- The OEM produces its final product in three versions with many variants. How many unique product combinations are possible? Explain. What are some examples of complexity (and related costs) that result from offering three product versions with many variants? What challenges does this complexity present for management accountants?
Krayden's Cycle Components (KCC) is a high-end specialty fabricator that manufactures one product with many variants. The basic product is known as a rolling chassis, a key component used in manufacturing motorcycles. While there are variations across the industry, a rolling chassis typically consists of a motorcycle frame, ont forks, wheels and tires, and handlebars.1 KCC is a rst-tier supplier to an original equipment manufacturer (DENT) that produces motorcycles in three versions: Sport, Cruising, and Retro. The OEM purchases KCC product and attaches its well-known proprietary engine and gearbox, wiring and gauges, seat, fenders, various components, and gas tank with iconic emblem. The OEM is KCC's sole customer as it essentially requires KCC's full capacity. KCC manufactures each frame from steel tubing but purchases a variety of parts from suppliers. Workers at KCC attach these parts to the ame to complete the rolling chassis. Figure 1 illustrates the supply chain. The suppliers of wheels, front forks, and handlebars are second-tier suppliers. These vendors provide parts that are ready to be attached to the frame. The tire vendor is considered a third-tier supplier. The company that builds the wheels acquires tires (that meet contract specifications directly negotiated by the OENI) and provides a complete wheel assembly ready to be attached to the front fork and rear frame. KCC has had numerous problems with delivery and quality over the past several years. Because the problems have been so acute, the company has employed four different plant managers in the last five years. Management acknowledges the supply chain has difficulties; unfortunately, there is virtually no room for error in meeting delivery schedules and product quality targets. Further, KCC has been under increased scrutiny from its stockholders because earnings have deteriorated over the past three years. See Tables 1-4 for KCC's nancial information (income statement, balance sheet, statement of cash ows, and unit cost information). The economic recession that ended around the summer of 2009 has enabled the OEM to expand production and sales. The company's sales have increased by 1,000 units per year since 2010. By 2015, KCC was delivering 30,000 units to the OEM; management believes this level of output represents capacity. Thus, production above 30,000 units is not possible without staff overtime or an investment in additional plant resources that will increase hourly throughput. Management at KCC has received notice that the OEM plans to increase production by 3,750 units next year (12.5%) and to demand price concessions of $200 per unit as specied in the contract. THE PRODUCT MIX ANT) OUTSOURCED PARTS The OEM produces motorcycles for three different market niches; therefore, KCC produces three distinctly different frame geometries as follows: - Sport bikes emphasize speed and agility. Customers expect rapid acceleration and responsive handling. - Cruising bikes emphasize power and comfort. They allow riders to enjoy long-distance touring. . Retro bikes appeal to customers who appreciate classic designs. They are typically smaller than cruising bikes and more stable than sport bikes. For each frame geometry, the OEM offers three possible handlebar types. Because riders are various sizes, handlebars can be configured in a variety of heights, widths, and lengths (straight bars or bars pulled back toward the rider). The OEM offers three different wheel set possibilities. Wheel sets consist of one front wheel and one rear wheel. The different wheel designs are: - Chrome spokes. - Cast aluminum polished (silver) alloy wheels. . Cast aluminum anodized (black) alloy wheels. The OEM offers four unique tire choices for each frame type. Thus, KCC could purchase as many as 12 different tire models to meet market demand (three frame types x four different tires per frame). Factors that differentiate the tires include: Bias-ply (characterized by a round profile and tall sidewalls). Radial (characterized by a flat profile and short sidewalls). Grip (soft-better road grip but shorter tread life; hard-poorer road grip, but longer tread life). Tread design (differences in the number of grooves in the tire pattern). Number of layers (known as plies) from which the tire is constructed; using more layers results in a stiffer tire. The OEM contracts directly with the tire manufacturer to supply specific tires to the wheel manufacturer. Much engineering effort has gone into identifying the proper tires and wheels for each type of motorcycle. The wheel vendor receives and mounts the appropriate tire on the wheel set and then delivers the set to KCC. The tire manufacturer sells its products to different OEMs, as well as to aftermarket customers. Recently, the OEM has complained to KCC about chassis that vibrate and exhibit poor handling qualities when the completed motorcycle is