Transcript REICHARD MASCHINEN, GMBH

REICHARD MASCHINEN,
GMBH
Group 5
Nguyen Thi Thanh Thao - M987Z237
Nong Hong Sa – M987Z231
COMPANY PROFILE
Grinding 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 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 SITUATIONS
At 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
Useful life: 2 months
 average was four rings per
machine.
 Price: 325/100
 Big quantity in stock

Plastic ring

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. Hainz
Development
engineer
Mr. Metz of the
Headquarter group
- strongly against
selling any steel rings
after the new plastic
rings became
available
-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 he
was sceptical of the
market acceptance
of such a product
- expect to recover
the investment in
steel inventory
What should be 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 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?




Mr. Kurtz must decide what to produce in
the future and what to do with his current
inventories. He needs a short- and a longterm 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
For the short run
Alternative 1: Sell steel rings which are already in
inventory and do not produce steel rings . (They can
continue to sell steel rings for 37 weeks)
Alternative 2. Produce next 34,500 steel rings. (They
can sell steel rings for 87 weeks.)
Alternative 3. Start to produce plastic rings in
September. (Throw away steel raw materials.)
Alternative 1: Sell steel rings which are already
in inventory and do not produce steel rings
Incremental cost per 100 Rings
Material
Direct Labor
Variable OH
Total
$0.00
$0.00
$0.00
$0.00
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.

Alternative 2:
Produce next 34,500 steel rings
Incremental cost per 100 Rings
Material
Direct Labor
Variable OH
Total
$0.00
$14.04
$11.23
$25.27
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

Alternative 3: Start to produce
plastic rings in September


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.
Incremental cost per 100 Rings
Material
Direct Labor
Variable OH
Additional Fixed OH
Total
$4.20
$15.60
$12.48
$54.69
$86.97

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
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 which
ring is more profitable, steel or plastic.
Plastic Rings
Contribution
Full Cost
Revenue
$340.00
$340.00
RM
$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
$4.20
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
25.27
160.89
Admin.
0
263.85
Profit
$325.00
$299.73
$164.11
$61.15
Total Profit of Steel
Rings
82,713
103,500
58,883
Volume of Plastic
Rings
25450/4= 6363
34500/4 = 8625
690*52 = 35880
Profit Contribution
of 100 Plastic Rings
308
308
308
Total Profit of
Plastic Rings
19,598
26,565
27,628
21,941
35880
273.40
24,524
Question 4: Con’t
1. 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 cost
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 Rings
Material
Direct Labor
Overhead
Manufacturing
Selling and Adm.
Cost total
Plastic
$4.20
$15.60
Steel
$76.65
$46.80
$31.20
$15.60
$93.60
$46.80
$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
Price reduction
Price
$340
$325
Bruggeman P sell
$264
RMG S full cost
RMG S sell
Expected P sell
RMG P full cost
$67
May
Sep ‘74
Time
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.

Demand decrease
Demand

Current steel
90%
690
621
Demand for Steel

Demand for Plastic
173
25%
69
10%
Sep ‘74
Graph: Demand for both types of rings

Time
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: Recommendation
Qualitative 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: Recommendations
Quantitative 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