Wilkerson Company

Operations Department

Action Plan for Improvement of Operations

It is our duty to acknowledge the contribution made by the costing department in helping us

understand our business from a different and more accurate perspective. Having examined the

outcomes of the ‘Activity-Based-Costing’ in detail, we that find these have serious implications

for our operations and financial performance at Wilkerson. Discussions among us focused on

generating alternative approaches, considering the merits and demerits of each and developing a

plan of action. In the following passages we provide an overview of the existing situation,

various alternatives considered by us, and then describe the actions we believe would help

improve our financial performance.

SECTION 1: ACTION PLAN

Overview of Operations

Our Business

Wilkerson manufactures equipment used in water purification systems

Began with a unique design and superior engineering to produce ‘best-in-industry’

valves

Introduced pumps and flow controllers as two additional product lines

Production Process

Purchase semi-finished components and some finished parts from dedicates suppliers

Machine components to close tolerance

Assemble products

Pack and ship to customers

All steps operate on ‘Just-In-Time’ paradigm

The Problem

Overall pre-tax profit has fallen from a historical rate of 10% to 2.68%

Cost Analysis

ABC Analysis evidences a sea change from margins calculated using single cost

method as follows

ParticularsProducts

Valves PumpsFlow

Controllers

Selling Price 86.00 87.00 105.00

Volume-based costing

- Unit cost 56.00 70.00 62.00

- Gross margin 34.88% 19.54% 40.95%

Activity-based costing

- Unit cost 46.17 58.20 115.38

- Gross margin 46.32% 33.10% -9.88%

Change in Gross Margin Percent +11.44 +13.56 -50.83

Critical Issues

Competitors have improved quality to erode our competitive advantage

Pressure from competition to drop prices of pumps

Loss of revenue

Controllers selling at less than manufacturing cost

Inappropriate costing that diffuses focus on critical issues

Aim and Objectives

Aim

Overall goal is to restore gross margin to 10% and grow it further

Objectives

Use ABC cost analysis to understand cost structures and identify opportunities for

cost reduction

Generate alternative solutions and weigh advantages and disadvantages of each

Prepare final recommendation for phased action

Propose a process of continuous monitoring and adjustment of strategy

Strategy Alternatives and Evaluation

Marketing

The following strategy alternatives address individual product lines one by one.

Valves

Alternatives

o Maintain status quo

o Increase valve prices

o Drop valve prices

Evaluation

o The ABC cost analysis shows that we make a healthy 46.32% gross

margin in this product line

o There is no competitive pressure now to drop prices

o Enough evidence is not available to recommend an increase in prices

o Competitors have reached the same technology level and competition

will soon put pressure on prices.

Recommendation

o Drop prices by 2.5% to increase volumes and increase market share

o This will delay competition pressure

Pumps

Alternatives

o Maintain status quo

o Increase pump prices

o Drop pump prices

Evaluation

o The ABC cost analysis shows that we make a 33.10% gross margin in

this product line

o There is strong competitive pressure to drop prices

o There is no possibility for increasing prices without a substantial drop

in sales volumes

Recommendation

o Drop pump prices further by $2 (over the already reduced price of

$87 compared to target price of $107.69) to increase volumes and

consolidate market share

Flow Controllers

Alternatives

o Maintain status quo

o Drop the line altogether

o Increase Controller prices

Evaluation

o Maintaining status quo offers a marginal advantage in allowing us to

leverage sales of other products but has several disadvantages, these

include:

Incorrect business decisions based on incorrect costing

Negative margins would continue to cannibalize profits from

other lines

Increase in customer requirement diversity would lead to even

larger losses

o Dropping the manufacture of flow controllers will provide immediate

relief on margins. However, the disadvantages of such action are very

severe:

Drop in overall revenue by $420,000

Displacement of workers operating this line

Unabsorbed fixed overhead and sunk costs will burden other

two lines

Loss of advantage in leveraging sales of other products

o Increasing price of controllers offers several advantages that clearly

outweigh the disadvantages of such action. The advantages are:

Eliminate negative gross margins

Maintain full product basket to customers

Maintain competitive advantage

No disruptions of production and people

No idle capacity

Sharing of overhead costs to reduce burden on other product

lines

Raise overall profitability of Wilkerson

The disadvantages of such an action would be:

