Parts Maker, Inc.
A Mid-Sized Auto Component Manufacturer
Parts Maker, Inc. was a mid-sized manufacturer of automotive components that used stamping, rolling, finishing and assembly operations to make a variety of automotive products. Its $24 million annual sales were split evenly among product types: fuel doors assemblies, roof racks and structural stampings. The company had been losing money for a half-dozen years with losses reaching an all-time high of $500 thousand in the most recent year.
To produce fuel door assemblies, the company purchase coils of steel from which it stamped the major components for the assembly. The fuel door itself was the only “Class A” stamping manufactured by Parts Maker. Class A stampings are used on the exterior of the vehicle and, as a result, are painted and subjected to much higher quality standards than the balance of the company’s stampings. The components were assembled into the finished product in a special assembly cell set up for just that purpose. Roof racks were produced on roll lines from coils of bi-metals or stainless steel. This was a continuous process that began with de-coiling and ended with the assembly of a complete roof rack. Structural stampings were produced in a one- or two-step processes – often referred to a “bang it and box it” – with the product being packaged immediately after the final stamping operation.
Parts Makers had been developing its cost information using traditional costing methods. It determined its product costs using a plant-wide, direct labor-based overhead rate calculated using the previous year’s actual results. These costing methods showed each of the three types of products to be generating annual losses of between $130 thousand and $200 thousand.
In creating a managerial costing model that more closely reflected the operation of the business, manufacturing activities – both value adding and non-value adding – were segregated into groups with similar cost structures:
Expenses and activities supporting production labor (payroll taxes, health insurance, human resource support. etc.) were segregated from those supporting non-labor production resources (depreciation, utilities, maintenance, etc.). These production labor-support costs were the only costs included in a production labor rate used to assign direct labor costs to products produced.
Expenses and activities involved in the pre-production set up of forging presses and roll lines were segregated and incorporated into a “cost per set up” for each process that was used to assign set up costs to products based on their production batch size.
Manufacturing processes were divided into three groups: stamping, rolling and fuel door assembly. Non-labor related production expenses and activities (occupancy, depreciation, utilities, maintenance, quality, etc.) were assigned to these three activity centers based on consumption metrics or estimates of knowledgeable individuals and these costs included in a press-hour rate for stamping, line-hour rate for rolling and cell rate for fuel door assembly.
Expenses and activities that supported materials were also addressed. Those related to purchasing, receiving, quality testing, handling and storing coils of steel, stainless and bi-metal were isolated and included in a “cost per pound” that was used to assign these costs to products.
Using this new costing structure, a cost model was developed that accumulated the total cost of operating the business under varying volume and mix scenarios and then translated those costs into “fully-absorbed” rates for costing individual products and customers.
The new “fully-absorbed” cost information resulted product profitability information significantly different than traditional cost methods. The roof rack business was shown to be generating a $700 thousand annual profit; the structural stamping business a $200 thousand annual profit; and the fuel-door assembly business a $1.4 million annual loss. Since the losses of recent years had put the company in a rather precarious financial position, management saw only two possible courses of action: get a 25% price increase for its fuel door assemblies or drop the product and downsize to produce only roof racks and structural stampings. Since being granted a 25% price increase was highly unlikely, it used its new model in predictive mode to create an executable plan for downsizing.
When it presented the results to the fuel door assembly customer, the customer replied, “We wondered when you would catch on. Every year when we re-bid your product the competition kept coming up with prices 20%-25% higher than yours.” Needless to say, the price increase was not granted. It would have set a dangerous precedent for the customer’s buyers. If, however, the job been bid at the 25% higher price years earlier, Parts Makers might have been the lowest bidder and won the job, at a profit, anyway.
Parts Maker was able to negotiate a “bridge arrangement” during which it would build the customer a three-month bank of parts that would provide protection while they resourced the work. Due to Parts Maker’s precarious financial position, the customer did allow for a 25% surcharge on all parts built for the bank. This provided Parts Maker with an infusion of extra cash that strengthened it financially and helped it survive during the months of transition that were to come.
After the three-month bridge period, the company was able to downsize in accordance with the plan created using its predictive model and became a $16 million operation earning a $500 thousand pre-tax profit. Having jettisoned its unprofitable fuel door assembly business, Parts Maker became an attractive acquisition candidate and was sold to a major auto supplier less than a year later.