Toyama Manufacturing Limited (TML)

It is late May 2014 and Antonio Inoki, who is the GM of the South Japanese plant of Toyama Manufacturing Limited (TML), plan a meeting with his sales manager, accountant and development engineer to discuss the introduction by the Indian firm Reliance Industries (a competitor) of a plastic spare part substitute for the steel spare part (SP-01) presently used in certain machines and sold by TML. The plastic spare parts that are new to the market, not only had a much longer life than TML spare parts (SP-01) but they are also costing a lot less in comparison. Inokis problem come from TMLs large quantity of steel spare parts (SP-01) on hand and the substantial inventory of special steel that had been purchased to manufacture these spare parts. Following a thorough investigation, he also concluded that the special steel cannot be re-used in other products neither it can be sold even for a scrap value. The total value of this steel is around $390,000.

TML is manufacturing and selling industrial machines and equipment to several countries for more than 6 decades. The machines involved in Inokis dilemma were made only at the companys plant in South Japan, where about 1,000 employees are working. The various models of the plant were priced between $18,900 and $28,900 and were sold by a separate sales company. Repair and replacement parts that are accounted for a substantial part of this plants business, were sold separately. As for as these specific steel spare parts (SP-01) are concerned, they can also be used in similar machines manufactured by competitors. The companys head office is in Tokyo and generally plants outside Tokyo have permission to manage their own affairs up to a good extent. However, the head office is also accessible by email, telephone or during executive visits to various plants.

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Competition in this industry has increased substantially during the late 1990s because of the Chinese manufacturing firms, who entered the market with low priced spare parts. Other companies entered the market with lower quality and lower priced machines. Therefore, it was clear in the 1990s that future competition would be more intense.

The existing steel spare part (SP-01) manufactured by TML have a normal life of about two months, depending upon the use of the machine. The replacement of the spare part is easy and quick. Some machines will require up to six spare parts, but they are all the same size and easy to be replaced.

Jushin Liger, the sales manager came to know about the new plastic spare parts as soon as they appear in the market and therefore asked, when TML will be able to supply them, specifically for sale to customers in South Asia, where Reliance Industries is the strongest competitor faced by TML. The development engineer, Kenta Kobashi estimated that the plastic spare parts could be produced by mid-September and for this purpose, the necessary tools and equipment can be obtained for about $7,500. However, Kenta Kobashi also highlighted the issue of the existing steel spare part (SP-01) inventories that would not be used up by September. The sales manager, Jushin Liger is of the view that the new spare part can be produced at a substantially lower cost than the steel ones (SP-01), hence the inventory problem is irrelevant. He suggested that we can sell the inventory but if we cannot sell it, we can just put it in the bin. Inoki was not looking very happy with this suggestion because of the large size of the inventory.

Inoki also highlighted the fact that Reliance Industries is selling the plastic spare parts on about the same price as our steel spare parts (SP-01) and since the production cost of the plastic spare part is a lot lower in comparison, our company is missing on the substantial profit margin if we do not introduce the plastic version of the spare parts. They end the meeting with a decision that the company should prepare to manufacture the new plastic spare parts as soon as possible but that until the inventories of the old SP-01 model and the steel were exhausted, the plastic spare parts would only be sold in those markets, where it is offered by our competitors. It was also expected that the new plastic model will not be produced by any other company other than Reliance Industries for some time, which means that no more than 10% of TMLs market would be affected.

Soon after this meeting, the head office in Tokyo sent, Masahiro Chono, to discuss and review the companys problems and during this review, they also discussed the SP-01 problem. Even though the spare part is only the small portion of the entire machine but Masahiro was still interested in this problem because the company wanted to establish specific policies for the production and pricing of all such parts that, in total, accounted for a substantial portion of TMLs revenue. Masahiro agreed for the production plans of the new plastic spare parts, but he then reiterated that the company should find another use for the steel spare parts inventory. However, if this looks completely impossible, then Masahiro expect the company to use all the raw material to produce SP-01.

Following Masahiro visit, both Jushin Liger and Kenta Kobashi came in to see Antonio Inoki. Kenta Kobashi came to highlight that test were conducted for the new plastic spare parts. They

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are looking to be at least four times better in performance than the existing SP-01 steel spare parts and therefore, it will destroy the demand for the steel spare parts. However, he is also aware that the price of the competitive spare part is high, and hence the decision to sell the plastic spare parts only in the markets where it was sold by competitors was a good one. In his view, this is a better way to get rid of our existing SP-01 steel spare part stocks and once this stock is finished, then we can introduce the plastic spare parts everywhere.

The sales manager, Jushin Liger still strongly opposed the sale of SP-01 once the plastic ones enter the market. He thinks, if we sell plastic ones in some areas and steel ones in other areas, customers will eventually find out and this would harm the overall reputation and sale of the TMLs machines, the sale price of which is many times more than the SP-01 spare part. Jushin Liger show some figures to highlight that if the selling price of both the steel and plastic spare parts remained at $1350 per hundred spare parts, the additional profit from the plastic spare parts (manufactured at a cost of $279.65 per hundred spare parts vs $1107.90 per hundred for steel spare parts) would easily recover the value of the steel inventory within a year as per the current sales volumes. However, Antonio Inoki refused to change the decision of the previous meeting but also agreed to sit down for another discussion on the issue within a week.

For the discussion in the third meeting and Masahiros concern in mind, Inoki obtained the data displayed in Table 1 from the cost accounting department on the cost of both plastic and steel spare parts.

Inoki also becomes aware that the inventory of special steel had cost $110,900, which is more than enough to produce approximately 34,500 SP-01 spare parts. If sale is continued at the current rate of 690 SP-01 parts per week, without any further production, about 15,100 finished spare parts would be left on hand by mid-September. Inoki then realize that during the next two or three months, the plant would not be operating at capacity. During these slack periods, the company have a policy of employing excess labour at about 70% of regular wages on various make-work projects rather than laying workers off. Therefore, he thought it would be a good idea to use some of this labour to convert the steel inventory into SP-01 spare parts during this period.

Table 1

Material Direct Labour Overhead1

100 plastic spare parts $17.65

$65.50

$131.00 $65.50 $279.65

100 steel spare parts $321.90

$196.50

$393.00 $196.50 $1107.90

Departmental Administrative

Total cost

Question:

What action should Antonio Inoki take? And Why?

1 Overhead was allocated based on direct labour cost. It was estimated that the variable overhead costs included here were largely fringe benefits related to direct labour and amounted to 0.80 per direct labour dollar or about 40% of the departmental amounts.