Arctic Insulation the differential between bulk prices and Arctic’s dock

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Arctic Insulation

Teaching Commentary

OVERVIEW

This is an excellent short case to cover basic concepts in cost analysis for cost control and managerial decisions. The

case always works well for me in class. Perhaps this is because the unusual industry context is intriguing to students

who enjoy thinking about business issues in strange settings. Also, the topics covered have high common sense appeal.

If students have not thought much about these issues before, this case is seen as very relevant new stuff. If they have

studied these issues before, the case is seen as solid review in a “fun” business setting.

ASSIGNMENT

In addition to the four questions in the case, I assign the following question:

ANSWERS TO ASSIGNMENT QUESTIONS

Question 1 (and Question 5)

I start the discussion of Question 1 by asking a student to comment on the division manager’s statement that it

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In class, I used the following textbook

introductory economics example of a situation where,

for two products, total cost is declining, total volume is

increasing, but unit costs are rising for both products.

Period 1

Unit Total

Price Consumption Cost

Period 2

Unit Total

Price Consumption Cost

This illustrates that it is possible to have a

situation like that shown in Table 1, contrary to what

the division manager’s intuition told him. This does not

mean, however, that this report is necessarily

meaningful for Arctic.

Next in class, I point out that since Depot OH

Question 5.

The following analysis shows that the existing

system would indicate emphasizing purchased bales but

the proposed system would indicate emphasizing

formed bales.

1980

Existing System Formed $10.41/bale

(allocate costs per labor $) Purchased 1.62/bale

premium for bulk paper is still justified because formed

bales cost $.029/lb. more to process. Under the

proposed system, a $.015 premium is not justified

because formed bales only cost $.011/lb. more to

process. Management could bid up the price for casual

paper until the difference declines to $.011 and still

prefer formed bales.

The point for the class to see is that an

1. Direct labor is no problem because it can be

directly identified per bale.

2. Allocated Division overhead is irrelevant to depot

cost control.

4. For all other cost items, the distinction between per

bale and per labor $ allocation seems purely

arbitrary.

5. Since the two biggest items vary per bale, I

personally would allocate everything else per bale

too. Thus, I would say costs per unit were

essentially irrelevant for cost control uses. What is

needed is a flexible budget for the controllable

variable costs (Direct Labor), a fixed budget for the

controllable non-variable costs (Depot OH) and

exclusion of the non-controllable costs (Allocated

Division OH).

2. Control over Indirect Labor seems okay. It takes

ninety-two+ drivers to staff twenty-two depots

internal unit cost information.

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1979 1980

Total Cost $1,875 $2,019

Less 22 Foremen (495) (525)

Drivers $1,380 $1,494

Apparently, Indirect Labor doesn’t rise much

as volume rises. Indirect Labor seems to be a

3. Control over direct labor seems good, but the

standards look somewhat “loose.”

Direct Labor

1979 1980

Conclude:

1. The “productivity” improve-ment just offset the

wage increase (6% each). A big coincidence?

2. Efficiency was “good” in 1979 and “better” in

to be an issue.

Question 3

paper at the dock (the

formed bales vs.

(in the bulk market) plus

variable processing costs per

3.

Pricing of the finished

product (bags of

insulation)

Economic value of the

insulation to the customer,

based on heating cost saved, and

competitive position of Arctic

products versus alternative

cost control. Question 4 asks the student to stand back

a little and see if there are any bigger issues floating

around.

Once the analysis presented above is covered

in class, probably the only “controversial issue” is the

Depot Cost Control

Flex budget for Direct Labor

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allow for that overhead.

In my view, the long run starts now! I would

argue that depot OH must be considered relevant even

in the short run. The depots are not “free.” The cost of

operating them must be recovered in the price

differential between bulk prices and Arctic’s loading

supply the four shredding and bagging plants.

In 1987, a Tuck student (Eric Spiegel)

presented the following analysis in class and blew me

away.

The decision to be in the casual paper

collection business vs. just buying spot from dealers or

speculating via inventory accumulation from dealers:

Volume of Paper Purchased

Costs of the Casual Collection Network (twenty-

two depots)

1. Direct Labor $3.84/bale vs. $.60/bale

2. Depot Overhead—Fixed or Variable?

How easily can the company get into and out

spread on Bid/Asked) you must expect to beat spot

by at least $35/T ($22 + $13) in order to justify

being in the business (ignoring a capital charge on

the real estate investment). This is highly unlikely

(impossible unless spot is above $35 consistently).

save some time at the end of class to consider the

strategic issue of trying to beat the spot market by at

least $35/T.

In 1989, for example, there was a glut of scrap

paper in the United States. An article in The Wall

Street Journal in January 1989 noted that New York

City was paying brokers $5/ton to haul away its

recycled newspapers (a minus $5 price for bulk scrap!).

In New Jersey, Gloucester County was paying $10/ton

$150 per ton for their recycled newspapers and office

waste paper.

Price swings from minus $25/T to plus $150/T

in a fifteen-year period indicate clearly how risky it is

to bet significant capital and operating dollars on one’s

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competencies vis-à-vis competing with bulk scrap

paper dealers.

The best classroom strategy is just to follow

the questions in order, based on the analysis presented

in this commentary. For a core, required course I

would plant to spend seventy-five minutes of a ninety–