window glass can be clear, tinted, or stained, and may also vary based upon different degrees of thermal performance, durability, weather resistance, etc. The shape of the windows can vary from simple standard size rectangles to circular, picture, or arched windows. Pelarsen produced two different types of windows: standard and architectural. Standard windows are square or rectangular, available in a limited number of sizes, and utilize a few basic glass options. Architectural windows vary significantly based upon the types of wood used in construction and a wide variety of glass options, shapes, sizes, styles, and hardware options. In general, the more variables used in the product design, the greater the level of process complexity. Production Scheduling Blutarsky and his team considered the details of Niedermeyer's demand allocation plan. On the surface, his plan was quite simple and seemed to be reasonable. He wanted to see a more equitable distribution of standard and architectural windows between his plant and Stratton's plant. Niedermeyer's proposal, outlined in Table 1 below, also ensured that the Oregon plant would continue to be profitable and to this end he had prepared a projected income statement (with the help of the corporate controller) showing the financial results for Texas under his proposed plan (see Exhibits 1 and 2). He had spoken with Calla Kopp, the chief marketing officer, and received the IMA ED U C ATIONAL C ASE JOU RNAL 270,000 Architectural Windows 4 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Product Quality Pelarsen operated on a 250-day per year production schedule. All Pelarsen plants followed a level capacity production schedule, producing the same volume of windows each day based upon average annual forecasted demand. Ingrid instructed Blutarsky to use this 250-day per year assumption in his team's process and cost analysis. However, she also told him that their process analysis should be based upon daily capacity and demand. All Pelarsen plants operated one production shift that worked 5 days per week. Pelarsen required each plant to conform to strict company policy - the workday was 7:30 - 4:30 with a onehour (unpaid) lunch break and two (paid) 15-minute breaks. The policy also prohibited overtime or second shifts, which was fine with Pelarsen's management, given their concerns with cost management. The preferred utilization rate for all plants was between 85% and 90%. Blutarsky's team prepared a detailed description of the process steps, standard production times, and machine as well as human resource allocation at the various steps. The results of this analysis would be available very soon. These data would include: \u0007 xhibit 3: Process steps, standard production times, and E machine-worker allocations for the production of standard windows at the Texas plant. \u0007 xhibit 4: Process steps, standard production times, E and machine-worker allocations for the production of architectural windows at the Texas plant. \u0007 xhibit 5: Process steps, standard production times, and E machine-worker allocations for the production of all windows at the Oregon plant. Production times are the same for standard and architectural windows at Oregon due to the use of robotics. The Oregon plant has only one highcapacity production line. [See Figure #1: Oregon Plant layout.] Blutarsky recently reminded Ingrid of two critical factors: \u0007 he process description and process times for both T standard and architectural windows in Exhibits 3 and 4 are for ONE production line at the Texas plant. The Texas plant has five identical production lines. [See Figure #2: Texas Plant layout.] \u0007 he change-over times required to shift from standard T windows to architectural windows at the Texas plant are very high. The shift requires a complete shutdown and re-tooling of the production line. Therefore, a single line MUST be dedicated to either standard window production or architectural window production. Change-over between lines from standard to architectural or architectural to standard only occur annually during the period when the plant is closed for maintenance. IMA ED U C ATIONAL C ASE JOU RNAL Pelarsen took pride in its reputation for delivering high quality products to its