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. 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. 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. 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.