REICHARD MASCHINEN, REICHARD MASCHINEN, GMBHGMBH

Group 5Nguyen Thi Thanh Thao - M987Z237Nong Hong Sa – M987Z231

COMPANY PROFILECOMPANY PROFILEGrinding Machines Division (GMD) is

one part of Reichard Machines Company.

Headquarter located in Frankfurt, operated mainly as a holding company.

For almost 100 years, Reichard had manufactured industrial machines which it sold throughout Europe and North America. It enjoyed a reputation for high quality, technology leadership, and excellent customer service.

BUSINESS SITUATIONSBUSINESS SITUATIONS In recent years many other manufacturers had

entered Reichard's markets with lower priced spareparts. Other companies had entered with lower quality and lower priced machines and parts.

Biggest competitor is Bruggeman Grinders, SA in Belgium, which manufacturing the plastic rings (one part of the machine) to take the place of steel rings (currently Reichard is using)

Mr. Kurtz (Managing Director) felt sure that competition would continue to intensify in the future. But, he was fully committed to Reichard's strategy of high quality, innovation and excellent service, at a price.

BUSINESS SITUATIONSBUSINESS SITUATIONSAt another level, when the

marketing and manufacturing issues are considered, the complexity of the decision becomes apparent.

The main dilemma of the case is "How long can the firm stay with the substantially more profitable, but technologically obsolete, steel rings while still holding to its strategy of being a top quality producer at a fair price?"

Steel ring Plastic ringUseful life: 2 monthsaverage was four

rings per machine. Price: 325/100Big quantity in stock

4 times wearing properties than steel ring

The factory already had a plastics injection molding department.

the factory could be ready to produce plastic rings by mid-

September The additional molds and

tooling necessary could be produced for about $10,000, but would have to be specially designed which would take a few months

Surely get 10% market share

Mr. Goerner Sales manager

Mr. HainzDevelopment engineer

Mr. Metz of the Headquarter group

- strongly against selling any steel rings after the new plastic rings becameavailable-The result would affect the sale of machines

- plastic ring would completely destroy demand for the steel ring- sell the plastic ring only in Bruggeman's market area - continue supplying the steel ring until stocks were used up

- no problem with GMD getting ready to produce plastic rings, although hewas sceptical of the market acceptance of such a product- expect to recover the investment in steel inventory

What should be What should be considered?considered?This case deals with cost analysis for

assessing the economics of a product transition facing Reichard Maschinen.

also involves the broader spectrum of business issues related to the transition.

At one level, the economics of the situation need to be brought into focus; fixed costs, marginal costs, and sunk costs must be separated and evaluated for their "relevance" to the decision.

What should be What should be considered?considered?The concept of eliminating applied

fixed overhead in a short run, relevant cost analysis.

The concept of sunk costs in a relevant cost analysis.

The concept of the "product substitution" aspects of contribution analysis.

The use of the above analysis as a numerical framework for a partial view of the pricing decision.

What should be done?What should be done?Mr. Kurtz must decide what to produce

in the future and what to do with his current inventories. He needs a short- and a long-term strategy.

Facing the introduction of plastics rings by one competitor, Bruggeman, RMG needs to decide:

1) whether they will start to produce plastic rings

2) when to start the production, if needed.

Incremental cost analysis Incremental cost analysis For the short runFor the short run

Alternative 1: Alternative 1: Sell steel rings which Sell steel rings which are already in inventory and do not are already in inventory and do not

produce steel ringsproduce steel rings

Because they will not incur any production cost and the finished goods to be sold are already in inventory, the incremental cost will be $0 as shown in the right table.

One can also point out that the 70% of wages will be incurred during the summer, but it is common to the three alternatives and will not be included in the incremental costs.

Incremental cost per 100 Rings

Material $0.00Direct Labor $0.00Variable OH $0.00Total $0.00

Alternative 2: Produce next 34,500 steel

rings

The special steel used in the manufacture of the rings has already been purchased and there is no alternative market for the raw steel. Since the scrap value of the steel used to make the rings is zero, the opportunity cost of the raw material is also zero. Thus, there is no further raw material cost

They will incur the direct labor cost in this period and the wages that will additionally paid will be 30% of the regular wages = 46,8 *30% = 14.04

The variable OH cost is 80% of direct labor costs = 14.04*80% = 11.23

Incremental cost per 100 Rings

Material $0.00Direct Labor $14.04Variable OH $11.23Total $25.27

Alternative 3: Start to Alternative 3: Start to produce plastic rings in produce plastic rings in

SeptemberSeptember Because RMG needs to

prepare for the plastics production until September. For the short run, we assume no capacity expansion, so we will exclude the fixed OH costs estimated by the controller and include the additional fixed OH incurred by the acquisition of molds and tooling

To calculate the additional fixed OH, i. e. molds and tooling, we assume the useful life of this equipment is 5 years. One can also assume that the demand for the plastic rings will start with 10% of the current demand for steel rings.