customers. To that end, the company had instituted methods to ensure product quality. In the Texas plant, inspectors were responsible for inspecting product and for taking corrective action when necessary to correct defects and ensure a high quality product. These corrective actions included rework to fix the defect or, if necessary, removing and scrapping the unit. Niedermeyer was confident that Pelarsen's Texas plant was producing high quality products. \"Our numbers indicate that very few products come back to us from the customer for production defects. We're proud of that fact. It tells us that we produce a quality product and that our procedures are catching most defects that do occur in the production process. However, I'd like to have a more systematic approach to quality. I believe that this will be essential for me if, as planned, I have responsibility for producing a higher volume of the more expensive architectural windows in the future. \"I've read about quality management practices and process control. I know that many firms are now pursuing six sigma quality management practices. I'm not sure that we're ready for 6-sigma, but I'd sure like to see us operating at the 3-sigma level of quality associated with total quality management (TQM) practices. My Texas plant has very few returns, and I'll need to maintain this level of quality performance if I'm dealing with more demanding architectural-window customer segments. Specifically, I'd like to explore greater use of process management consistent with TQM and the adoption of leaner inventory systems - something on the idea of JIT. Architectural window materials are expensive, so I don't want to carry any unnecessary inventory charges. I see this strategy as essential to the improvement of our operations and the success of my proposal.\" In contrast, there were no designated inspectors on the Oregon line - quality was \"everyone's job\" and the automated system monitored key process tolerances on a continuous basis. When asked if he had any data related to quality, Niedermeyer again noted the low rate of returns but said that he had little else that he could share at this time. He did mention that he had some data from the forming (step #2) process at the Texas plant. He also explained that this was a crucial step in the process. \"Mistakes in forming can affect product quality and cause problems later in the process. The forming process determines the size of the space or gap for the glass insertion 5 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 process - it's the space where the glass fits into the window. Inaccurate forming of the unit could result in production problems at later job steps. A space that was too small could cause breakage during the glass insertion process. A space that was too large could result in poor thermal performance and/or breakage after the completed window unit was installed. This is particularly important with the more expensive architectural windows. The target value is the same for both window types, 0.250 inches. However, the specifications are tighter for architectural windows. I have some data from the forming process at the Texas plant for both standard windows (Exhibit 6) and architectural windows (Exhibit 7). I don't know if this is helpful for you, but you're welcome to take what I have. I'll see that John's team gets these data when we deliver the promised process analysis data tomorrow.\" Purchasing was centralized, but the supplier network was somewhat dispersed. Wood for standard windows was a commodity, but specialty wood products for architectural windows were sourced either from the Pacific Northwest or from regions surrounding the original Minnesota facility. Specialty hardware suppliers tended to be more available in the areas where larger custom homes were being constructed. The material costs for wood, glass, and hardware, therefore, were roughly the same with only minor differentials for transportation costs. On the labor side, all plants employed two types of labor - skilled carpenters and unskilled apprentice carpenters and helpers. At Texas, the current mix was 50-50 for each type of labor. Niedermeyer had increased the percentage of skilled carpenters in anticipation of producing a greater proportion