Alexis Klark, managing director of Pharsalia Electronics (PE), is concerned about the prospects of one of its major products. She has been reviewing a marketing report with Jeff Keller, marketing product manager, for their 10-disc car compact disc (CD) changer. The report indicates a price reduction is needed to meet anticipated competitors’ reductions in sales prices. The current selling price for their 10-disc car CD changers is $350 per unit. It is expected that within three months PE’s two major competitors will be selling their 10-disc car CD changers for $300 per unit. This concerns Klark, because the current cost of producing and selling the CD changers is $315, which yields a $35 profit on each unit sold.
The situation is especially disturbing because PE had implemented an activity-based management (ABM) system about two years ago. The ABM system helped them better identify activity costs, root cause cost drivers, and cost reduction opportunities. Changes made as a result of adopting ABM reduced costs on this product by approximately 15 per cent over the last two years. Now it appears that costs will need to be reduced considerably more to remain competitive and to make a profit on the o-disc car CD changers. Total costs to produce, sell, and service the CD changer units are as follows:
Klark has decided to hire Donald Collins, a consultant, to review the situation and to implement any changes that are needed. After two weeks of review, discussion and analysis, Collins suggested that PE adopt a just-in-tie (JIT) system to help reduce costs. He also suggested that using target costing would help in meeting the new target selling price of $300.
By changing to a JIT manufacturing system, PE expects that material handling, inspection, and finished goods warehousing will all be eliminated. However, the cost of other manufacturing activities will increase by 10 per cent due to more highly skilled labour. Customer service costs are expected to be reduced by 50 percent.
1. Determine PE’s target cost per unit assuming that the current profit margin remark a changed
2. If the JIT system is implemented, will PE meet the target cost?
3. Outline other steps that the company could undertake to further reduce the process cost.