The variable OH cost is 80% of direct labor costs = 15.60*80% = 12.48

The annual demand for the plastic rings:

Annual demand for the plastic rings = 690units/wk * 53wks * 10% =3657 units 

The additional OH cost per 100 plastic

Cost per 100 units = (Acquisition cost/( useful life*annual demand )) * 100 =10,000*100/(5*3657) =$54.69

Incremental cost per 100 Rings

Material $4.20Direct Labor $15.60Variable OH $12.48Additional Fixed OH $54.69Total $86.97

Question 3:Question 3:

This question asks for the differential cost of the 25,450 steel rings which already are in inventory at the end of May. The idea here is to see that the 25,450 finished steel rings already in inventory have zero differential cost. No additional work needs to be done on these rings.

Question 4:This question asks Question 4:This question asks which ring is more profitable, which ring is more profitable, steel or plastic.steel or plastic.

Plastic Rings Contribution Full Cost

Revenue $340.00 $340.00

RM $4.20$4.20

DL 15.60 15.60

OH:Dept. 12.48 31.20 + 15.60

Admin. 15.60 $32.28 $66.60

Profit Contribution $307.72 $273.40

Steel Rings Steel Rings 25,450

Next Future Rings 34,500 in stock Rings

Contribution (690 per week X 52 weeks) = 35880

Full Cost (690 per week X 52 weeks) = 35880

Revenue $325.00 $325.00 $325.00 $325.00

RM 0 0 76.65 76.65

Labor 14.04 46.80 46.80

OH:Dept 11.23 37.44 93.60+ 46.8

Admin. 0 25.27 160.89263.85

Profit $325.00 $299.73 $164.11$61.15

Total Profit of Steel Rings

82,713 103,500 58,88321,941

Volume of Plastic Rings

25450/4= 6363 34500/4 = 8625 690*52 = 3588035880

Profit Contribution of 100 Plastic Rings

308 308 308273.40

Total Profit of Plastic Rings

19,598 26,565 27,62824,524

Question 4: Con’tQuestion 4: Con’t1. For the next of 25,450 rings, steel rings are much more profitable than plastic rings.2. For the next 34,500 rings after that, steel rings are still much more profitable than plastic rings.3. For all rings beyond 59,950 units: teel rings are more profitable than plastic on a marginal contribution basis but plastic rings are more profitable than steel on a full cost basis.

Question 5: Long term Question 5: Long term cost analysiscost analysis

The decision based on the incremental cost analysis is that the company do not produce any rings. However, we strongly recommend to analyse the profitability of producing plastic rings in the long run, because the analysis above does not include all the costs that will be incurred in the long run. For the long term analysis, we will take the full costing calculation made by the controller.

Costs per 100 RingsPlastic Steel

Material $4.20 $76.65Direct Labor $15.60 $46.80Overhead Manufacturing $31.20 $93.60 Selling and Adm. $15.60 $46.80

Cost total $66.60 $263.85

For the long run, the cost per 100 plastic rings is far less than that of steel rings. If the prices of both rings are the same, the plastic rings are profitable. It is clear that in the long run, steel rings will not take any share because of its high production cost.

However, even though the company shift to the plastic rings production and drop the steal rings, it still poses 3 concerns as below. ◦Further price reduction◦Overhead cost on plastic rings◦Demand decrease

May

Bruggeman P sell$340RMG S sell$325

RMG S full cost$264

RMG P full cost$67

Sep ‘74 Time

Price

Expected P sell

Price reductionPrice reduction

At the very beginning, we can expect high price and high margin on plastic rings.

However, the price of the plastic rings can be lowered to $82 per 100 units in the long run.

Current steel69090%621

25%173

10%69

Sep ‘74 Time

Demand

Demand for Steel

Demand for Plastic

Graph: Demand for both types of rings

Demand decreaseDemand decrease We can expect the

increasing demand for the plastic rings at the beginning, because there would be replacement demand from steel rings.

However, the demand will be ¼ of the current demand for the steel rings, because of its durability.

At the same time, the demand for the steel rings will be 0 in two and half years, assuming 10% decrease in three months.

Question 6: Question 6: Recommendation Recommendation Qualitative AnalysisQualitative Analysis

Competitive Market: Given the plastic rings production is not very difficult (as RMG is trying to shift to plastic ring production soon) and it brings higher margin than steel rings, the market will be very competitive. Even if RMG does not produce the plastic rings, the plastic rings will be produced by other companies and the market will shift to plastic rings naturally.

Reichard Maschinen’s market leadership: By introducing the plastic rings into market earlier, the company will maintain their position as a leading industrial machine producer of high quality and technology.

Global Penetration: Given plastic rings’ higher OH cost structure and decreasing demand prospect, the company should expand their client base by global penetration. Since their competitor, Bruggeman, is only selling the plastic rings within Belgium, through this expansion, Reichard Maschinen GmbH could justify their plastic rings production.

Steel Rings are no longer feasible: The steel rings’ higher costs do not justify the continuous manufacturing under the competition.

Question 6: Question 6: Recommendations Recommendations Quantitative AnalysisQuantitative Analysis

In conclusion, considering all the aspects of short term incremental cost analysis, long term prospects of demand, price, profitability and quantitative analysis, we suggest followings◦Shift to plastics rings within a year◦Price at first, around $325◦Cut price as competition goes◦Differentiate ◦Go global and expand the customer base