of architectural windows than his current mix. However, both types of carpenters were available in the local Houston labor market and Niedermeyer had no difficulty increasing or decreasing the numbers of either class of workers on short notice. Recently, many of the plants had started to switch to activity based costing (ABC) for their internal decisions. Oregon had switched to ABC completely, but Texas was only halfway in its transition to ABC. At Texas, the marketing costs had been recomputed using ABC (see Exhibit 9). The manufacturing costs were still based on the traditional cost system, although a lot of the process data to perform the ABC analysis had been identified (see Exhibit 10). With its current staffing level, the Texas plant was using approximately 900,000 labor hours per year. At this level the budgeted variable costs were $2.5 million per year, resulting in a variable overhead rate of $2.78 per labor hour. The fixed production costs were $7.125 million, and these were assigned to products based on production volume. Exhibits 1A-1H summarize the detailed cost and operations data that the Texas plant controller used to support the profit projection in Exhibit 1. Cost Structure The plant used a traditional job costing system, which had been put into place in the early 1960s. The only change since then was computerizing the system for faster, more automated data processing. There are several basic factors that determine a final window design. While there are many different combinations of windows that can be produced using those factors, the study discovered that the cost of the windows mirrored the product and process complexity of producing that window. Standard (the standard rectangular wood window) was the cheapest to produce, while architectural (curved or arched vinyl clad windows with special glass and accessories) was the most expensive to produce. Currently, both the Texas and the Oregon plants were producing standard and architectural windows - though in different proportions. In the past, nearly 90% of the windows produced at Texas were standard while in Oregon, only 33% of the windows were standard. Three types of production costs - direct materials, direct labor, and variable production overhead - were traced directly to each job. All other indirect production costs (e.g., general production overhead such as equipment depreciation, rent and occupancy, supplies, scrap costs, etc.), fixed marketing cost and general administration costs were allocated to the jobs based on production volume (that is, the number of windows produced). The Texas plant controller's notes to Exhibit 1 describe the allocation process in a bit more detail. The company purchased all of its materials centrally with vendors delivering the materials to the plant as requested. IMA ED U C ATIONAL C ASE JOU RNAL Scrap, Rework, and External Benchmarking Blutarsky asked the Texas plant controller to supply him with some historical data related to scrap and rework costs at the Texas plant. That data is contained in Exhibit 1H. Blutarsky also collected benchmarking data on the industry to see how Niedermeyer's plant compared to others in his peer group. Selected portions of the benchmarking data that are relevant for plants with a profile similar to Texas (that is, high labor and simpler machines) are shown in Exhibit 8. 6 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Based on that research, Blutarsky concluded that the Texas plant was performing well below the peer group in three key areas. These were scrap and rework quality costs, labor mix management, and working capital management. In the area of product quality, most of the problem stemmed from materials scrapped before production started or from leaks in glass installation uncovered after the windows were installed. Architectural windows utilized a greater variety of glass and thermal design features. Thus, they were more sensitive to the effects of climatic changes and thermal performance, both heating and cooling. Furthermore, the design of these windows often made them more sensitive to the constant ground movement in earthquake zones or foundation expansion and contraction, which created stress on window panes. Most (75%) of the broken or cracked glass had