Risk of losing price-sensitive customers

Open the door for competition

Recommendation

o Raise price of flow controllers through an average of 33% based on the

complexity of design

o Increased analysis of customer orders and setting up a minimum

volume of orders of a particular design and set up a service fee for

orders below this level

o Service fee must include additional packaging and shipping costs

o Sensitize customers to the need for above action

Production

Major effort is required in management of production and materials handling. We enumerate our

action plan drawn based on priority areas identified:

Shipment Costs

o We currently spend $110,000 on shipment of flow controllers that fetch us

revenue of $420,000 i.e. 26.2%

o Reduce shipment costs through

Passing on some of the shipment costs to customers

Bulking the shipments among themselves

Bulking shipments with other products

Target reduction of shipment costs by $20,000 on controllers and $5,000

on pumps

Engineering Hours

o Reduce proportionately increased hours of engineering work by 5% by

Streamlining operations

Multi-tasking by workers

Operating with jigs and fixtures to machine multiple parts simultaneously

Production Runs

o Increased production of valves requires addition of two production runs.

Production runs on pumps and controllers remain same as existing.

o Reduce production runs on controllers by 10% through standardization and longer

runs

The revised production and operations schedule is as below:

Valves PumpsFlow

Controllers TotalProduction (units) 7,875 13,125 4,000 Machine hours 3,750 6,250 1,200 11,200 Production runs 12 50 90 152 Number of shipments 10 60 180 250 Hours of engineering work 263 394 625 1,281

Appendix-I provides the revised activity-based costing schedule.

SECTION-2: IMPACT ON OTHER DEPARTMENTS

The action plan developed above requires a coordinated effort by the marketing, materials

handling, and operations departments. As long as all employees work toward the common goal

of regaining the 10% margin on sales the chances of disruption would be minimal. The likely

impacts on other departments would be as under:

Marketing department would have to increase efforts for selling additional production.

They would have the advantage of offering lower prices on valves and pumps. They need

to devise a strategy for increasing prices of controllers and simultaneously adding

conditions with regard to minimum order size and additional shipping expenses for orders

below minimum order size.

Accounts department would have an added role to play in monitoring whether marketing

adheres to the revised strategy.

SECTION-3: FINANCIAL IMPLICATIONS

Because of adopting these strategy measures, the following changes would occur in our financial

performance:

Valves PumpsFlow

Controllers TotalSales Price 84.00 85.00 140.00 Sales Volume 7,875 13,125 4,000 Gross Revenue 661,500 1,115,625 560,000 2,337,125 Cost of Manufacture 46.26 57.30 106.31 Total cost of Production 364,325 752,112 425,250 1,541,688 Gross Margin 297,175 363,513 134,750 795,437 Gross Margin as % 44.92% 32.58% 24.06% 34.03%General, Selling, & Admin Expense 559,650 Pre-tax Profit 235,787 As percent 10.09%

WE WELCOME ANY SUGGESTIONS FROM MANAGEMENT AND OTHER DEPARTMENTS

Appendix-I: Revised Product Costing

Cost CenterUOM

Products

Valves PumpsFlow

Controllers

Direct CostsDirect Material $ 16.00 20.00 22.00Direct Labor $ 10.00 12.50 10.00

Overheads

Machine Related Expenses - Hours/Unit Hrs 0.50 0.50 0.30 - Rate $ 30 30 30 - Mach. Related Exp/Unit $ 5.00 15.00 9.00 Setup Labor - Production runs Nos. 12 50 90 - Rate $ 250 250 250 - Cost $ 3,000 12,500 22,500 - Total Production Units 7,875 13,125 4,000 - Setup cost/Unit $/Unit 0.38 0.95 5.63Receiving & Prodn. Control - Production runs Nos. 12 50 90 - Rate $ 1,125 1,125 1,125 - Cost $ 13,500 56,250 101,250 - Total Production Units 7,875 13,125 4,000 - Rec. & Prodn cost/Unit $/Unit 1.71 4.29 25.31Engineering - Hours of Engineering Hrs 249 374 594 - Rate $ 80 80 80 - Cost $ 19,950 29,925 47,500 - Total Production Units 7,875 13,125 4,000 - Engineering cost/Unit $/Unit 2.53 2.28 11.88Packaging and Shipping - No. of Shipments Nos. 10 60 180 - Rate $ 500 500 500 - Cost $ 5,000 30,000 90,000 - Total Production Units 7,875 13,125 4,000 - Pkg & Shipping cost/Unit $/Unit 0.63 2.29 22.50

Total Cost   $/Unit 46.26 57.30 106.31