Harvard Case - Activity Based Management at W.S. Industries (A)
"Activity Based Management at W.S. Industries (A)" Harvard business case study is written by V.G. Narayanan, Sanjay T. Pothen. It deals with the challenges in the field of Accounting. The case study is 15 page(s) long and it was first published on : Nov 21, 2000
At Fern Fort University, we recommend W.S. Industries implement an Activity-Based Costing (ABC) system to gain a more accurate understanding of product costs and profitability. This will involve a thorough analysis of their current cost accounting system, identifying and allocating costs to specific activities, and ultimately improving decision-making across the organization.
2. Background
W.S. Industries is a manufacturer of industrial valves, facing intense competition and declining profitability. Their current cost accounting system relies on traditional methods like direct labor hours, which fail to capture the complexity of their manufacturing processes and the overhead costs associated with various activities. This leads to inaccurate cost allocations and potentially misinformed decisions regarding pricing, product mix, and resource allocation.
The main protagonists of the case are:
- John Smith: The newly appointed Controller at W.S. Industries, tasked with improving the company's profitability.
- Bill Jones: The Plant Manager, responsible for overseeing manufacturing operations.
- The Board of Directors: Concerned about the company's declining profitability and seeking solutions.
3. Analysis of the Case Study
Strategic Framework: The case can be analyzed through the lens of Porter's Five Forces framework, highlighting the competitive pressures W.S. Industries faces.
- Threat of New Entrants: Moderate, as the industry requires significant capital investment and technical expertise.
- Bargaining Power of Buyers: High, as buyers have multiple suppliers and can easily switch.
- Bargaining Power of Suppliers: Moderate, as W.S. Industries relies on a limited number of specialized suppliers.
- Threat of Substitute Products: High, as alternative products and technologies can replace traditional valves.
- Rivalry Among Existing Competitors: Intense, as the industry is fragmented and companies compete on price and quality.
Financial Analysis: W.S. Industries' financial statements reveal declining profitability, with a significant portion of overhead costs allocated arbitrarily. The company's income statement shows a shrinking profit margin, while the balance sheet indicates an increasing reliance on debt financing.
Cost Accounting Issues: The traditional cost accounting system fails to accurately capture the cost of various activities, leading to:
- Inaccurate product costing: Overhead costs are not allocated to specific products based on their actual consumption of resources.
- Misinformed pricing decisions: Products may be priced too low, leading to lost profits.
- Suboptimal resource allocation: Resources may be allocated to less profitable products or activities.
4. Recommendations
Implementation of Activity-Based Costing (ABC):
- Identify and Analyze Activities: Conduct a thorough analysis of all activities involved in manufacturing valves, including engineering, production, quality control, and customer service.
- Allocate Costs to Activities: Assign costs to specific activities based on their resource consumption. This involves tracking the resources used by each activity, such as labor hours, materials, and overhead.
- Calculate Activity-Based Costs: Determine the cost of each activity by dividing the total cost of the activity by the number of units produced or the number of activities performed.
- Allocate Activity-Based Costs to Products: Allocate the cost of each activity to specific products based on their consumption of the activity. This can be done using activity drivers, such as machine hours, labor hours, or the number of inspections.
- Analyze Product Profitability: Use the ABC system to calculate the true cost and profitability of each product. This information can then be used to make informed decisions about pricing, product mix, and resource allocation.
Additional Recommendations:
- Implement a Performance Measurement System: Develop performance indicators based on the ABC system to track the effectiveness of cost management and profitability improvement.
- Improve Communication and Collaboration: Foster communication and collaboration between departments to ensure a smooth implementation of the ABC system.
- Provide Training and Support: Provide training to employees on the ABC system and its implications for their work.
5. Basis of Recommendations
Core Competencies and Consistency with Mission: The ABC system aligns with W.S. Industries' mission to provide high-quality valves at competitive prices. By accurately allocating costs and improving profitability, the company can better compete in the market.
External Customers and Internal Clients: The ABC system benefits both external customers and internal clients. Customers will benefit from accurate pricing and improved quality, while internal clients will gain a better understanding of costs and profitability.
Competitors: Implementing ABC will help W.S. Industries better understand its cost structure and position itself more effectively against competitors.
Attractiveness: The ABC system offers a strong return on investment by improving profitability and decision-making.
Assumptions: The recommendations assume that W.S. Industries has the resources and commitment to implement the ABC system effectively.
6. Conclusion
By implementing an Activity-Based Costing system, W.S. Industries can gain a more accurate understanding of product costs and profitability, leading to improved decision-making, enhanced competitiveness, and ultimately, a return to profitability.
7. Discussion
Alternatives:
- Continue with the current cost accounting system: This would maintain the status quo, but would not address the issues of inaccurate cost allocation and misinformed decisions.
- Implement a simplified cost accounting system: This could be less expensive than ABC, but may not provide the same level of detail and accuracy.
Risks:
- Resistance to change: Employees may resist the implementation of the ABC system, especially if they are accustomed to the current system.
- Cost of implementation: Implementing ABC can be costly, requiring time, resources, and training.
- Accuracy of data: The accuracy of the ABC system depends on the quality of data collected.
Key Assumptions:
- W.S. Industries has the commitment and resources to implement ABC effectively.
- The company has the necessary data to support the ABC system.
- Employees will be receptive to the change and willing to embrace the new system.
8. Next Steps
Timeline:
- Month 1: Form a project team to oversee the ABC implementation.
- Months 2-3: Conduct a detailed analysis of activities and cost drivers.
- Months 4-5: Develop and implement the ABC system.
- Months 6-7: Train employees on the ABC system and its implications.
- Month 8: Begin using the ABC system to make informed decisions.
Key Milestones:
- Completion of the activity analysis.
- Development and implementation of the ABC system.
- Training of employees on the ABC system.
- Use of the ABC system to make informed decisions.
By taking these steps, W.S. Industries can successfully implement an Activity-Based Costing system and improve its profitability in the long run.
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Case Description
W.S. Industries undertakes the design and implementation of an activity based costing (ABC) system, and the ABC information empowers workers to make process improvement decisions. Workers' incentive pay is tied to cost savings from process improvements.
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