The Value Chain
P 7. Soft Spot is a manufacturer of futon mattresses. Soft Spot’s mattresses are priced at $60, but competition forces the company to offer significant discounts and rebates. As a result, the average price of the futon mattress has dropped to around $50, and the company is losing money. Management is applying value chain analysis to the company’s operations in an effort to reduce costs and improve product quality. A study by the company’s management accountant has deter-mined the following per unit costs for primary processes and support services:
Primary Process Cost per Unit
Research and development $ 5.00
Customer service 1.00
Total cost per unit $42.00
Support Service Human resources $ 2.00
Information services 5.00
Management accounting 1.00
Total cost per unit $ 8.00
To generate a gross margin large enough for the company to cover its over-head costs and earn a profit, Soft Spot must lower its total cost per unit for primary processes to no more than $32.00 and its support services to no more than $5.00. After analyzing operations, management reached the following con-clusions about primary processes and support services:
• Research and development and design are critical functions because the market and competition require constant development of new features with “cool” designs at lower cost. Nevertheless, management feels that the cost per unit of these processes must be reduced by 20 percent.
• Ten different suppliers currently provide the components for the futons. Ordering these components from just two suppliers and negotiatin glower prices could result in a savings of 15 percent.
• The futons are currently manufactured in Mali. By shifting production to China, the unit cost of production can be lowered by 40 percent.
• Management believes that by selling to large retailers like Wal-Mart it is feasible to lower current marketing costs by 25 percent.
• Distribution costs are already very low, but management will set a target of reducing the cost per unit by 10 percent.
• Customer service and support to large customers are key to keeping their business. Management therefore proposes increasing the cost per unit of customer service by 20 percent.
• By outsourcing its support services, management projects a 20 percent drop in these costs.
1. Prepare a table showing the current cost per unit of primary processes and support services and the projected cost per unit based on management’s proposals.
2. Will management’s proposals achieve the targeted total cost per unit? What further steps should management take to reduce costs?
3. What role should the company’s support services play in the value chain analysis?
Financial Performance Measures
C 2. Tarbox Manufacturing Company makes sheet metal products for heatingand air conditioning installations. Its statements of cost of goods manufacturedand income statements for the last two years are presented below and on the next page.
Tarbox Manufacturing Company
Statements of Cost of Goods Manufactured
For the Years Ended December 31
This Year Last Year
Direct materials used Materials inventory, beginning $91,240 $93,560
Direct materials purchased (net) 987,640 959,940
Cost of direct materials available for use $1,078,880 $1,053,500
Less materials inventory, ending 95,020 91,240
Cost of direct materials used $983,860 $962,260
Direct labor 571,410 579,720
Indirect labor $182,660 $171,980
Power 34,990 32,550
Insurance 22,430 18,530
Supervision 125,330 120,050
Depreciation 75,730 72,720
Other overhead costs 41,740 36,280
Total overhead 482,880 452,110
Total manufacturing costs $2,038,150 $1,994,090
Add work in process inventory, beginning 148,875 152,275
Total cost of work in process during the period $2,187,025 $2,146,365
Less work in process inventory, ending 146,750 148,875
Cost of goods manufactured $2,040,275 $1,997,490
Sales $2,942,960 $3,096,220
Cost of goods sold Finished
Goods inventory, beginning $142,640 $184,820
Cost of goods manufactured 2,040,275 1,997,490
Cost of goods available for sale $2,182,915 $2,182,310
Less finished goods inventory, ending 186,630 142,640
Total cost of goods sold 1,996,285 2,039,670
Gross margin $946,675 $1,056,550
Selling and administrative expenses
Sales salaries and
Commission expense $394,840 $329,480 Advertising expense 116,110 194,290
Other selling expenses 82,680 72,930 Administrative expenses 242,600 195,530
Total selling and administrative expenses 836,230 792,230 Income from operations $110,445 $264,320
Other revenues and expenses Interest expense 54,160 56,815 Income before income taxes $56,285 $207,505 Income taxes expense 19,137 87,586
Net income $37,148 $119,919
For the past several years, the company’s income has been declining. You have been asked to comment on why the ratios for Tarbox’s profitability have deteriorated.
1. In preparing your comments, compute the following ratios for each year:
a. Ratios of cost of direct materials used to total manufacturing costs, direct labor to total manufacturing costs, and total overhead to total manufacturing costs. (Round to one decimal place.)
b. Ratios of sales salaries and commission expense, advertising expense, other selling expenses, administrative expenses, and total selling and administrative expenses to sales. (Round to one decimal place.)
c. Ratios of gross margin to sales and net income to sales. (Round to one decimal place.)
2. From your evaluation of the ratios computed in 1, state the probable causes of the decline in net income.
3. What other factors or ratios do you believe should be considered in determining the cause of the company’s decreased income?