to be replaced by a skilled carpenter who had to travel on average two hours to a customer's site to perform the replacement and reseal the window. In the labor mix area, peer plants typically used a much smaller proportion of highly paid skilled carpenters. Plants that produced predominantly standard windows typically used 20% skilled carpenters and the rest of the work was handled by apprentice carpenters and helpers. Finally, peer plants seemed to have a smaller investment in working capital - keeping little inventory and collecting their receivables faster. The Oregon plant, in contrast to the Texas plant and the plants in the industry benchmark group, is capital intensive, with a focus on modern numerically-controlled machines to do special forming, glass sealing, and gas insertion. The cost of the assets in this plant was several times the cost of the Texas plant and, consequently, the depreciation at the Oregon plant was nearly four times higher than Texas. While a large portion of the depreciation in the Texas plant was related to furniture, fixtures, and hand-controlled tools, most of the depreciation at the Oregon plant came from expensive production equipment. On the other hand, since Oregon used a highly automated process, the plant there employed far fewer laborers (mostly skilled machine operators). Figure #1: Plant Layout at Pelarsen Windows Oregon Plant [1 Automated (robotic) Production Line] RECIEVE & STORE RAW MATERIALS Pre-fabrication step #1 Pre-fabrication step #3 Multi-stage, fully automated robotic fabrication system (Capacity of the automated system is 1,150 windows/day) Post-fabrication step Figure #2: Plant Layout at Pelarsen Windows Texas Plant [5 Identical (parallel) Production Lines] R E C I E R V E E C E & I Cut & Shave Form & Shape Insert Glass Attach Hardware Apply Primer Install Cladding Inspection Step StampBar Code & Pack Cut & Shave Form & Shape Insert Glass Attach Hardware Apply Primer Install Cladding Inspection Step StampBar Code & Pack Cut & Shave Form & Shape Insert Glass Attach Hardware Apply Primer Install Cladding Inspection Step StampBar Code & Pack Cut & Shave Form & Shape Insert Glass Attach Hardware Apply Primer Install Cladding Inspection Step StampBar Code & Pack Cut & Shave Form & Shape Insert Glass Attach Hardware Apply Primer Install Cladding Inspection Step StampBar Code & Pack V S E T & O R S E T O R R A E W R M A A W T M E A R T I E A R L I S A L S IMA ED U C ATIONAL C ASE JOU RNAL Pre-fabrication step #2 7 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 1 Projected Texas Plant Product Line Income Statements for2008 Prepared for Doug Niedermeyer Revenue Standard\tPercent\tArchitectural\tPercent\tTotal $81,000,000 100.0% $40,750,000 100.0% $121,750,000 Variable Costs Wood 31,129,313 38.4% 11,264,688 27.6% 42,394,000 Glass 15,012,422 18.5% 9,530,078 23.4% 24,542,500 Cladding, Hardware, etc. 6,750,000 8.3% 7,250,000 17.8% 14,000,000 Total Materials Cost 52,891,734 65.3% 28,044,766 68.8% 80,936,500 Wages, Skilled Carpenters 13,253,625 16.4% 2,454,375 6.0% 15,708,000 Wages, Helpers 6,834,375 8.4% 1,265,625 3.1% 8,100,000 Total Wages 20,088,000 24.8% 3,720,000 9.1% 23,808,000 Variable Overhead 1,635,268 2.0% 898,065 2.2% Total Variable Costs 74,615,002 32,662,831 107,277,833 Contribution Margin 6,384,998 8,087,169 14,472,167 Fixed Production Overhead 6,182,367 7.6% 1,144,883 2.8% 7,327,250 Marketing and G&A Costs 2,700,000 3.3% 500,000 1.2% 3,200,000 Accounting Profit -2,497,369 -3.1% 6,442,286 8.0% 3,944,917 2,533,333 Capital Charge 5,128,500 Economic Profit -$1,183,583 Controller's Notes: 1. \u0007 he projected plant income statement above employs T the standard costs and revenues for the plant, as detailed in Exhibits 1B to 1H, below, but assumed production of 270,000 standard windows and 50,000 architectural windows, as shown in the schedule labeled Exhibit 1A. 2. \u0007 ood and glass cost projections in the projected income W statement include the standard cost of material as shown in Exhibit 1B plus the cost of spoilage, scrap, and rework at recent historical levels (see Exhibit 1H). These additional costs have been allocated to product lines based on the production volume (84% and 16%) of each window type. 3. \u0007 imilar to materials, skilled labor