test driven. Engineers at KCC have traced the source of the problem to the tire manufacturer. A wheel/tire combination that is not balanced properly causes vibration and is a control and safety issue. The solution requires placing the wheel/tire set on a machine to determine the location of the imperfection causing the imbalance. A small weight is attached to the wheel to offset the tire imperfection and to remove the vibration. Because of pressure from the OEM to deliver a quality chassis, KCC purchased a wheel balancing machine and tested each set before installing it on their chassis. The quality delivered to the OEM has improved, but management at KCC is unhappy because the OEM refuses to increase the contract price to help offset KCC's additional cost of equipment and labor. The supply chain has additional complications. One of KCC's suppliers (a second-tier supplier that produces handlebars) is also a subsidiary of the holding company that owns KCC. This supplier has contracts with manufacturers of bicycles, scooters, and power chairs. On several occasions, this supplier has missed scheduled deliveries. When confronted, management explained they had external customers whose orders must be filled. At certain times of the year, demand exceeds the supplier's ability to meet it. As a result, KCC management has scrambled to find suitable suppliers (at much greater cost) in order to meet their own delivery schedules. PROCESS DESCRIPTION KCC receives an order from the OEM exactly three hours before the specific chassis is needed on the OEM's assembly line. The company employs four production line workers who are cross-trained to perform multiple functions. Figure 2 illustrates the manufacturing process for KCC, a manufacturing cell that includes the following processes: Step 1. Tube cutting and assembly. Steel tubes arrive by forklift at Step 1, the cutting and welding process. Cutting. Using a computer numerically controlled (CNC) machine, steel tubes are bent and cut to proper angles and lengths that match the engineering design specifications for each frame type-Sport, Cruising, or Retro. Welding. After the tubes are cut, they are clamped to a jig that holds them stationary at the proper angle for welding. A robot tack-welds each joint, which is a temporary weld to hold the assembly in preparation for final welding. Once the frame is completely assembled by tack welds, the robot permanently welds the joints. Step 2. Weld cleanup and preparation. The welded metal frame advances to the next process where the welds are smoothed and polished, then to a cleaning bath where the frame is cleansed of oils and surface contamination prior to the powder coating process. Step 3. Powder coating. KCC powder coats, rather than paints, the frames. Consistent with environmental sustainability issues, the powder coating process emits almost zero volatile organic compounds (VOCs). In addition, any overspray can be captured and reused. Powder coating is a dry powder that does not require a solvent. The powder coating is robotically sprayed within a booth by a nozzle that imparts a negative electrical charge to the powder. The powder electrostatically adheres to the grounded frame. The frame is heated to approximately 400 degrees Fahrenheit for around three minutes to melt the powder that flows to produce a smooth, strong, glossy finish. 2Step 4. Fork assembly. The forks are manually attached to the frame. Step 5. Tire balancing. The wheel tire set is tested for balance, and any necessary modifications are made. Step 6. Wheel/tire assembly. The wheel/tire assembly is manually attached to the frame. Step 7. Handlebar mounting. The handlebars are mounted on the frame. Step 8. Loading the frames. The frames are carefully loaded into a cargo trailer for transport. KCC'S JUST-IN-TIME/ JUST-IN-SEQUENCE INVENTORY SYSTEM The OEM produces motorcycles for eight hours each weekday. KCC makes eight deliveries (once per hour) during this period. The frames are delivered just-in-time (JIT) and just-in-sequence (JIS). JIS delivery implies the first frame unloaded from the truck is the next frame needed for production by the OEM. KCC is linked to the OEM's production information system via an electronic data interchange system. The system identifies the appropriate frame geometry, handlebar type, wheel type, and tire specifications for each order. Management at KCC has been working to improve operating efficiency and profitability. Because KCC operates according to Lean principles, the company strives to hold minimal parts inventory. Thus, on-time delivery and the quality of purchased parts are crucial to keep production lines operating at desired output levels. If KCC causes the OEM to stop its line because of delivery or quality problems, the contract allows the OEM to bill KCC for lost production time at a rate of $2,000 per minute. The OEM believes this clause is justified because it loses contribution margin if production is brought to a halt. In some cases, KCC has passed these costs along to second-tier suppliers that caused KCC to miss a delivery. KCC has met on several occasions with its suppliers to try to resolve supply issues. Vendors have been frustrated by the Lean system demanded