POOBAH MANUFACTURING COMPANY

PooBah Manufacturing produced a single product called the Grand PooBah. During the past three weeks, Lee High, the new cost accountant, had observed that production efficiency and input prices were constant but that output varied considerably. These three weeks were thought of as typical by the sales representative, who said that they could be taken as average. Production costs were accumulated and accounted for under seven different groups listed below:

	Units of Output	Direct Materials	Direct Labor	Indirect Labor	Indirect Materials	Electricity	Factory Insurance	Other Overhead
Week 1	400	$300	$500	$180	$300	$115	$125	$310
Week 2	500	375	625	200	300	125	125	360
Week 3	600	450	750	220	300	135	125	410

Lee High thought that this would be an ideal time to do some cost analysis on the Grand PooBah. Based on the data for the three weeks production costs, he felt it would be possible to identify fixed costs, variable costs, and semivariable costs. Furthermore, Lee wanted to develop some equations that might be useful for managerial decision making. From such equations, it seemed that break-even volume could be generated. Since production was usually based on orders actually received and since products were shipped immediately upon completion, inventories of work-in-process and finished goods were practically nonexistent. When talking to the sales representative, Lee discovered that on typical orders the selling price of Grand PooBah was $7.00. During lunch one day, Lee was told by the president that office expenses, including certain selling items, were fixed at $781 per week.

Lee High decided to begin his analysis with income statements from the past three weeks:

	Week 1	Week 2	Week 3
Sales	$ 2,800	$ 3,500	$ 4,200
Cost of goods sold	1,830	2,110	2,390
Gross Margin	$ 970	$ 1,390	$ 1,810
Less: other expenses	1,061	1,131	1,201
Net Income	$ (91)	$ 259	$ 609

From these statements, Lee realized that selling more added to profit. He also realized that cost of goods sold per unit seemed to fall as output rose:

When sales were 400, then cost of goods sold per unit was $4.58.

When sales were 500, then cost of goods sold per unit was $4.22.

When sales were 600, then cost of goods sold per unit was $3.98.

Lee wasnt sure why cost of goods sold per unit should fall, because, after all, the efficiency and input prices had remained the same. He reasoned that there was something odd about the data and decided it would be good to work with some average. Since the three weeks for which Lee had data were thought to be typical, he decided that some standardized cost information based on sales of 500 units per week would be helpful. He derived the following chart:

Useful Data on Grand PooBah

Average variable cost per unit produced	$2.80
Average fixed cost per unit produced	1.42
	$4.22
Average fixed administrative and selling cost per unit	1.56
Commission per unit sold	.70
	$6.48
Added amount for rounding error and some funny results in data	.12
	$6.60

The following should be kept in mind when selling Grand PooBah:

It costs us $6.60 to deliver a unit of Grand PooBah, so we make only 40 cents per unit at $7.00 selling price.

Decisions rule #1 (for sales representative on the road): Never sell Grand PooBah for less than $6.60 plus a profit margin because at $6.60 we just break even.

Decision rule #2 (for direct office sales on which no commission is paid): Never sell Grand PooBah for less than $5.90 plus a profit margin because at $5.90 we just break even.

Lee was very pleased with his chart, particularly the part about different decision rules. When the chart was finished, Lee passes it on to Mr. Tom Bosley, who was the owner, president and chief decision maker at PooBah Manufacturing. Bosley, who was skeptical of scientific analysis, studied Lee Highs chart and underlying data. That night Tom said to his lawyer, with whom he was having dinner, I finally have found the kind of practical fast-track analysis I need. This kid, Lee High, has just developed a set of decision rules that will solve all my pricing and profit problems.

The next day Tom Bosley sent a memo to the sales representative and others who were involved in pricing Grand PooBah. Among other things the memo stated, Everyone should study Mr. Highs chart, especially the decision rules he has generated through complex cost accounting procedures. From now on, all pricing decisions will follow these rules, and under no conditions will we price at less than 10% above our delivery cost. Therefore, the lowest prices that can be quoted by the sales representative and office force are $7.26/unit and $6.49/unit, respectively. This new policy means the sales representative had better stop taking orders at $7.00 per unit.

When he read the memo, Lee was both pleased and a bit disturbed. In the first place, he didnt expect Mr. Bosley to take his chart so seriously; in the second place, he knew intuitively that any price higher than $7.00 per unit for Grand PooBah was too high. Lee explained his position to Mr. Bosley, who in turn informed the sales representative that orders at $7.00 would be OK but nothing less would be accepted.

After this revision in policy, Lee felt better. Bosely went on vacation; the sales representative was confused; and the members of the office force, who could take orders by phone, were please with their new role.

During the next week, the following four sales prospects were available to PooBah Manufacturing for Grand PooBah.

The sales representative sold 450 units at $7.00 per unit.

The sales representative turned down a request from an irregular customer for 50 units at $6.50 per unit because of the $7.00 rule.

One telephone order was accepted for $6.50 per unit for 80 units, but another was rejected at $5.75 per unit for 50 units because of the $6.49 rule.

Ms. Adelaide Ladywell, a nineteen-year-old file clerk, received a phone call from Maze Woolwich when no one else was in the office. Maze said that he has seen Lee Highs data on costs, and since PooBah could produce more economically than Woolwich, he wanted to order 100 unites at $5.50. Furthermore, Maze explained that since he was going out of business, this would be his only order. Adelaide said that $6.50 was the minimum price, but Maze responded that that was just PooBah double-talk. Ms. Ladywell looked over the data and realized that on a special order like this, $5.50 would be a good price, considering that otherwise Maze Woolwich would produce 100 units himself. She accepted the order and anticipated a promotion when Mr. Bosley returned.

At the end of the week, Lee High prepared the following sales-cost report for Mr. Bosley.

Source	# of Units	Price/Unit	Cost/Unit	Profit/Unit
Orders We Accepted
From sales representatives	450	$7.00	$6.60	$.40
Office manager	80	6.50	5.90	.60
Adelaide Ladywell	100	5.50	5.90	(.40)
Orders We Rejected
From sales representative	50	6.50	6.60	(.10)
Office manager	50	5.75	5.90	(.15)

After Mr. Bosley looked over the report, he did two things:

He called in the sales representative and explained that it would be better for the company to sell 350 units at $8.00/unit than the 450 at $7.00/unit. He went on to say that at $8.00/unit, he would pay a commission of 15% instead of 10%. His reasoning was as follows:

$8.00	Revenue	$7.00	Revenue
5.90	Cost per unit per Lees chart	5.90	Cost per unit per Lees chart
$2.10	Contribution	$1.10	Contribution
1.20	Commission	.70	Commission
$ .90	Clear profit per unit	$ .40	Clear profit per unit
	350 units times 90 cents per unit equals $315 profit per week		450 units times 40 cents per unit equals $180 profit per week

The salThe sales representative was instructed to sell at $8.00 and guaranteed at least a commission of 15% on the sales of 350 units.

Bosley fired Adeline Ladywell over the Maze Woolwich mess. He said, No one is going to cause me to lose 40 cents per unit.

REQUIRED

What do you think about the whole situation write a one paragrapn summary of the case study? Evaluate Decision Rule #1 and #2, and develop a proper set of decision rules should these need changing.