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ACG 6425 - Strategic Cost Accounting Body Glove Russ Lesser, President of Body Glove (BG), a small wetsuit manufacturer, reviewed the progress his company had made, as well as the problems it had encountered, in the nine months he had been president. The company was performing well: it was profitable and was ranked number 2 in market share in the wetsuit industry. But Russ knew that his newly appointed management team could not afford to be complacent. The wetsuit industry is highly competitive and the markets are complex, with rapid growth, fashion conscious customers, and seasonal demand. Much of BG's success depends on its ability to respond quickly and in a coordinated fashion to changing market conditions. These responses should be facilitated by the company's management control systems, and Russ wondered if the company had the right control systems in place. The wetsuit industry was founded by small entrepreneurs, but it was currently dominated by a small number of larger companies, O'Neill, the largest company in the industry, with approximately 60% of the market share, had the reputation for producing high quality 'basic' wetsuits. BG, number two in the industry, was known as a fashion conscious, high quality producer. O'Neill and BG competed directly against each other in all market segments; the remaining manufacturers specialized. For example, Rip Curl, the third largest firm in the industry, focused on the surfing market. BG marketed itself as a wholesome 'life-style' brand, while O'Neill had a 'bad boy' image. Maintaining this image required BG managers to approve everything sold with the company logo on it for image and quality, since they licensed their logo for use by other clothing manufacturers. In order to remain competitive in the wetsuit industry, manufacturers have to provide a large array of styles and colors to meet consumer demands, and their ability to react quickly to changing trends determined their success. The large product line required manufacturers to carry significant amounts of raw materials and a large finished goods inventory. History In 1953, two former lifeguards, twin brothers, Bob and Bill Meistrell, opened Dive 'n Surf, a retail water sports store in Hermosa Beach, CA. Later that year they developed a wetsuit made of neoprene that 'fit like a glove' in order to protect surfers and divers from the cold ocean temperature. They began manufacturing the wetsuits with the BG logo and selling them both within their shop and to other retailers. In the first thirty years of existence, the BG division of Dive 'n Surf Inc. developed a small but loyal customer base in California based on dependable products, fair prices, and superior customer service. BG started as a family owned business and remains one today. Total revenue for BG's parent, Dive 'n Surf, is approximately $15 million, with nearly $8 million coming from wetsuits. Total annual revenues of other companies using the BG label (licensed products) was approximately $100 million. Dive 'n Surf received approximately $2.5 million in licensing fees based on these sales. Market BG produced a full line of wetsuits and accessories designed to meet the needs of all water sport enthusiasts. Demand is highly seasonal, so to smooth out the workload and cashflows, the company started producing snow skiing and snowboarding apparel and orthopedic products, such as knee braces and pads. BG sold its products through sports and specialty retail stores, including its own Dive 'n Surf retail stores in Redondo Beach and Del Amo, California. Table 1 shows all of the product lines sold by BG. 1 Table 1: Body Glove Product Line Overview Surfing Triathlons Waterskiing and Jet Skiing Diving Whitewater Sport Accessories Ski and Snowboard Line Orthopedic Products Cold water wetsuits Triathlon wetsuits Cold water wetsuits Cold water wetsuits Cold water wetsuits Surf accessories, booties, gloves, hoods Neoprene pants, bibs, and jackets Braces, pads, gloves, supports, shorts The company's number one goal is to dethrone O'Neill and become the number 1 wetsuit manufacturer. But the growth the company experienced in the last 5 years had put pressure on the manufacturing operations. The manufacturing areas not only had to increase capacity, but also had to maintain flexibility to meet the highly segmented and changing consumer demands. Marketing Strategy BG had increased its market share over the past few years because of its quality product line and firm commitment to dealer and customer service. BG's strategy is to provide excellent service and products not available elsewhere to the smaller specialty and large retail stores. In total, BG sells their wetsuits in 1,500 stores in 33 different countries. BG's competitive advantage comes from their manufacturing quality and flexibility and their designs that satisfy customer needs. BG maintains its commitment to service by rewarding their sales representatives based on customer service goals, not the number of units sold. The sales representatives are salaried employees and do not receive commission. They are given the opportunity to earn bonuses based on both the amount of sales made during the year and their client's satisfaction. Order Cycle BG produced products for two seasons, fall and spring. The fall line, which is produced from thicker neoprene than the spring line, consists of full suits, jackets, leg suits, hoods, and hooded vests, as well as skiing and snowboarding products. The spring line consists of spring suits, warm water wetsuits, trunks, vests, and water ski suits. Fall suits are more labor intensive and used more expensive material. The cost of a full fall suit averaged about $200; for the spring line the average is about $125. Customers begin buying the fall line in retail outlets in August/September and the spring line in February/March. The company produces all product lines throughout the year, but the majority of each line is sold during the season the wetsuit is intended. BG's revenues are derived approximately 60% from fall and 40% from spring. Production Process The mission of BG's production department is to manufacture quality products efficiently while maintaining the production flexibility necessary to satisfy constantly changing consumer demands. BG is the only manufacturer that did all of its production domestically in a single facility, which is located in Hermosa Beach, CA. The company's ideal is to produce at a constant rate, but that is not always possible. One constraint is the