Question

Internal and External Linkages, Strategic Cost Management

Maxwell Company produces a variety of kitchen appliances, including cooking ranges and dishwashers. Over the past several years, competition has intensified. In order to maintain—and perhaps increase—its market share, Maxwell’s management decided that the overall quality of its products had to be increased. Furthermore, costs needed to be reduced so that the selling prices of its products could be reduced. After some investigation, Maxwell concluded that many of its problems could be traced to the unreliability of the parts that were purchased from outside suppliers. Many of these components failed to work as intended, causing performance problems. Over the years, the company had increased its inspection activity of the final products. If a problem could be detected internally, then it was usually possible to rework the appliance so that the desired performance was achieved. Management also had increased its warranty coverage; warranty work had been increasing over the years.

DAVID Haight, president of Maxwell Company, called a meeting with his executive committee. Lee Linsenmeyer, chief engineer; Kit Applegate, controller; and Jeannie Mitchell, purchasing manager, were all in attendance. How to improve the company's competitive position was the meeting’s topic. The conversation of the meeting was recorded as follows:

DAVID: We need to find a way to improve the quality of our products and at the same time reduce costs. Lee, you said that you have done some research in this area. Would you share your findings?

LEE: As you know, a major source of our quality problems relates to the poor quality of the parts we acquire from the outside. We have a lot of different parts, and this adds to the complexity of the problem. What I thought would be helpful would be to redesign our products so that they can use as many interchangeable parts as possible. This will cut down the number of different parts, make it easier to inspect, and cheaper to repair when it comes to warranty work. My engineering staff has already come up with some new designs that will do this for us.

JEANNIE: I like this idea. It will simplify the purchasing activity significantly. With fewer parts, I can envision some significant savings for my area. Lee has shown me the designs so I know exactly what parts would be needed. I also have a suggestion. We need to embark on a supplier evaluation program. We have too many suppliers. By reducing the number of different parts, we will need fewer suppliers. And we really don’t need to use all the suppliers that produce the parts demanded by the new designs. We should pick suppliers that will work with us and provide the quality of parts that we need. I have done some preliminary research and have identified five suppliers that seem willing to work with us and assure us of the quality we need. Lee may need to send some of his engineers into their plants to make sure that they can do what they are claiming.

DAVID: This sounds promising. Kit, can you look over the proposals and their estimates and give us some idea if this approach will save us any money? And if so, how much can we expect to save?

KIT: Actually, I am ahead of the game here. Lee and Jeannie have both been in contact with me and have provided me with some estimates on how these actions would affect different activities. I have prepared a handout that includes an activity table revealing what I think are the key activities affected. I have also assembled some tentative information about activity costs. The table gives the current demand and the expected demand after the changes are implemented. With this information, we should be able to assess the expected cost savings.

Handout
Activities	Activity Driver	Capacity	Current Demand	Expected Demand
Purchasing parts	Number of different parts	2,000	2,000	500
Inspecting products	Inspection hours	50,000	50,000	25,000
Reworking products	Number reworked	As needed	62,500	25,000
Warranty repair	Number of defective products	10,000	9,000	3,500

Additionally, the following activity cost data are provided:

Purchasing parts: Variable activity cost: $30 per part number; 20 salaried clerks, each earning a $45,000 annual salary. Each clerk is capable of processing orders associated with 100 part numbers.

Inspecting parts: Twenty-five inspectors, each earning a salary of $40,000 per year. Each inspector is capable of 2,000 hours of inspection.

Reworking products: Variable activity cost: $25 per unit reworked (labor and parts).

Warranty: Twenty repair agents, each paid a salary of $35,000 per year. Each repair agent is capable of repairing 500 units per year. Variable activity costs: $15 per product repaired.

Required:

Compute the total savings possible as reflected by Kit’s handout. Assume that resource spending is reduced where possible. When calculating the number of employees no longer needed, round down to the nearest whole number. For example, if there are 10 employees and the number required equals 5.2, then 6 employees will be retained and 4 will be let go.

Answer 1