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 companyâ€™s operations in an effort to reduce
costs and improve product quality. A study by the companyâ€™s management accountant has determined the following per unit costs for primary processes and support services:
Cost per Unit
Research and development
Total cost per unit
Support Service Human resources $ 2.00
Total cost per unit
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:
â€¢ Research and development and design are critical functions because the market and
competition require constant development of new features with â€œcoolâ€ designs at lower cost.
Nevertheless, management feels that the cost per unit of these processes must be reduced by 20
â€¢ 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
â€¢ The futons are currently manufactured in Mali. By shifting production to China, the unit cost of
production can be lowered by 40 percent.
â€¢ Management believes that by selling to large retailers like Wal-Mart it is feasible to lower
current marketing costs by 25 percent.
â€¢ Distribution costs are already very low, but management will set a target of reducing the cost
per unit by 10 percent.
â€¢ 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.
â€¢ By outsourcing its support services, management projects a 20 percent drop in these costs.
1. Prepare a table showing the current cost per unit of primary processes and support services
and the projected cost per unit based on managementâ€™s proposals.
2. Will managementâ€™s proposals achieve the targeted total cost per unit? What further steps
should management take to reduce costs?
3. What role should the companyâ€™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 page.
Tarbox Manufacturing Company
Statements of Cost of Goods Manufactured
For the Years Ended December 31
Direct materials used Materials inventory, beginning
Direct materials purchased (net)
Cost of direct materials available for use
Less materials inventory, ending
Cost of direct materials used
Other overhead costs
Total manufacturing costs
Add work in process inventory, beginning
Total cost of work in process during the period
Less work in process inventory, ending
Cost of goods manufactured
Cost of goods sold Finished
Goods inventory, beginning
Cost of goods manufactured
Cost of goods available for sale
Less finished goods inventory, ending
Total cost of goods sold
Selling and administrative expenses
Sales salaries and
Other selling expenses
72,930 Administrative expenses
Total selling and administrative expenses
792,230 Income from operations
Other revenues and expenses Interest expense
56,815 Income before income taxes
$207,505 Income taxes expense
For the past several years, the companyâ€™s income has been declining. You have been asked to
comment on why the ratios for Tarboxâ€™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
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
3. What other factors or ratios do you believe should be considered in determining the cause of
the companyâ€™s decreased income?