Problem - Matt Holland, president of Holland Electronics, was concerned about the end-of-the year marketing report that he had just received. According to Emily Jiminez, marketing manager, a price decrease for the coming year was again needed to maintain the company's annual sales volume of integrated circuit boards (CBs). This would make a bad situation worse. The current selling price of $18 per unit was producing a $2-per unit profit - half the customary $4-per unit profit. Foreign competitors keep reducing their prices. To match the latest reduction would reduce the price from $18 to $14. This would put the price below the cost to produce and sell it. How could the foreign firms sell for such a low price? Determined to find out if there were problems with the company's operation, Matt decided to hire Bunney Schmidt, a well-known consultant who specializes in methods of continuous improvement. Bunney indicated that she felt that an activity-based management system needed to be implemented. After three weeks, Bunney had identified the following activities and costs:
Batch-level activities:
Setting up equipment $125,000
Materials handling 180,000
Inspecting products 122,000
Product-sustaining activities:
Engineering support 120,000
Handling customer complaints 100,000
Filling warranties 170,000
Storing goods 80,000
Expediting goods 75,000
Unit-level activities:
Using materials 500,000
Using power 48,000
Manual insertion labor 250,000
Other direct labor 150,000
Total costs $1,920,000
Bunney indicated that some preliminary activity analysis shows that per-unit costs can be reduced by at least $7. Since Emily had indicated that the market share (sales volume) for the boards could be increased by 50 percent if the price could be reduced to $12, Matt became quite excited.
Required:
1. Identify as many non-value-added costs as possible. Compute the cost savings per unit that would be realized if these costs were eliminated. Was Bunney correct in her preliminary cost reduction assessment? Discuss actions that the company can take to reduce or eliminate the non-value added activities.
2. Compute the target cost required to maintain current market share, while earning a profit of $4 per unit. Now, compute the target cost required to expand sales by 50 percent. How much cost reduction would be required to achieve each target?
3. Assume that Bunney suggested that kaizen costing be used to help reduce costs. The first suggested kaizen initiative is described by the following: switching to automated insertion would save $60,000 of engineering support and $90,000 of direct labor. Now, what is the total potential cost reduction per unit available? With these additional reductions, can Holland achieve the target cost to maintain current sales? To increase it by 50 percent? '
4. Calculate the income based on current sales, prices, and costs. Now, calculate the income using a $14 price and a $12 price, assuming that the maximum cost reduction possible is achieved (including requirement 3's kaizen reduction). What price should be selected?