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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

Products Particulars Selling Price Volume-based costing - Unit cost - Gross margin Activity-based costing - Unit cost - Gross margin Change in Gross Margin Percent 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 Valves 86.00 56.00 34.88% 46.17 46.32% +11.44 Pumps 87.00 70.00 19.54% 58.20 33.10% +13.56 Flow Controllers 105.00 62.00 40.95% 115.38 -9.88% -50.83

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 o o The ABC cost analysis shows that we make a 33.10% gross margin in this product line There is strong competitive pressure to drop prices 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: 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 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

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: Flow Controllers 4,000 1,200 90 180 625

Production (units) Machine hours Production runs Number of shipments Hours of engineering work

Valves 7,875 3,750 12 10 263

Pumps 13,125 6,250 50 60 394

Total 11,200 152 250 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: Flow Controllers 140.00 4,000 560,000 106.31 425,250 134,750 24.06%

Sales Price Sales Volume Gross Revenue Cost of Manufacture Total cost of Production Gross Margin Gross Margin as % General, Selling, & Admin Expense Pre-tax Profit As percent

Valves 84.00 7,875 661,500 46.26 364,325 297,175 44.92%

Pumps 85.00 13,125 1,115,625 57.30 752,112 363,513 32.58%

Total

2,337,125 1,541,688 795,437 34.03% 559,650 235,787 10.09%

WE WELCOME ANY SUGGESTIONS FROM MANAGEMENT AND OTHER DEPARTMENTS

Appendix-I: Revised Product Costing Products Cost Center Direct Material Direct Costs Direct Labor Machine Related Expenses - Hours/Unit - Rate - Mach. Related Exp/Unit Setup Labor - Production runs - Rate - Cost - Total Production - Setup cost/Unit Receiving & Prodn. Control - Production runs - Rate - Cost Overheads - Total Production - Rec. & Prodn cost/Unit Engineering - Hours of Engineering - Rate - Cost - Total Production - Engineering cost/Unit Packaging and Shipping - No. of Shipments - Rate - Cost - Total Production - Pkg & Shipping cost/Unit Total Cost UOM $ $ Hrs $ $ Nos. $ $ Units $/Unit Nos. $ $ Units $/Unit Hrs $ $ Units $/Unit Nos. $ $ Units $/Unit $/Unit Valves 16.00 10.00 0.50 30 5.00 12 250 3,000 7,875 0.38 12 1,125 13,500 7,875 1.71 249 80 19,950 7,875 2.53 10 500 5,000 7,875 0.63 46.26 Pumps 20.00 12.50 0.50 30 15.00 50 250 12,500 13,125 0.95 50 1,125 56,250 13,125 4.29 374 80 29,925 13,125 2.28 60 500 30,000 13,125 2.29 57.30 Flow Controllers 22.00 10.00 0.30 30 9.00 90 250 22,500 4,000 5.63 90 1,125 101,250 4,000 25.31 594 80 47,500 4,000 11.88 180 500 90,000 4,000 22.50 106.31

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