29 Jun Question The Value Chain
Question
The Value Chain
P 7. Soft Spot is a manufacturer of futon mattresses. Soft Spot’s mattresses are priced at $60, but competition forces the company to offer significant discounts and rebates. As a result, the average price of the futon mattress has dropped to around $50, and the company is losing money. Management is applying value chain analysis to the company’s operations in an effort to reduce costs and improve product quality. A study by the company’s management accountant has deter-mined the following per unit costs for primary processes and support services:
Primary Process Cost per Unit
Research and development $ 5.00
Design 3.00
Supply 4.00
Production 16.00
Marketing 6.00
Distribution 7.00
Customer service 1.00
Total cost per unit $42.00
Support Service Human resources $ 2.00
Information services 5.00
Management accounting 1.00
Total cost per unit $ 8.00
To generate a gross margin large enough for the company to cover its over-head costs and earn a profit, Soft Spot must lower its total cost per unit for primary processes to no more than $32.00 and its support services to no more than $5.00. After analyzing operations, management reached the following con-clusions about primary processes and support services:
• Research and development and design are critical functions because the market and competition require constant development of new features with “cool” designs at lower cost. Nevertheless, management feels that the cost per unit of these processes must be reduced by 20 percent.
• Ten different suppliers currently provide the components for the futons. Ordering these components from just two suppliers and negotiatin glower prices could result in a savings of 15 percent.
• The futons are currently manufactured in Mali. By shifting production to China, the unit cost of production can be lowered by 40 percent.
• Management believes that by selling to large retailers like Wal-Mart it is feasible to lower current marketing costs by 25 percent.
• Distribution costs are already very low, but management will set a target of reducing the cost per unit by 10 percent.
• Customer service and support to large customers are key to keeping their business. Management therefore proposes increasing the cost per unit of customer service by 20 percent.
• By outsourcing its support services, management projects a 20 percent drop in these costs.
Required
1. Prepare a table showing the current cost per unit of primary processes and support services and the projected cost per unit based on management’s proposals.
2. Will management’s proposals achieve the targeted total cost per unit? What further steps should management take to reduce costs?
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