M-L Fasteners, GmbH All Once The Lower Prices Charged The

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M-L Fasteners GmbH

Teaching Commentary

OVERVIEW

This heavily disguised case is very rich in cost analysis opportunities with a strong strategic dimension. We use it as the

first case in a segment on cost system design in the required Managerial Accounting course at Tuck.

The setting is 1986 in a German manufacturer of snap fasteners (for garments) and of the machines that attach

In these cases, the less profitable segment was consciously used as a market entree. Individual component

costing and profitability was not as important for the overall strategy as bundled profitability. For these firms, the

strategy was very successful for many years.

The problem in the ML case is a company with a bundled business strategy coupled with an accounting system

that does not accurately reflect the profit implications of the bundling. Unfortunately, this situation is all too common—

the “full line” producer whose conception of product profitability is dangerously flawed by inaccurate product costing.

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ANSWERS TO ASSIGNMENT QUESTIONS

Questions 1 and 2

Question 3

The Company’s Strategic Situation. The

“product–line profitability” report (Question 1) gives a

general picture of where ML earns its profit. Attaching

machines generated a large loss ($10.8 million) in 1986.

All manufacturing cost for attaching machines is

fundamentally sound.

The competition from HI is troubling because

the Japanese seem to have zeroed-in precisely on the

major weakness in the ML strategy—the customer who is

more price conscious and less concerned about the quality

and free service for the attaching machines. It is

accounting system shows them that they cannot afford to

cut prices 20% on the SS and Ring products. Margins are

already low on these products. ML has more to lose than

to gain by meeting the low prices. Since their overall

high quality/high price strategy seems to be working, they

on a large scale (they hope). Raising machine rental rates

is not necessary from an overall economic return

standpoint and is probably not smart because it would

is lower priced from ML.

Yet, there is a nagging concern that the real

threat is HI using its small foothold to learn how to make

good-quality products at a cheaper price, at which point

they become a serious threat. How can ML stop them

from using the least quality conscious customers as a

quality development laboratory?

information, it might thus very well represent an

appropriate response to the Japanese threat. But it is not

based on solid product cost information. The ML cost

accounting system is fundamentally flawed. The flaw is

all too common in manufacturing firms throughout the

world—unintended cross-subsidization of costs. ML

Question 4

The problem with ML’s cost accounting system

is that it assigns general overhead to products based on

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Exhibit A

SS Ring Prong Tack

Direct Labor Cost $1.32 $1.43 $.21 $.66

General Overhead Allocation $27.75 $25.31 $4.42 $14.10

General Overhead, (excluding Attaching

*Attaching machines overhead is $17.8M and Direct Labor Cost is $1.6M (Exhibit 1). This is a ratio of 1,113%

(17.8/1.6). Thus, for each dollar of direct labor, a fastener is currently charged $11.13 of attaching machines overhead.

The instructor should note that in answering this question, many students will use a different logic that is reasonable, but

not quite accurate. They will simply eliminate 54% of the general OH allocation, based on the fraction 17.8/33. This is

plausible and we don’t make a big deal in class about this approach versus the one we believe is somewhat more

accurate.

This is really an unwitting cross-subsidy because

particular fastener should bear more or less of the

Exhibit B

Product Profitability (representative products)

SS Ring Prong Tack

Average Selling Price $46.75 $39.83 $17.80 $38.40

ML Price versus the “Cartel” A Little Higher A Little Lower

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All at once, the lower prices charged by the

Japanese for SS fasteners are more understandable.

Without the subsidy from attaching machines and without

the distortion of a labor-based allocation system for the

Now, it looks like we may even be losing

money on Prongs, when attaching machines are

considered:

1. Automatic Machines sales = $49M = 51% of

$96M.

2. If Automatic Machines usage is distributed

proportionally across the four product categories,

Automatic Machines volume = 51% x 4.2 billion

= 2.14 billion units.

dominance may well be a result of underpricing Prongs

based on the flawed information about product cost.

What ML has mistakenly seen as high margin business is,

in reality, bargain-priced business. It is not so difficult to

achieve a leadership position for a product one is

consistently underpricing.

Exhibit C

Assignment of Nonmanufacturing Cost to Product Lines

The Higher Fashion Prong and Tack Lines

R&D 75% x 5.8 = $4.4 Million

By subtraction, for the more standardized SS and Ring segments:

$23.5M – $18.4M = $5.1M

Units Sold = 480 Million

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Exhibit D

(Sixteen hours per day and 250 days per year, for each machine)

Machines Total Units

Hours/Year Units/Hour Units/Year in Use (millions)

M1 4,000 300 1,200,000 700 840

Question 5

Annual attaching capacity (in units) of all the

machines in the field is shown in Exhibit D.

This analysis leads to some interesting

observations:

1. Considering capacity, one would need to use six

“overengineering” the machines.

2. Apparently, customers use much faster machines

than necessary.

Average Annual $ volume:

Automatic machines = $7,000

6. There are 3,500 A3 models out there and our total

company volume would only keep 350 of them

busy. Why, really, did we see the need to offer the

A3 model?

7. We generated $77,000 sales from manual machines

this year (steady state?) and $6.8 million rentals

from automatic machines (steady state?).

Questions 6 and 7

A Deeper Look...

2. Machine manufacturing is buried in all fasteners,

but most heavily in SS and Rings.

1. All four major categories show very good margins

(even on a full cost basis).

2. Note that our very low penetration in SS and Rings

4. Cartel response to our price changes?

• Can’t cut Prong prices much (cost sets a floor).

• If they cut Tack prices, we have more to gain in

SS/Ring than to lose in Tack.

Next Level: Are prongs really undercosted? Do we have

Using the unbundled and thus more accurate cost

information, ML might well be able to make a case for

lowering SS and Ring prices. Some reduction is even

possible without undercutting the “cartel” at all. The

“cartel” could not respond by cutting Prong prices very

much because cost sets a price floor very quickly here.

Even if the cartel were to respond by cutting Tack prices

(ML’s other strong position), ML seems to have far more

TEACHING STRATEGY

Overhead allocation based on direct labor is still the rule

in most manufacturing firms of which we are aware. In

options can change dramatically based on “better” cost

information. Seeing this is the real teaching point of the

case.

In most firms, the unwitting cross subsidy is

much more subtle and complex and deep-seated. Yet it is

just as real and just as damaging to the prosperity of the

firm. Until managers begin to question their costing

systems much more vigorously and to challenge them

about product lines using the costing system. This

part of the discussion draws on Questions 1, 2, and 3.

2. Discuss the problems with the costing system and

how to “improve” the system. This part draws on

Question 4.

3. Discuss recommendations for management action