costs in the projected S income statement include the standard labor cost as shown in Exhibit 1C plus the cost of rework at recent historical levels (see Exhibit 1H). The rework costs have been allocated to product lines based on the production volume (84% and 16%) of each window type. 4. \u0007 ariable overhead costs in the projected income statement V employ the standard variable cost rates shown in Exhibit 1D, adjusted for rework at recent historical levels (see Exhibit 1-H). The rework costs have been allocated to product lines based on the production volume (84% and 16%) of each window type. IMA ED U C ATIONAL C ASE JOU RNAL 5. \u0007 ixed overhead costs in the projected income statement F are based on amounts budgeted at the beginning of each year, detailed in Exhibit 1E, and allocated based on the production volume (84% and 16%) of each window type. 6. \u0007 arketing costs are estimated to be $3.2 million (see M Exhibit 1F) and they have been allocated based on the production volume (84% and 16%) of each window type. 7. \u0007 poilage, breakage, and rework percentages in Exhibit S 1H are expressed as % of final output (270,000 and 50,000 windows). For architectural windows, 3% of the broken glass is replaced at the plant while the remaining 12% is replaced at the customer site by a skilled carpenter who takes on average 2 hours to do this. 8 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 1A Standard Revenues Schedule Standard Percent of Total Units Architectural Units Produced & Sold 270,000 84% Average Per Unit Selling Price $300.00 50,000 Percent of Total Units 16% $815.00 Exhibit 1B Standard Material Cost Schedule Percent Standard Sales Price of Architectural Wood 110.00 36.7% Percent of Sales Price 220.00 27.0% Glass 50.00 16.7% 185.00 22.7% Cladding, Hardware, etc. 25.00 8.3% 145.00 17.8% Total Materials Cost 185.00 61.7% 550.00 67.5% Exhibit 1C Standard Labor Cost Schedule Paid Hours per Day 8 Paid Days per Year 250 Paid Labor Hours per Worker/Year 2,000 Hourly Wages + Benefits - Skilled Carpenters $34.00 Hourly Wages + Benefits - Carpenter Helpers $18.00 Labor Hours - Skilled Carpenters 450,000 Labor Hours - Helpers 450,000 Labor Hours - Standard Windows 578,571 Labor Hours - Complex Windows 321,429 Total Labor Hours 900,000 Exhibit 1D Standard Variable Overhead Schedule Budgeted Variable Overhead Cost $2,500,000 Budgeted Labor Hours 900,000 VOH Rate 2.78 per DLH Exhibit 1E Standard Fixed Overhead & Other Costs Schedule Salaries, Support and Supervisory Occupancy Costs (rent, furniture, etc.) $1,875,500 4,125,000 Equipment and Tools Depreciation 539,250 Other Depreciation 787,500 Total Fixed Overhead 7,327,250 IMA ED U C ATIONAL C ASE JOU RNAL 9 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 1F Marketing, Distribution, and G&A Costs Employees Sales Account Representatives Order Entry Clerks Shipping and Packing Salaries Space Used 6.00 7.00% 165,000 6.00 46.00% 300,000 5.00 18.00% 235,000 12.00 General Administrative Staff Salaries $900,000 4.00 Billing Associate Salaries 9.00% 20.00% 1,058,000 Packing Materials and Supplies 21,000 Annual Furniture and Fixtures Depreciation 205,000 Building Rent, Heat, and Other Occupancy Costs 100.00% 316,000 $3,200,000 Exhibit 1G Texas Plant Asset Base and Capital Charge Ratios Cash $2,000,000 5.91 days of sales Receivables 9,500,000 28.09 days of sales Inventories 12,000,000 53.38 days of materials cost Machine Tools & Equipment 7,190,000 Other Fixed Assets 10,500,000 Total Assets 41,190,000 Less Accounts Payable Net Investment 7,000,000 23.49 days of materials + labor+ VOH $34,190,000 Weighted Average Cost of Capital 15% Capital Charge $5,128,500 Exhibit 1H Texas Plant Asset Base and Capital Charge Standard Architectural Wood Loss or Spoilage 2% 10% Glass Breakage 3% 15% On-site Replacement of Broken Glass 12% Hours Needed to Replace On-site Glass 2.00 IMA ED U C ATIONAL C ASE JOU RNAL 10 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 2 Projected Income Statement for Oregon (Based on Niedermeyer's Suggested Production Schedule) Standard\tArchitectural\tTotal\tPercent Units Produced & Sold 130,000 180,000 Average Per Unit Selling Price $300.00 $815.00 Variable Costs as Percent of Sales 79.2% 74.0% Net Assets (Investment Base) 40,151,807 Weighted