Kanthal Case Study Solutions

Kanthal is company that specializes in the production and sales of electrical resistance heating elements. Kanthal has about 10,000 customers and they produce about 15,000 items. The company consists of three divisions and these three divisions are as follows:

1)Kanthal Heating Technology – 25% global market share

2)Kanthal Furnace Products – 40% global market share

3)Kanthal Bimetals – Manufacturer of one of the few fully integrated temperature control devices

Mr. Ridderstrale, who became the President of the company in 1985, developed and

implemented a plan that has involved completely changing and over-hauling their pre-existing traditional cost system. The new plan has been installed with the hopes that it will provide more accurate information about their manufacturing cost structure, as well as the costs of supplying individual customers and orders. With this new information, Kanthal plans to redirect its resources to customers with hidden profits and reduce efforts that are focused on customers with hidden losses. The ultimate purpose for this system change is to achieve higher growth and profitability.

PROBLEMS, ANSWERS & SOLUTIONS:

Question 1:

Why have selling administrative costs not traditionally been traced to individual products and customers?

Answer 1:

Under the old costs system, Kanthal management felt that selling and administration costs were fixed costs, and as a result they could not be changed, manipulated, or utilized to influence growth or profitability. Traditionally, Kanthal had considered S&E expenditures to be period costs and were expensed in that manner rather than allocating them to the various product lines and customers. Under the old system, management failed to realize that some of their customers placed heavy demands on the organization while others did not. Therefore, no attempts were made to allocate S&A costs to the customers or product lines. As a result, costs were spread evenly and the focus of the sales force was on volume rather than the percent profit margin or the true bottom line contribution of each order to the company.

Question 2:

Evaluate the approach taken at Kanthal to compute the profit of individual orderliness, including assigning S&A costs to each customer order. How were the costs of customer orders and the costs of producing non-stocked items estimated?

Answer 2:

The company re-invented a way to approach their cost allocations. Instead of treating S&A expenditures as period costs, the company derived a methodology for allocating these costs where they were applicable. The financial managers solicited information from the various departments in the organization about the nature of the activities in each department. A new cost allocation method was constructed based on the information received.

The new costs system allowed for management to capture the costs either as work that was either order related or volume related. These were the primary cost drivers for the S&A and manufacturing expenditures. After discussing everything with the different department heads, the company would then determine how much of each departments’ expenditures related to sales volume and production and how much related to handling individual production and sales orders. Four categories for cost allocation were later established:

1)Manufacturing volume related costs

2)Manufacturing order related costs

3)S&A volume related costs

4)S&A order related costs

Although this system was much more rigorous, it made a good faith effort to assign the various production and S&A expenditures to customers and products lines. The departments captured in this system were comprehensive and were also generally identified as to who would have responsibilities for manufacturing costs.

Computing order and volume costs was a four-step process. First, S&A order costs were computed by dividing the total number of orders into total S&A costs (refer to Exhibit 4 in the case). Second, the manufacturing order costs for non-stocked items was calculated by dividing total manufacturing order costs for non-stocked items by the number of orders for non-stocked products. Non-stocked products have additional costs associated with processing orders that went above and beyond the costs associated with a stocked product. The third step involved determining what the S&A allocation factor would be for calculating the S&A volume related costs. This allocation factor would then be applied to manufacturing COGS. The fourth and final step involved the calculation of the operating profit based on backing out volume related costs from sales revenues followed by deducting S&A and manufacturing order costs from the resulting gross margin to arrive at a operating profit.

Question 3:

Consider a product line with 50% gross margins (after subtracting volume-related expenses from prices). The cost for handling an individual customer order is SEK 750, and the extra cost to handle a production order for a non-stocked item is SEK 2,250.

a). Compare the operating profits and profit margins of two small orders, both for SEK 2,000. One order is for a stocked item, and the other order is for a non-stocked item.

b).Compare the operating profits and profit margins for two large customers.

Customers A & B both purchased SEK 160,000 worth of products this year.

Customer A placed just three orders, for three different non-stocked items.

Customer B placed 28 orders, 6 for stocked items and 22 for non-stocked items.

Answer 3:

The calculations used for this problem (large and small customers) may be found in Exhibit A. Part (A) shows the calculations for a small customer who places an order for a stocked item and a non-stocked item. All associated costs concerning the processing of an order for a non-stocked item are substantial. They have created a loss situation. For the order of a stocked item, the charges associated with a non-stocked item are not present and an operating profit is generated.

The large customer order has a trend that is similar. Its impact on the final figure is not as severe as the result of the larger order. Also, because of the 50% gross margin percentage, Customer A shows an operating profit of SEK 71,000 (44%), while Customer B shows an operating profit of SEK 9,500 (6%).

The number of non-stocked items processed will indeed impact the operating profits substantially. Ordering costs related to both S&A and manufacturing are incurred on both orders.

Question 4:

What should Ridderstrale do about the large number of unprofitable customers revealed by the account management system? Should salespersons be allowed to accept an unprofitable order from a customer?

Answer 4:

The company should concentrate on selling to high volume customers who purchase stocked items. Efforts should be made to boost orders for stocked items and move away from non-stocked items. This is under the assumption that prices will be held constant.

Kanthal management should not necessarily decline the orders for non-stocked items; rather they should charge a healthy premium for them. By charging the higher prices, this allows the company to see how important non-stocked items are to the customer. If the non-stocked items are of any importance to the operations of the customer, they will continue to purchase and pay the premium, or they will try to adjust their operations so that it will accommodate the stocked items. On the other hand, the customer could decide to purchase these items from another supplier. This would definitely have a negative effect on Kanthal’s profitability.

CONCLUSION:

Kanthal should take measures to minimize costs that are associated with the non-stocked items. The case does not show any evidence of Kanthal attempting to reduce cost activities. If the company could successfully reduce costs, this would lead to an improved operating profit margin related to stocked items. Also, Kanthal needs to focus their sales on the percent profit margin or the true bottom line contribution of each order to the company.