Savannah Paper Co (SPC) Problems

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Description

Savannah Paper Co (SPC) currently manufactures commodity grade papers for use in computer printers and
photocopiers. SPC has reported losses for the last two years due to intense pressure from much larger competitors.
The SPC management team is contemplating a change in strategy to restore financial viability.
The commodity paper manufacturing business is all about economies of scale in which the largest
competitor with the lowest cost per unit wins. Therefore SPC has been focused on cost reduction, with a particular
focus on maintaining full capacity utilization of its machines. However, SPC’s older machines with limited capacity
have made it difficult for them to succeed at the “crank out as many tons of paper as possible” strategy. SPC does
not have the financial resources to expand its capacity by acquiring a new paper-making machine. Therefore, the
management team is proposing a new strategy to pursue low-volume business opportunities that exist in nonstandard, specialized paper grades. These customers want prompt deliveries of smaller quantities of a full range of
paper grades. This would require shrinking the elapsed time between order placement and order fulfillment as well
as expanding product offerings. SPC management believes it will be able to charge premium prices because there
is limited competition in this market. Management also believes that this strategy will allow it to increase sales from
current customers and bring in new customers. To succeed at this new strategy, SPC would need to adjust its
operations in several ways, including:
? Improve the ability to switch between paper grades. Right now they require an average of four hours to
change over to another grade. Prompt customer deliveries are a function of changeover performance.
?

Expand the range of paper grades they can manufacture. Currently they only manufacture three grades,
and they would need to expand grade capability so as to be perceived by customers as a “one stop shop.”
This would require new supply chain relationships and production worker training.

?

Improve their yields (i.e., tons of acceptable output relative to total tons produced) in the non-standard
papers. Currently, the percentage of waste within the non-standard grades is unacceptably high. Variable
costs will be way too high if they cannot increase their yields.

?

Attract and cater to customers who want just-in-time delivery of small quantities of a full range of papers.

1. Generally speaking, why would a company need to change its performance measurement system when it
changes its strategy?
2. Provide two examples of measures that would be appropriate under the old strategy. Why would these measures
fail to support SPC’s new strategy?
3. Create a balanced scorecard for SPC. Make sure that your answer demonstrates to me that you understand how
a properly-designed BSC works. You may create goals and measures that are not explicitly mentioned here in
order to design a complete BSC as long as they are reasonable and you are clear in communicating your
assumptions.
4. Management wants to ensure that its employees are motivated to attain this new strategy. Provide guidance to
management for achieving such motivation. Make sure that your discussion includes advantages and
disadvantages of tying incentive compensation to BSC measures. Be as complete in your discussion as you can in
incorporating the concepts we learned in the course but also make sure that your discussion relates specifically to
the facts of SPC.

Olympic Car Wash Company owns and operates 54 car wash locations in the Seattle area. The general
managers of each of the 54 locations report to Hugh Libby, the chief operating office.
At the end of each quarter, Hugh evaluates the performance of each of the car wash locations. His
evaluations determine the size of a bonus pool that is allocated to that location. The general manager of the
location then distributes the bonus to him/herself and the rest of location’s employees. According to the formulabased incentive plan, the location receives $3,000 for its bonus pool if it meets its budget target. An additional $1 is
added to the bonus pool for each $10 that the location exceeds its profit target.
Hugh has the right to make subjective adjustments to the size of the bonus pool (i.e., total dollars) for the
effects of factors that he deems outside the control of personnel at the location. In the past, Hugh has made such
adjustments for the adverse effects on revenues due to construction taking place on the street just in front of the car
wash location and on profit due to the costs of vandalism at another location.
By far the largest uncontrollable
factor that Hugh has to consider is weather. In particular, sales volume drops sharply when it rains, and it rains
frequently in Seattle. The budget, which is prepared quarterly, is based on the assumption of hours of good
weather. Inevitably, though, those assumptions are not accurate.
During the spring quarter of 2013 it rained many more hours than were assumed in the company’s budget,
and actual profits for all locations are far below the projected profit level. The results for the Cascades location are
shown in Table 1. Table 2 shows the operating assumptions and statistics for the quarter. The Cascades location is
open every day, ten hours per day. The hours of operation are set per Olympic Car Wash policy. The car wash
pays its employees, other than the manager, a fixed amount for each car wash completed, so labor costs are
largely variable with revenues.
Table 1: Budgeted and Actual Amounts
Budget
Actual
Variance
Revenues
$ 184,000 $ 124,080 $ 59,920 U
Variable expenses
92,000
62,040
29,960 F
Fixed expenses
53,820
55,000
1,180 U
Total expenses
145,820
117,040
28,780 F
Profit
$ 38,180
$ 7,040 $ 31,140 U
Table 2: Assumptions and Actual
Budget
Assumption
Average number of vehicles washed per
hour in good weather
23
Average revenue per vehicle
$10.00
Hours of bad weather per quarter
120
Hours of good weather per quarter
800
Total hours per quarter
920

Actual
Outcome
24
$11.00
450
470
920

1. Compute the total revenue variance, including the price and volume components. Split the volume variance into
weather and a pure quantity component. Hint: use # of good hours, # of washes/good hour and price/wash to
determine the appropriate revenues.
2. Prepare a flexible budget for variable and fixed costs for the quarter; use number of car washes as the variable
cost driver.
3. According to the formula-based incentive contract, the Cascades location is not eligible for a bonus pool because
its actual profit is less that the budgeted profit. Would you recommend to Hugh that he adjust the bonus pool
amount as part of his subjective performance evaluation? If so, by how much? Make sure that you justify your
answer.

2

Part 3:
Which scenario would most likely benefit from investing in an activity-based costing system:
? SPC before its strategy change
?

SPC after its strategy change

?

Olympic Car Wash

Justify your choice.

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