Average Cost of Capital 15% Revenue Current 39,000,000 146,700,000 185,700,000 Variable Costs 30,875,000 108,514,853 139,389,853 Contribution Margin 8,125,000 38,185,147 46,310,147 Total Fixed Costs 6,729,460 12,599,474 19,328,933 Accounting Profit 1,395,540 25,585,674 26,981,214 Capital Charge Economic Profit 25% 15% 6,022,771 $20,958,443 11% Exhibit 3 Process and Process Times for Production of Standard Windows at the Texas Plant 1. Cutting and Shaving: The cutting and shaving process cuts \u0007 5. \u0007\u0007\u0007\u0007 Applying Primer Coat: There are 10 machines and 10 wood pieces into the correct window size and smoothes them. This batch process accommodates 8 units of production within each batch. The set-up time required to align wood for each frame is 1.5 minutes. Following alignment, it takes 44 minutes of cutting and shaving time for each batch of 8. There are 12 workers and 6 cuttingshaving machines dedicated to this process - i.e., 2 workers per machine. 2. Forming: The forming process shapes the wood pieces into \u0007 the correct window styles (examples: bay windows, arches, transoms). The forming machine processes batches of 6 windows. This batch process requires 3 minutes to load each window onto the forming machine. Following loading of the 6 windows, it requires 43 minutes of forming time per batch of 6. There are 16 workers and 8 forming machines dedicated to this process. 3. Inserting Glass: Glass insertion requires 7.7 minutes of \u0007 processing time per window. Each window must be processed individually at this step and in all remaining steps (steps 4-8) in the window fabrication process. There are 6 machines and 6 workers at this process step. 4. Attaching Hardware: There are 12 machines and 12 workers \u0007 at this process step. Each window requires 15.2 minutes of processing time to complete the hardware attachment process step. workers at this process step. Each machine requires 12.0 minutes of processing time per window. 6. \u0007nstalling Cladding: There are 6 machines and 12 workers at I this production step. Each machine requires 7.4 minutes of processing time per window. 7. Inspection: There are no machines at this step. There are \u0007 12 inspectors, each of whom works independently (i.e., one worker per window inspection). Each worker requires 14.0 minutes to thoroughly inspect a window. 8. UPC application, bar code scanning, and packing for ship\u0007 ment: A single machine applies the UPC code, scans the code, shrink wraps the window, and packages the units for shipping. It requires 2 workers to operate this machinery, 1 to guide the flow of units into the machine and 1 to remove the packaged units. There are 5 machines and 10 workers at this production step. Each machine processes a unit every 6.0 minutes. IMA ED U C ATIONAL C ASE JOU RNAL 11 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 4 Processing Times for Architectural Windows at the Texas Plant Exhibit 5 Operations at the Oregon Plant Fabrication of architectural windows at the Texas plant follows the exact same 8-step process as fabrication of standard windows. The only difference is the amount of time required to complete each step, which is generally longer for architectural windows as compared to standard windows and the batch size in steps #1 and #2. Each processing line has the same number of workers and machines at each step. As noted in the case, a given production line can only produce one type of window - either standard or architectural - at any given time. When computing operating capabilities for architectural windows, the consultants should assume the same 8 steps with the same number of machines and workers as detailed above in Exhibit #3. However, the processing times will be different. For processing time at each step, architectural window require: 1. \u0007 he batch size is reduced to 4 for architectural windows. T Alignment time increases to 5 minutes per window. Processing time for the batch of 4 is 55 minutes for architectural windows. 2. \u0007 he batch size is again 4 for architectural windows. T Loading time per window is now 4 minutes and processing time for the batch of 4 is 43 minutes. Steps 3-8 are identical to steps 3-8 in Exhibit 3, but the processing times for architectural windows are different. The process times for architectural windows are as follows: 3. 