south dakata microbrewery case study

i don't know how to do this case, is anyone can help me

SOUTH DAKOTA MICROBREWERY1 In 1992, two former Anheuser-Busch employees started their own brewery, South Dakota Microbrewery (SDM). Sandy Bennett and Dave Goldstone developed a business plan and obtained a Business Start-up Loan from a local commercial bank. The loan proceeds, combined with their own savings were sufficient capital to purchase a small manufacturing facility and equipment. To save money, they purchased most of the stainless steel equipment at a dairy farm auction and then converted the equipment to suit their needs. Other supplies and equipment were purchased from a brewers supply house in Wisconsin. As of December 1997, South Dakota Microbrewery has grown steadily and now produces three labels of specialty beers. The company posted its first profit in December 1995. The Brewing Process Brewing is essentially a four-stage process, as shown in Exhibit 1. Direct labor is incurred primarily in stages one, two and four. The first stage requires mixing malt, sugar, hops, and water and \"cooking\" the mixture. At this point the mixture is referred to as wort. SDM uses a 350 liter copper kettle with a natural gas burner for this part of the process. Preparing wort takes 4 to 7 hours, depending on the particular brew produced. The second stage of the brewing process requires siphoning the wort through a wort chiller into one of eight fermentation tanks owned by SDM. The wort chiller is a double copper tube in which cold water is forced one direction in the outer tube and the 1 Marjorie Platt adapted this case from one written by James A. Weisel in order to aid classroom discussion. wort is pumped the other direction (into the fermentation tank) through the inner tube. This action is required to chill the wort as rapidly as possible from boiling temperature to approximately 21C or 70F. Rapid chilling is necessary to minimize the possibility of contamination and bacterial growth in the wort. This stage of the process takes about one-half hour per batch, as the chiller can process about 10 liters per minute. Fermentation is the third step in brewing. Brewers yeast is added after the wort has been properly chilled and collected in the fermentation tank. The tank is then sealed and a fermentation lock is placed on the tank. Yeast, malt and sugar combine to form two products: carbon dioxide and alcohol. The carbon dioxide is allowed to escape through the fermentation lock that prevents air from entering the tank. The fermentation process takes from 3 to 14 days, again depending on the product being brewed. Several samples are taken from the brew during the fermentation process. Some samples are taken for taste testing. Others are used to determine the status of the fermentation process using a hydrometer. After this first fermentation is completed, flat beer has been produced. Thus, the final stage of the brewing process consists of carbonating the brew and siphoning it from the fermentation tank through a filter into bottles. The filter is used to prevent wild yeast from entering the bottles and to help the beer \"clear\" properly. Wild yeast can result in bacterial growth and cause the beer to have a cloudy appearance. SDM utilizes the injection method of carbonation. Essentially, CO2 is injected into the bottle simultaneously with the beer. The bottles are then capped, labeled and put into cool storage for several days. After three to five days of aging, the brew is ready to be sold and delivered to the local pubs that sell South Dakota beer. 2 South Dakota Microbrewery produces three different types of beer: Buffalo Ale, Four Heads Stout and Bismark Bock. Buffalo Ale is a medium-colored amber ale with a slightly sweet taste. SDM's Four Heads Stout is similar to the rich, bitter stouts from well-known Irish breweries. For both of these brews, the production process is fairly straightforward. By contrast, Bismark Bock requires more attention in order to obtain the thick, rich, full-flavored aromatic taste characteristic of bock beers. The ale was sold primarily to bars in college towns that ordered large shipments. SDM is planning to brew 250 batches of ale in the 1998 fiscal year. The stout and bock beers were more specialtytype products that were shipped to upscale restaurants and hotels that ordered smaller quantities. Consequently, SDM plans to brew 120 batches of both their stout and their bock beers. Distribution logistics was an important factor in maintaining a stable customer base and opening up new opportunities for SDM. After covering all of their manufacturing costs and distribution costs, Sandy and Dave split the remaining profits after paying their interest costs, taxes and setting aside a reasonable amount to fund unforeseen expenses. Company Prospects Between them, Sandy and Dave have 15 years of experience in the brewing industry. However, neither was experienced in management until they formed SDM. Local competition has been intense, causing some beer prices to fluctuate substantially. Ale prices have been falling throughout the market and SDM has followed recently with price declines over the last year. However, SDM recently raised its bock beer price 10% with no apparent market response to the price increase. Sandy attributed this to steady 3 demand and no local competition for this particular product offering. She was concerned, however, that ale prices had fallen such that the ale's gross margin had eroded far below the targeted 30% that she and Dave had established as a goal for each brew label. Sandy was concerned that extended sales of Buffalo Ale at low margins would cause SDM's profitability to decline. Currently, SDM was charging $1.05 per 18-oz. bottle for Buffalo Ale, $1.50 for Bismark Bock and $1.40 for Four Heads Stout. Sandy and Dave mentioned their concerns about the Buffalo Ale's declining gross margin to the company's accountant, Tom Hawkins. After some discussion, Tom suggested that the