size of the facility in Hermosa Beach, which is not large enough to store the desired levels of inventory. Historically, there was only one production line. Currently, BG is 2 expanding to two production lines: one for large and forecast orders and the second one for specialty orders. Demand Forecasting and Production Policies The new management team headed by Russ Lesser, believing that the costs of inventory stock-outs (when there is demand, but no inventory to sell) are greater than the 12% annual inventory carrying costs, decided to stock more finished goods in inventory. In addition, company managers began basing their forecasts for production scheduling purposes on a combination of pre-book and historical data. They knew that historically the pre-book numbers represented 50 - 60 percent of BG's total sales for the season so they began building 50 percent of their forecast early as Russ Lesser was confident that \"half was safe because we shouldn't be off by 50 percent.\" The early results of these production changes are encouraging and they are able to turn their inventory twice in a season. Spring sales this year had increased 45% over the prior year sales. Planning, Budgeting, and Operating Reviews BG prepared its first revenue and expense budget last year. Up to that time, they had never prepared a formal budget. To produce their first budget, Russ employed a simple bottom-up process. Russ wanted a bottom up process because, as he said, \"It's not right for me to pick a number out of a hat and tell Kurt, 'You have to meet this number.\" For the initial budget last year, the management team estimated a 25 percent increase in sales and Kurt Rios, national sales manager, broke the sales down by month and by product. The budgeting process begins each year in November where Russ requests each department develop monthly projections of key expenses for the upcoming fiscal year. After the preliminary budgets are prepared, Russ consolidates, reviews, and discusses them with his managers, sometimes suggesting changes. Russ thought most of his managers are too optimistic in forecasting revenues but their expense projections are \"amazingly accurate\". Budgets are finalized by the end of December and the final approval rests with Russ. The projections are not utilized by any external parties for financing. BG has had a 20 year relationship with their bank and they do not require projections since all loans are secured by assets. During the year, the budget is used by Russ to monitor performance as well as to detect early warning signs of problem areas. Russ compares actual performance on a monthly basis. If a department did not achieve its budget targets, the department's head performance evaluation could be affected, but Russ would first try to isolate the reason(s) behind the department not making budget and assess whether the department head had any control over the problem. For example, in July of last year, the company's sales were below budget, but Russ concluded that the variance was not a real problem since production efficiency in June resulted July's orders shipping in June; therefore, the revenues and profits were also recognized in June. The annual budget is not revised formally unless significant uncontrollable circumstances exist because Russ wants to see at the end of the year \"how we did vs. what we thought we'd do.\" However, Russ did revise the prior year budget based on world events occurring in the geo/political arena. After reviewing the actual results for the first three months of last year, he adjusted the budget numbers for the second quarter of the year downward, but he adjusted the second half numbers upward, so the totals for the year were unchanged. The current year budget, which includes the July budget and the year-to-date cumulative numbers through July, is attached as Addendum 1. 3 Budget related performance is not explicitly linked with any performance-based incentives. BG has a profit sharing plan for all the rank and file employees with at least two years employment. Profit sharing can total 6 - 7 percent of base salary. If there is money left in the bonus pool after paying employee bonuses, the remainder is set aside for management bonuses. Thus in BG, contrary to the practice in many firms, managers earned their bonuses last. In a normal year, bonuses for managers are 10 - 12 percent of salary. In a bad year, such as the prior year, no manager bonuses are paid out. Assignment of management bonuses is done subjectively. Top-level managers assigned the bonus pool based on a number of indicators relevant to each individual's job, including customer service and satisfaction, sales levels, factory productivity, and expense control. BG has a five year organizational plan, the focus of which is on marketing. This plan had few numbers in because of the high uncertainty in the market. Russ said, \"If the bank ever wants numbers, I can give them to them. In fact, I can give them any set they want. It's all smoke.\" Concern for the Future As Russ considered the future of BG, he wondered if the company should do anything differently. Should he implement more formalized planning and performance evaluation processes? Many people thought the company's informal culture had been a key to its success over the years, but the company is now larger and its operations significantly more complex than they had been in the past. Should he break out BG's financial operations as a separate entity. This might require allocation of some shared expenses, such as corporate overhead. Should he prepare separate financial reports for each product line? Questions to be addressed in the case study write-up: 1. Which of these roles does BG's budgeting system currently assist them in and how: Planning, Communication, Motivation, Control, Evaluation, and/or Education? 2. Would you recommend any changes to the Russ' budgeting process and performance review process? 3. Is BG's current budget (Addendum 1) in a format that will assist managers in their planning and decision-making? Why or why not? If not, please provide the budget in a revised format even if you do not have all of the information that you think is needed. 4. Is BG's budget operating as an effective lever in their overall MCS (think about all of Simon's Levers of Control)? As part of the MCS, is BG using performance measurement and incentives to effectively influence behavior and achieve the objectives they desire? 5. Last, but not least, based on Russ' opinion (tone at the top) that the numbers are all \"smoke\