Mile High Cycles

In 2005, Bob Moyer was reviewing production costs for Mile High Cycles. Located in Denver, Colorado, the company sold very high-quality, handcrafted mountain bikes to bicycle retailers throughout the country. Sales for the company were $13 million that year.

Bob Moyer had been an avid cyclist in college, racing for the Stanford University cycling team while completing his degree in mechanical engineering. After working for a few years as a design engineer for a company in Denver, Bob decided to start his own business. As a hobby, he had designed and built several prototypes of a mountain bike, which had been entusiastically received by his mountain-biking friends. Approaching several friends and relatives for start-up money, Mile High Cycles was founded in 2003.

A mountain bike was a bicycle with 15 to 21 speeds, designed and built to take the punishment of riding on dirt trails and roads. The bikes were first made by avid cyclists who customized their 10-speed road bikes in order to ride on mountain trails and dirt roads. Some with framebuilding experience began to experiment making their own frames in order to handle better the additional demands of off-road riding. By 1992, several small companies had emerged selling bicycles specifically designed for riding under these conditions.

During the rest of the 1990s, mountain bikes had taken off in popularity, not only for use off-road but also for use in the city, where their sturdy construction could withstand the poundingfrom potholes and curbs. In addition, many casual cyclists preferred the mountain bike's more upright riding position in comparison to that of the hunched position of the 10-speed road bike. Sales of all bicycles in the United States had declined in 2003. However, over the same time period, sales of mountain bikes increased to more than 2.0 million units.

Bob Moyer had planned to produce 10,000 bikes in 2004, all of one model. Operations at Mile High Cycles consisted of three departments: frames, wheel assembly, and final assembly. In frames, steel tubing was cut to length for the components of the frame. The the prices were carefuly welded together to form the completed frameset. This part of the process was quite time-consuming, requiring frequent inspection and measurement to ensure that the frameset was aligned perfectly. After welding, the frame was painted in one of 10 different colors schemes and prepared for final assembly.

In wheel assembly, front and rear wheels were assembled from their key components: hubs, spokes, and rims. All of the components were purchased from an outside supplier. Mile High Cycles used a high-quality automatic lacing and truing machine to build its wheels. This machine would lace the spokes between the hubs and rim and then automatically tighten the spokes to the appropriate tension. The machine was quite precise but would occasionally damage spokes during the insertion process. In such a case, the operator would replace any damaged parts and restart the machine. Each wheel would also be inspected and trued by hand in order to insure that the wheels were in perfect alignment.

In final assembly, the frame and wheels were combined with other purchased parts to create the final package that would then be shipped to bicycle dealers. In this area, the front fork and many other key componets were attached to the frame, and the inner tubes and tires were mounted on the wheels. In order to minimize damage while shipping, some of the bicycles' components were left packaged for the bicycle dealer to assemble before selling the bike to the final customer. All of the components were purchased from outside suppliers and then were combined to form kits for the bicycles. Mile High Cycles carried an inventory of spare parts to replace any parts damaged during assembly or shipping, although such replacement was quite infrequent.

In reviewing his costs, Bob noted that he had produced 10,800 bicycles in 2004, 800 more than planned. Bob thought that operations durning the year had done well to meet the additional demand, but he wondered if Mile High Cycles was doing a good job in managing its costs. Exhibit 1 shows the planned material, labor, and overhead costs for 2004. Exhibit 2 shows the actual material, labor, and overhead costs for that year.

1. Should Bob Moyer be concerned about Mile High Cycles' performance? How significant are these variances?

Exhibit 1 2004 Production Budget Budget based on 10,000 bicycles production Frame assembly: Steel tubing Paint Labor Total frame $3,300,000 25,000 $1,500,000 $4,825,000 (110,000 lbs. @ $30.00/lb.) (1,250 gals. @ $20.00/gal.) (100,000 hrs. @ $15.00/hr.) $1,200,000 65,000 $1,265,000 (10,000 kits @ $120.00/kit) (5,000 hrs. @ $13.00/hr.) $3,500,000 105,000 $3,605,000 (10,000 kits @ $350.00/kit) (7,500 hrs. @ $14.00/hr.) Wheel assembly: Parts Labor Total wheel Final assembly: Parts Labor Total final assembly Overhead costs: Rent Office staff Depreciation Other costs Total overhead Total Annual Costs $250,000 100,000 100,000 750,000 $1,200,000 $10,895,000 (estimated to be 2/3 variable) Exhibit 2 2004 Production Costs Actual production: 10,800 bicycles Frame assembly: Steel tubing Paint Labor Total frame $3,572,100 28,187 $1,528,050 $5,128,337 (113,400 lbs. @ $31.50/lb.) (1,375 gals. @ $20.50/gal.) (100,200 hrs. @ $15.25/hr.) $1,317,600 25,000 74,250 $1,416,850 (10,800 kits @ $122.00/kit) (spokes and rims) (5,500 hrs. @ $13.50/hr.) $3,963,600 45,000 116,000 $4,124,600 (10,800 kits @ $367.00/kit) (miscellaneous parts) (8,000 hrs. @ $14.50/hr.) Wheel assembly: Parts Rework parts Labor Total wheel Final assembly: Parts Rework parts Labor Total final assembly Overhead costs: Rent Office staff Depreciation Other costs Total overhead Total Annual Costs $250,000 100,000 100,000 850,000 $1,300,000 $11,969,787