Soft Spot is a manufacturer of futon mattresses. Soft Spot’s mattresses are priced at $60, but competition forces



The Value Chain

P 7.
Soft Spot is a manufacturer of futon mattresses. Soft Spot’s mattresses
are priced at $60, but competition forces the company to offer significant
discounts and rebates. As a result, the average price of the futon mattress has
dropped to around $50, and the company is losing money. Management is applying
value chain analysis to the company’s operations in an effort to reduce costs
and improve product quality. A study by the company’s management accountant has
deter-mined the following per unit costs for primary processes and support

Primary Process Cost per Unit

Research and development $ 5.00

Design 3.00

Supply 4.00

Production 16.00

Marketing 6.00

Distribution 7.00

Customer service 1.00

Total cost per unit $42.00

Support Service Human resources $ 2.00

Information services 5.00

Management accounting 1.00

Total cost per unit $ 8.00

To generate a gross margin large enough for
the company to cover its over-head costs and earn a profit, Soft Spot must
lower its total cost per unit for primary processes to no more than $32.00 and
its support services to no more than $5.00. After analyzing operations,
management reached the following con-clusions about primary processes and
support services:

• Research and development and design are
critical functions because the market and competition require constant
development of new features with “cool” designs at lower cost. Nevertheless,
management feels that the cost per unit of these processes must be reduced by
20 percent.

• Ten different suppliers currently provide
the components for the futons. Ordering these components from just two
suppliers and negotiatin glower prices could result in a savings of 15 percent.

• The futons are currently manufactured in
Mali. By shifting production to China, the unit cost of production can be
lowered by 40 percent.

• Management believes that by selling to
large retailers like Wal-Mart it is feasible to lower current marketing costs
by 25 percent.

• Distribution costs are already very low,
but management will set a target of reducing the cost per unit by 10 percent.

• Customer service and support to large
customers are key to keeping their business. Management therefore proposes
increasing the cost per unit of customer service by 20 percent.

• By outsourcing its support services,
management projects a 20 percent drop in these costs.


Prepare a table showing the current cost per unit of primary processes and
support services and the projected cost per unit based on management’s

2. Will management’s proposals achieve the
targeted total cost per unit? What further steps should management take to reduce

3. What role should the company’s support
services play in the value chain analysis?

Financial Performance Measures

C 2.
Tarbox Manufacturing Company makes sheet metal products for heatingand
air conditioning installations. Its statements of cost of goods manufacturedand
income statements for the last two years are presented below and on the next

Manufacturing Company

of Cost of Goods Manufactured

the Years Ended December 31

This Year Last

Direct materials used Materials inventory,
beginning $91,240 $93,560

Direct materials purchased (net) 987,640

Cost of direct materials available for use $1,078,880

Less materials inventory, ending 95,020

Cost of direct materials used $983,860

Direct labor 571,410


Indirect labor $182,660 $171,980

Power 34,990 32,550

Insurance 22,430 18,530

Supervision 125,330 120,050

Depreciation 75,730 72,720

Other overhead
costs 41,740 36,280

Total overhead 482,880

Total manufacturing costs $2,038,150

Add work in process inventory, beginning 148,875 152,275

Total cost of work in process during the
period $2,187,025 $2,146,365

Less work in process inventory, ending 146,750 148,875

Cost of goods manufactured $2,040,275

Sales $2,942,960

Cost of goods sold Finished

Goods inventory, beginning $142,640 $184,820

Cost of goods manufactured 2,040,275 1,997,490

Cost of goods available for sale $2,182,915 $2,182,310

Less finished goods inventory, ending 186,630 142,640

Total cost of goods sold 1,996,285

Gross margin
$946,675 $1,056,550

Selling and administrative expenses

Sales salaries and

Commission expense $394,840 $329,480 Advertising expense 116,110

Other selling expenses
82,680 72,930
Administrative expenses 242,600

Total selling and administrative expenses 836,230 792,230 Income from operations $110,445

Other revenues and expenses Interest
expense 54,160
Income before income taxes $56,285
$207,505 Income taxes expense 19,137

Net income $37,148

For the past several years, the company’s
income has been declining. You have been asked to comment on why the ratios for
Tarbox’s profitability have deteriorated.

1. In preparing your comments, compute the
following ratios for each year:

a. Ratios of
cost of direct materials used to total manufacturing costs, direct labor to
total manufacturing costs, and total overhead to total manufacturing costs.
(Round to one decimal place.)

b. Ratios of
sales salaries and commission expense, advertising expense, other selling
expenses, administrative expenses, and total selling and administrative
expenses to sales. (Round to one decimal place.)

c. Ratios of
gross margin to sales and net income to sales. (Round to one decimal place.)

2. From your evaluation of the ratios
computed in 1, state the probable causes of the decline in net income.

3. What other factors or ratios do you
believe should be considered in determining the cause of the company’s
decreased income?



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