15 minutes per window 4. 30 minutes per window 5. 24 minutes per window 6. 10 minutes per window 7. 14 minutes per window 8. 6 minutes per window The Oregon plant is highly automated and makes extensive use of robotics in the fabrication of windows. The automation utilized in the Oregon plant creates a production system that has the same processing times, thus the same capacity, for both standard and architectural windows. The majority of the production line is automated and controlled by robotics. There are three steps requiring workersmachines that precede the movement of product into the automated line and one step at the end of the automated line where workers simply remove completed windows from the line and place them in shipping containers. 1. \u0007 re-fabrication step #1: There are 6 machines and 6 P workers at this step. These workers load the window components onto the automated line. The processing time per window is 2.4 minutes. 2. \u0007 re-fabrication step #2: There are 6 robotic machines and P 3 workers at this step. These machines properly align the components before feeding into the automated fabrication system and each worker can monitor 2 machines. The processing time per window is 2.45 minutes. 3. \u0007 re-fabrication step #3: There are 6 robotic machines and P 3 workers at this step. These machines feed the aligned components into the automated fabrication system and each worker can monitor 2 machines. The machines are sequenced so that there is a constant flow of components into the automated system. The processing time per window is 2.5 minutes. 4. \u0007 utomated-robotic fabrication line: This is a fully A automated fabrication system consisting of a series of robots that fully fabricate, finish, stamp, shrink-wrap, and package the windows. No production calculation is required here as the robotics control production. The robotic line is rated at a maximum production capacity of 1,150 windows per day. 5. \u0007 ost-fabrication step: There are 6 workers at this step. P The workers remove the fully fabricated, packaged windows from the production line and place them in the appropriate shipping containers. Each worker operates independently and requires 2.4 minutes of processing time per window. IMA ED U C ATIONAL C ASE JOU RNAL 12 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 6 - Process Data Standard Window Production at the Texas Plant Process specifications for Standard Windows are: 0.250 plus or minus .03 Unit # 1 Unit # Unit # Unit # 0.265 21 0.251 41 0.247 61 0.252 2 0.25 22 0.248 42 0.257 62 0.251 3 0.261 23 0.248 43 0.239 63 0.246 4 0.245 24 0.251 44 0.245 64 0.25 5 0.239 25 0.263 45 0.265 65 0.251 6 0.247 26 0.245 46 0.25 66 0.248 7 0.251 27 0.242 47 0.266 67 0.251 8 0.248 28 0.247 48 0.245 68 0.254 9 0.248 29 0.251 49 0.233 69 0.247 10 0.251 30 0.248 50 0.247 70 0.257 11 0.262 31 0.251 51 0.251 71 0.239 12 0.245 32 0.254 52 0.248 72 0.245 13 0.236 33 0.247 53 0.251 73 0.265 14 0.247 34 0.257 54 0.254 74 0.25 15 0.251 35 0.239 55 0.247 75 0.266 16 0.248 36 0.245 56 0.257 76 0.245 17 0.248 37 0.265 57 0.239 77 0.233 18 0.251 38 0.25 58 0.245 78 0.247 19 0.266 39 0.266 59 0.265 79 0.25 20 0.245 40 0.245 60 0.25 80 0.25 Exhibit 7 - Process Data Architectural Window Production at the Texas Plant Process specifications for Architectural Windows are: 0.250 plus or minus .025 Unit # Unit # Unit # Unit # 1 0.2655 21 0.2625 41 0.2525 61 0.2535 2 0.2615 22 0.2305 42 0.2625 62 0.2535 3 0.2625 23 0.2325 43 0.2445 63 0.2565 4 0.2305 24 0.2535 44 0.2505 64 0.2555 5 0.2325 25 0.2485 45 0.2705 65 0.2565 6 0.2535 26 0.2275 46 0.2735 66 0.2535 7 0.2485 27 0.2535 47 0.2695 67 0.2735 8 0.2275 28 0.2645 48 0.2705 68 0.2695 9 0.2535 29 0.2565 49 0.2385 69 0.2705 10 0.2645 30 0.2275 50 0.2405 70 0.2385 11 0.2565 31 0.2305 51 0.2615 71 0.2405 12 0.2275 32 0.2365 52 0.2565 72 0.2615 13 0.2305 33 0.2565 53 0.2355 73 0.2565 14 0.2365 34 0.2455 54 0.2615 74 0.2355 15 0.2565 35 0.2455 55 0.2725 75 0.2615 16 0.2455 36 0.2485 56 0.2645 76 0.2725 17 0.2455 37 0.2625 57 0.2355 77 0.2645 18 0.2485 38 0.2495 58 0.2385 78 0.2355 19 0.2655 39 0.2655 59 0.2445 79 0.2385 20 0.2615 40 0.2445 60 0.2645 80 0.2445 IMA ED U C ATIONAL C