by KCC. To reduce their exposure to line stoppage costs, some second-tier suppliers have responded by increasing inventory levels. Additionally, some suppliers have purchased redundant manufacturing equipment on key production processes that can be used if the primary equipment fails, further adding to manufacturing costs. Management at the OEM believes in developing long-term strategic partnerships with its suppliers. Thus, each supplier is rewarded with a multiyear contract. The OEM prefers to use a single supplier for each component, rather than to contract with two (or more) different companies for a component. KCC has the exclusive contract to produce rolling chassis for the OEM, and has recently been awarded the next contract covering five years of production. As a result, KCC made significant investments in retooling and plant modernization during the current year. Unfortunately, the investments did not increase KCC's capacity sufficiently to meet expected demand. THE MANAGEMENT DILEMMA KCC's management operates as one participant in a complex supply chain. They are managing relationships involving multitier suppliers and a demanding delivery schedule. Further, stockholders are expressing concern over KCC's declining profitability in recent years. Management has not developed a plan for addressing the increase in production required by the OEM, nor have they developed an understanding of the financial consequences of accepting the new contract.Figure 1: Supply Chain Third Tier Tires Second Tier ( Wheels Front Handlebars Powder- Steel Fork coating tubing First Tier Krayden's Cycle Components Direct Contract OEMTable 1 Income Statement Years Ended December 31 2015 2014 2013 Sales $111,000,000 $113, 100,000 $112,000,000 Cost of goods sold 81,000,000 79,025,000 76,720,000 Gross margin 30,000,000 34,075,000 35,280,000 Operating expenses Freight-out 4,900,000 4,500,000 4,000,000 Research and development 2,800,000 3,000,000 3,700,000 General and administrative 8,500,000 9,000,000 9,500,000 Total operating expenses 16,200,000 16,500,000 17,200,000 Operating income 13,800,000 17.575,000 18,080,000 Nonoperating expenses: Interest 1,100,000 1,100,000 1,100,000 Income before taxes 12,700,000 16,475,000 16,980,000 Provision for income taxes 4,229, 100 5,486,175 5,654,340 Net income $8,470,900 $10,988,825 $11,325,660 Basic net income per share $0.278 $0.360 $0.371 Diluted net income per share $0.267 $0.346 $0.357 Weighted average shares outstanding: Basic 30,500,000 30,500,000 30,500,000 Diluted 31,750,000 31,750,000 31,750,000 Dividends per share $0.22 $0.23 $0.25 Average selling price $3,700 $3,900 $4,000 Units produced and sold 30,000* 29,000 28,000 Average unit cost $2,700 $2,725 $2,740 Management believes this quantity represents existing capacity.Table 2 Balance Sheets as of December 31 2015 2014 ASSETS Current Assets: Cash and cash equivalents $15,000,000 $13,900,000 Trade receivables, net 13,500,000 9,300,000 Inventory 9,700,000 7.200,000 Prepaid expenses 515,000 2,050,000 Deferred tax assets 6,250,000 5,675,000 Total current assets 44,965,000 38,125,000 Property and Equipment: Land and buildings 12,010,000 12,010,000 Property and equipment 57,500,000 42,500,000 less: Accumulated depreciation 39,000,000 22,500,000 Total property and equipment 18,500,000 20,000,000 Goodwill 5,000,000 5,000,000 Total assets $80,475,000 $75,135,000 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $9,000,000 $8,500,000 Accrued expenses 25,000,000 21,500,000 Income taxes payable 700,000 1,250,000 Total current liabilities 34,700,000 31,250,000 Notes payable 31,000,000 31,000,000 Total liabilities 65,700,000 62.250,000 Shareholders' equity: Common stock 1,000,000 1,000,000 Retained earnings 13,775,000 11,885,000 Total shareholders' equity 14,775,000 12,885,000 Total liabilities and shareholders' equity $80,475,000 $75,135,000Table 4: Unit Cost Information 2015 Costs that vary by individual unit (example of one product) Materials: Steel tubing $200.00 Front fork 650.00 Wheel set (front and rear) 700.00 Tires 350.00 Handlebars 125.00 $2.025.00 Direct labor: (4 line workers x 40 hours per week x 50 weeks 13.33 per year x $50 per hour/ 30,000 units) Overhead (generally varies in total with production, but is relatively constant on a per-unit basis): Welding rods flux $11.00 Degreasing chemicals and supplies 7.70 Powder coating materials 25.00 Electricity for machines 10.00 Heating and cooling building 8.50 Indirect labor: Plant supervision and plant maintenance 20.00 Materials, WIP, and FG inventory handling 30.30 $112.50 Depreciation (generally fixed in total): Total per cash flow statement $16,500,000.00 $550.00 Total unit cost $2,700.83 Approximately $2,700.00Figure 2: Process Diagram (Time Shown in Minutes : Seconds) Fork assembly Tire balancing Process time 1:45 Process time 3:00 Step 4 Step 5 T Powder coating Wheel assembly Process time 3.00 Process time 2:15 Step 3 Step 6 T Weld clean-up 2:00 Degrease and Handlebar mounting powder coat prep :30 Process time 1:30 Step 2 Step 7 T Cut tubing :30 Steel tubing Welding Transport to loading delivered by Setup time (jig) :15 queue for JIT JIS forklift Process time 3:15 Step 1 delivery Step 8 To the OEM: One delivery per hour