current plant-wide method of allocating indirect costs might not be the best method to use when different products utilize productive resources to varying degrees. It was agreed that Tom would investigate alternative costing approaches that could lead potentially to different pricing and marketing decisions. Specifically, Tom mentioned that SDM could probably benefit from using a cost accounting system that more directly traces overhead costs of production for each label. Cost Analysis After spending some time with Sandy and Dave as well as in the plant, Tom broke down estimated total annual overhead costs into eight different activities based on last year's records and anticipated cost increases, as shown in Exhibit 2. Also shown in Exhibit 2 are the cost drivers that Tom determined were associated with each activity. Exhibit 3 contains Tom's estimated total volume for each cost driver for the coming fiscal year (Panel A) and broken down by product (Panel B). Tom noted that depreciation 4 and storage are primarily fixed costs, while the maintenance & sterilization cost is halfvariable and half-fixed. The remaining cost pools are substantially variable in nature. Tom then started to compile the direct product costs associated with Buffalo Ale, Bismark Bock and Four Heads Stout. His analysis thus far is presented in Exhibit 3. Tom was still uncertain whether the plant-wide allocation of overhead based on direct labor-hours was appropriate. He wanted to compare this approach to activity-based cost (ABC) systems he had seen implemented in other firms. Once this analysis was completed, he should be able to assist Sandy and Dave with pricing decisions regarding their three beer labels. Questions to Guide the Analysis 1. Prepare a complete product cost estimate for Buffalo Ale, Bismark Bock and Four Heads Stout (See Exhibit 4) using: a. the plant-wide allocation based on direct-labor hours; b. an activity-based cost system. 2. For each costing method, what is the gross margin per batch for each beer label, in dollars? What is the gross margin percentage (GM/Selling Price)? What is the total gross margin for each beer label? 3. What are the advantages and disadvantages for both allocation systems in (1)? 4. What problem(s) does South Dakota Microbrewery face? If you observe problems with gross margins, what actions could you take to improve gross margins? Consider actions that affect product costs as well as actions that affect product revenues. Be specific. Analyze the impact of your actions on gross margin and gross margin percentage per batch and in total. If you recommend a price decrease, how much will volume have to increase (as a percent of current volume) to achieve the same total gross margin as the beer label currently earns? If you recommend a price increase, how much can your volume drop (as a percent of current volume) before your total gross margin is less than the beer label currently earns? What do you recommend? Justify your answer with supporting arguments. 5. How does the allocation cost system used affect SDM's total net income for the upcoming year? (Assume that the company produces and sells 250 batches of Buffalo Ale and 120 batches each of Bismark Bock and Four Heads Stout, and that prices and costs are as shown in the case.) 5 Exhibit 1: The Brewing Process Brewer's Yeast Malt Sugar Hops Fermentation Tanks Wort Kettle Wort Chiller CO2 Water 6 Stage 1 Stage 2 Stage 3 Stage 4 Exhibit 2. Budgeted Overhead Costs for the 1996/1997 Fiscal Year Activity Maintenance & Sterilization Mixing & Cooking Chilling & Siphoning Equipment Depreciation Quality Control Bottling & Labeling Storage Shipping Total Estimated Cost $30,000 8,000 7,500 5,500 10,500 21,000 3,000 31,250 $116,750 Cost Driver Fermentation Days Fermentation Days Direct Labor Hours Machine Hours Number of Quality Control Inspection Number of Bottles Number of Bottles Number of Orders Exhibit 3. Estimated Activities for the 1996/1997 Fiscal Year Panel A: Estimated Annual Volume Cost Drivers Fermentation Days* Direct Labor Hours Machine Hours Number of Orders Number of Quality Control Inspections Number of Bottles Produced# Total 2,910 7,500 82,700 3,740 4,850 229,920 * A fermentation-day is one 24-hour period in which wort occupies a fermentation tank. South Dakota Microbrewery owns eight fermentation tanks. Thus, eight tanks occupied 365 days per year results in 2,910 F-Ds, when time is allowed for cleaning (about 1 hour/tank/year). # There are 24 bottles to one case. Panel B: Estimated Requirements per Batch -- by Beer Label Cost Drivers Fermentation Days Direct Labor Hours Machine Hours Number of Orders Number of Quality Control Inspections Number of Bottles per Batch Buffalo Ale 3 18 110 2 5 528 Bismark Bock 14 12 325 18 22 384 Four Heads Stou 4 13 135 9 8 432 Exhibit 4. Direct Cost Analysis for a Single Batch of each Beer Label Buffalo Ale (Expected Yield = 22 cases) Direct Materials: Coopers Amber Malt Northumberland Malt Corn sugar Geleany hops Filtered water Brewers yeast Total DM Cost 50 kgs 50 kgs 5 kgs 1.75 kgs 220 ltrs 100 gms @ @ @ @ @ @ $0.60 0.30 0.25 1.00 0.03 0.08 $30.00 15.00 1.25 1.75 6.60 8.00 $62.60 Direct Labor 18 hrs @ $6.00 108.00 Overhead Costs ? Total Product Cost per Batch Cost per bottle ? ? Bismark Bock (Expected Yield = 16 cases) Direct Materials: John Bull Dark Malt Newquay Brown Malt Perle hops Filtered water Brewers yeast Total DM Cost 55 kgs 20 kgs 2.87 kgs 160 ltrs 70 gms @ @ @ @ @ $1.08 0.75 1.50 0.03 0.08 $59.25 15.00 4.30 4.80 5.60 $88.95 Direct Labor 12 hrs @ $6.00 72.00 Overhead Costs ? Total Product Cost per Batch Cost per bottle ? ? Four Heads Stout (Expected Yield = 18 cases) Direct Materials: Irish Stout Malt Strong Export Bitter Malt East Kent Goldings hops Filtered water Brewers yeast Total DM Cost 40 kgs 14 kgs 1.32 kgs 180 ltrs 75 gms @ @ @ @ @ Direct Labor 13 hrs @ $1.02 2.40 2.80 0.03 0.08 $6.00 $40.80 33.66 3.69 5.40 6.00 $89.55 78.00 Overhead Costs ? Total Product Cost per Batch Cost per bottle ? ? 2