ASE JOU RNAL 13 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 8 - Benchmarking Data for Millwork Industry Item\tPercent of Revenue Average Selling Price per Unit 100.0% Purchased Materials and Parts 64.5% Labor Cost 16.2% Depreciation 1.2% Utilities 0.8% Rent 1.1% Other* 6.2% Profit 10.0% Receivable Turnover 20.00 days Inventory Turnover 15.00 days Accounts Payable Turnover 30.00 days *includes .05% of waste and spoilage cost IMA ED U C ATIONAL C ASE JOU RNAL 14 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 Exhibit 9 - Process Cost Data for Texas Resources Used by Activities Cut & Form & Insert\tAttach\tApply Plane\tShape\tGlass Hardware\tPrimer Install Inspect\tStamp & Total Cladding Bar Code Skilled Workers 30 40 15 30 25 30 30 25 225 Hours Per Year 60,000 80,000 30,000 60,000 50,000 60,000 60,000 50,000 450,000 Unskilled Workers 30 40 15 30 25 30 30 25 225 Hours Per Year 60,000 80,000 30,000 60,000 50,000 60,000 60,000 50,000 450,000 Total Labor Hours 120,000 160,000 60,000 120,000 100,000 120,000 120,000 100,000 900,000 Square Footage 20,000 12,000 15,000 15,000 13,000 9,000 4,000 12,000 100,000 3 4 Supervisory/Support Staff Total Machinery Cost 13 16 8 6 6 1,050,000 840,000 900,000 2,100,000 675,000 750,000 4 60 875,000 7,190,000 Annual Depreciation Rate Depreciation Expense 78,750 63,000 67,500 157,500 50,625 56,250 65,625 Resource Drivers Direct Labor Traced directly to process steps by direct labor hours Variable Overhead Assigned to process steps based on direct labor hours Supervisor & support salaries Assigned to process steps based on percentage of total supervisor/support headcount Occupancy costs Assigned to process steps based on percentage of square footage occupied Machinery Depreciation Traced directly to process steps Other Depreciation Assigned to process steps based on percentage of total supervisor/support headcount Activity Drivers Used by Products Per Window Total\tStandard Architectural Number of Saw Cuts 2,520,000 6.0 18.0 Skill Saw Time 470,000 1.0 4.0 Glass Insert Time Units* 840,000 2.0 6.0 Hardware Pieces Attached 940,000 2.0 8.0 Paint Gun Hours 185,000 0.5 1.0 Number of Units Clad 106,000 0.3 0.5 Number of Items Inspected 18,500 0.05 0.1 Number of Windows Produced 320,000 1.0 1.0 IMA ED U C ATIONAL C ASE JOU RNAL 15 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008 7.5% 539,250 Exhibit 10 - Sales, Administration, and Distribution Activities Cost Data for Texas Plant Sales and Administrative Cost and Resource Drivers Equivalent Headcount\tSpace Used\tSalaries Paid Sales Account Representatives 6.00 9.00% $900,000 Order Entry Clerks 4.00 7.00% 165,000 Shipping and Packing Salaries 6.00 46.00% 300,000 Billing Associate Salaries 5.00 18.00% 235,000 General Administrative Staff Salaries 12.00 Packing Materials and Supplies 20.00% 1,058,000 100.00% 21,000 Annual Furniture and Fixtures Depreciation 205,000 Building rent, heat, and other occupancy costs 316,000 Total 33.00 $3,200,000 Sales and Administrative Resources Used by Activities Salaries and Wages Call on Customers\tProcess Orders\tPack & Ship\tBill Accounts\tGeneral Admin\tTotal $900,000 $165,000 $300,000 $1,058,000 $2,658,000 $21,000 Packing Supplies and Boxes $235,000 $21,000 Equipment Depreciation $37,273 $24,848 $37,273 $31,061 $74,545 $205,000 Occupancy Costs $28,440 $22,120 $145,360 $56,880 $63,200 $316,000 Total Activity Cost $965,713 $211,968 $503,633 $322,941 $1,195,745 $3,200,000 Activity Drivers Used by Products Per Window Total\tStandard Architectural # Customer Contact Hours 33,500 17,500 16,000 # Orders 21,000 13,300 1,700 # of Boxes Packed 53,000 27,000 26,000 # of Billing Transactions* 22,000 16,000 6,000 *Activity Cost Driver for both Bill Accounts and General Administrative Activities About IMA With a worldwide network of nearly 60,000 professionals, IMA is the world's leading organization dedicated to empowering accounting and finance professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through Certified Management Accountant (CMA) certification, research, professional education, networking and advocacy of the highest ethical and professional standards. For more information about IMA, please visit www.imanet.org. IMA ED U C ATIONAL C ASE JOU RNAL 16 VOL. 1, N O. 3, ART. 3, SEPTEMBER 2008