Brunswick Plastics But the case also deals with activity-based costing

Brunswick Plastics

Teaching Commentary

OVERVIEW

This is an excellent short case that blends basic cost analysis themes with strategic management themes. The ostensible

topic is cost analysis for bidding in a small job shop. But the case also deals with activity-based costing and the blending

of business analysis, strategic analysis, and cost analysis. It is a great case to see the interactions among these various

themes—not much can be done here with any of them, but they all are clearly relevant, once the context is clarified.

Thus the case is a good one to review some basic, conventional cost management themes while clearly

demonstrating the limitations of the conventional themes and the relevance of the “SCM” themes. “Cost analysis for

decision-making” here must go well beyond the conventional framework.

ANSWERS TO ASSIGNMENT QUESTIONS

Question 1

The short answer here is that Exhibit 3 suggests there would be no increment to “PFMOH” from producing one

more order. These are “fixed” costs that are clearly not closely related to volume in the short run.

A closer examination of Exhibit 3 raises other issues as well:

1. Notice the dramatic swings in monthly “PFMOH” over the thirty–two months shown in the exhibit—

from $3,536 to $17,196 between January and February of 1984; from $11,325 to $1,161 between

2. The cost total was about $99,000 for 1984 and about the same for 1985 (if December 1984 and January

1985 are averaged to correct for fairly obvious cut-off problems). For 1986, the total seems to be

running about $205,000, twice the earlier annual rate. This suggests that Smith’s strategy to increase

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3. For whatever reasons, the regression equations

in Exhibit 3 are essentially meaningless. The

very low R2 statistics and statistically

students see this?

Question 2

However one interprets Exhibit 3, it should be

clear to students that there is not likely to be any

incremental “PFMOH” for the milk crate order. These

costs are not volume sensitive, order by order.

A second rule of thumb for BP can be derived

from the 2.33 multiplier mentioned in the case (“sales

price should equally 2.33  (material + labor)). This

crates of $4.32 ($1.85  2.33) and variable overhead of

$.69/unit, using the “16% of sales” estimate in Exhibit

1.

Why is this estimate—$.69/unit—so much

different from the $.18/unit figure that comes from the

same overall cost structure? This difference can be

explained as follows:

1. Estimated Direct Materials + Direct Labor for 1986

is $515,000, per Exhibit 1.

5. For milk crates, the ratio of materials to labor is

about twelve times (1.75/.14). This indicates that

milk crates are a very low labor product, versus

four times less labor intensive than average

(~12x/~3x), a better estimate would be $.69 ÷ 4 =

~$.17/unit.

8. This estimate—$.17/unit—matches very closely

the $.18/unit estimate based strictly on labor hours

(running hours).

Question 3

Industry Average Pricing for Milk Crates

The presumed market price of $3.00 implies

competitors discount the normal, rule of thumb price

here by almost 10%.

Industry Average Cost

Direct Material +

Direct Labor $1.81 (Same as for BP?)

Variable Overhead .56 (.31  DM + DL)

Question 4

Strategically Relevant Cost of Milk Crates?

No argument

Variable Overhead?

1. At $13/Running Hr. = $.18

(13  2084/150,000)

Probably the most likely estimate is $.18.

Fixed Overhead

1. The 2.33 rule implies (35%  Normal Sales Price

$1.51 per unit of $4.31)

Level 2 No Go—bad strategic fit for BP and not

profitable in the long-run. Avoid the

temptation to cheat on your strategy, even in

the short run.

• Bad strategic fit

• Not a game we can win

Level 5 Go For It – As a base load product to support

our efforts at finding high value niches

“ABC” Analysis – Dual thrust – “Factory

Within A Factory”

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6,000 + hours each).

But!

Level 2

• Crates represent low margin, low value-added

No Strategic Fit!

• Bad business is bad business, even in the short run.

The long run always starts now.

But!

Level 3: Crates are very simple to make

An Activity Based Costing Perspective

Fixed Cost/Running Hour for Vanilla Products:

1. Factory OH 100,000 (other $105 is

complexity related)

4. 2605 x $12 ÷ 150,000 = ~$.20/unit

Labor goes down from $.14 to ~$.09 with .80 up time

Full cost, complexity adjusted, may only be about

2.25/unit.

$2.25

Fixed $.20

At a “true” full cost of $2.25, BP could bid $2.90 and

still show a full cost profit of 20%+.

If they are easy for us, they are easy for

everyone else, too.

The easy products, over time, will go to the

low cost producers — That is not BP (a small, niche

Crates do not fit BP’s strategy and should be

avoided. Management should devote the capacity to

products that justify the strategy of high fixed

cost/niche products/differentiation focus.

Level 5: There is still the “Factory within a Factory”

perspective

Crates are a great product to “base–load” the

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least average contribution margin all the way down to a

price of $2.40.

As long as the industry uses “average rules of

• Price the specialties high

• Price the vanilla low

• Make sure you understand the cost structure for

simple vs. complex products.

In general, the idea in Question 4 is for

Question 6 (Question 5 on following page)

The key idea here is for students to think about

BP’s overall strategic positioning. Without the milk

crate order, the business will be barely profitable in

1986, a good business year, in spite of Michael Smith’s

two-year repositioning efforts.

Smith has moved the business heavily into

specialty products. How can we tell?

1. The product mix for 1986, heavy on specials,

will show contribution margin (CM) of

~$490,000 on ~15,000 running hours, per

Exhibits 1 and 3.

$32.67/running hour.

3. For a very easy, “vanilla” product, such as

facilities or demand more overhead support

should show much higher CM/running hour

than vanilla products.

5. But, let’s assume crates are really overpriced

at $3.00. The industry is ignorant of “ABC”

[$2.55 – $2.10 = $.45 x 150,000 = $67,500 ÷

2,084 = ~$32.40].

8. Thus, the conclusion stands that BP’s current

average CM/running hour is far too low, given

the heavy mix of specialty products. The

“specials” are underpriced.

9. If any other commodity items are overpriced,

here if Smith charged prices based on complexity-

adjusted full cost?

He has gone from thirty to fifty different

products, relying on “CM” pricing. But his fixed

overhead hasn’t stayed fixed! Production Fixed

averaging ~40% CM on the overall business in 1986

(~$490,000/~$1,200,000 = ~40%). At this rate, the

Question 5

It should be clear from Question 6 that Smith’s

real problem is how to increase the prices on “specials”

without losing the business. In situations where “ABC”

issues are not well understood, it is common to see

There is no obvious answer here. The likely

range of competing bids, per the case, is from $2.90 to

$3.10.

The differentiation strategy/niche markets/high

cost and high margin perspective suggests not bidding

on milk crates. BP must find products that fit its

strategy.

TEACHING STRATEGY

We often use this case as the final class in the

many different “solutions” are plausible. The case is

likely to generate controversy in class, which reinforces

the basic ideas that cost analysis is a journey, not a

destination, and that the “goal” is better questions, not

definitive answers.

We start class with Question 1, expecting lots

class. Once the various analytic issues are raised, the

case will support as much discussion as time permits on

the fundamental question: What should Michael Smith

do, and why?