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Calculating Cost Per Unit and OEM

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Winkley & White

Bob White leaned back and wiped his forehead with his hand. He was the president of the home oven division of Winkley & White, a manufacturer of a full line of home appliances that included refrigerators, ranges, ovens, dishwashers, disposals, dryers, washers, and range-hoods. The oven division made 24" and 26" built-in ovens, both self-cleaning (pyrolytic) and continuous clean (catalytic) models.

The ovens were used mainly for home improvement, although a small portion was used in new construction. The Winkley & White oven was regarded as a high-quality, premium product and was expensive. Winkley & White ovens were sold to independent distributors, who in turn sold to appliance stores, home improvement centers, building and remodeling contractors, and other retail outlets.

Although the Winkley & White oven was a premium product and was distributed nationally, it had never achieved the large volume of better known brands such as General Electric, Magic Chef, Caloric, or Amana. As a result, the Winkley & White oven division was only marginally profitable due to its low volume.

Last year, in order to increase volume, Winkley & White had entered into OEM1 contracts to manufacture ovens under other brand names. This was common practice in the industry, and in fact several of Winkley & White appliances (including gas ranges and disposals) were manufactured by other firms.

Under one contract, Winkley & White made ovens for Samantha Stoves, a well-known established brand that was sold by its own distribution division to appliance stores, home improvement centers, building and remodeling contractors, and other retail outlets. Under another contract, Winkley & White manufactured ovens for Mastercraft Stores, which was a mass-market retailer with over a thousand stores throughout the United States. The Samantha and Mastercraft ovens were essentially similar to the Winkley & White brand ovens.

Bob White was perspiring because he had just finished a phone conference with the top executives of Samantha. The Samantha executives had demanded a 5% price cut. What bothered Bob even more was that if Samantha received a 5% price cut, word would soon leak out, and Mastercraft would soon be demanding a price cut of 5% too. Within ten minutes, Bob had his three top executives around a conference table and had relayed to them the substance of Samantha's call.

Jack Hewitt, the plant manager, was saying, "The Samantha and Mastercraft ovens are basically like our own ovens, but their walls are not as well insulated or as well sealed at the door opening. The difference in cost is $5 for rock wool insulation and $1 for the door gasket per oven. Labor cost is the same for all three brands.

"Under the contracts with Samantha and Mastercraft, their production is scheduled 90 days in advance- which allows our 'just-in-time' inventory system to be implemented for raw materials. As a result, inventories of raw materials, work in process, and finished goods average about 30 days versus the 100 days of inventory we normal carry for the Winkley & White brand ovens. Sidney, what are our inventory carrying costs?"

Sidney Cohen, the division controller, tapped his pencil on the table and cleared his throat. "We have carefully studied our inventory carrying costs, and these add up to double the interest rate that we pay on our short-term borrowings. We have a line of credit at two points over prime, with a compensating balance requirement of 20%. Prime rate is presently 8%. Our Selling, General and Administrative expenses are mainly stable year after year, and have not increased since we began making OEM ovens," Sidney continued. "So, there are definitely manufacturing cost savings on our OEM ovens for Samantha and Mastercraft."

Next to speak was Barbara Craig, the division sales manager. "Our terms of payment are 10 days from invoice for Samantha and Mastercraft, as compared with the normal 60 days on accounts receivable that we carry for our own distributors. Also, Winkley & White pays the freight on all truckload orders from our distributors. Samantha and Mastercraft pay the freight to ship all of their OEM ovens from here to to their central distribution points in Dallas and Chicago, respectively. Winkley & White provides a three-year warranty on labor and materials for our own brand ovens, but we do not provide warranties or warranty service on the OEM ovens."

Bob White said, "Each of you has identified possible sources of lower costs on our OEM ovens versus our Winkley & White ovens. The question is whether these cost savings add up to enough to justify the lower prices that our OEM ovens sell for. If not, we may be in hot water. I seem to recall there's a law, Robertson-
Patrick or some such name, on price discrimination. I hope that's not going to cause our distributors to sue us for price discrimination. To avoid a lawsuit we must prove that our OEM prices are lower than what we charge our own distributors, due to cost savings on OEM sales. Sidney, would you put a report together on this right away? Then let's all get together again this afternoon at four to see how we stand."

Sidney replied, "So they're bringing in their lawyer, are they? Well I don't like to be threatened. We can bring in lawyers too. Isn't there some law against trade conspiracies, Bob? Can't you call our lawyer and see if he can be here for the meeting?"

Bob called the Winkley & White attorney. He had a previous engagement but agreed with Bob that this appeared to include a Robinson-Patman issue, unless Winkley and White could prove that its OEM prices were lower than what it charged its own distributors because of cost savings on OEM sales.

OEM stands for Original Equipment Manufacturer, indicating that Winkley & White were the Original Equipment Manufacturer for Samantha and Mastercraft ovens.

Assignment: You are Sidney's assistant. He asks you to prepare his report, and to clearly and fully explain your reasoning and your calculations.

Exhibit 1 is the Income Statement for the oven division for the recently ended fiscal year.


Winkley and White Corporation
Home Oven Division
Income Statement for the Year Ended December 31 (in $'000)
Sales (net) 30,538
Raw materials 6,894
Factory wages 8,642
Factory overhead 7,003
Cost of goods manufactured 22,539
Add: Beginning inventories 5,079
Less: Ending inventories 5,985
Cost of goods sold 21,633 21,633
Gross profit 8,905
Less operating expenses:
Product warranty service costs 1,256
Freight out 1,321
Selling and marketing 958
Product advertising and promotion 432
General and administrative 1,623
Allocated corporate overhead* 329
Total operating expenses 5,919 5,919
Division income before income taxes 2,986

*Note: Corporate overhead includes interest expense.

Average Total
Ovens Sold Number Price Sales ($'000)

Winkley & White brand 23,673 $626.00 $14,819
Samantha OEM brand 17,654 $407.00 $7,185
Mastercraft OEM Brand 20,966 $407.00 $8,533
Totals 62,293 $30,537

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Solution Preview

See the attached file. The steps you need to take to fill out the spreadsheet are given on the corporation notes. The spreadsheet is actually not that difficult to fill out if you follow the instructions. Each part of the corporation notes relates to a different part of the spreadsheet, and goes from top to bottom. Here are some clarifications on the corporation notes that you might find helpful:

With percent of total figures already provided, we can easily create formulas in Excel. For example, the raw materials COGS for Samantha is simply the total (689400) multiplied by the percentage (28.34%). The other calculations are made in the same way. The inventory figures are a little more difficult, but notice that Mastercraft's has ...

Solution Summary

Business planning involving offering lower prices to OEM and price-discrimination law.

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ClearHear is a manufacturer of cell phones, where Kendra Sherman works as a business development specialist. Kendra anxiously awaits her appointment with Lisa Norman, the production manager for ClearHear. Kendra has secured an order for 100,000 cell phones, virtually identical to ClearHear's Alpha model which will support a promotion that a major chain, Big Box, is running with a telephone service provider. The delivery date is in 90 days. Lisa is interested, in part, because she has an excess capacity of 70,000 cell phone units over the next three months, and part of her bonus is based on running the factory at capacity. However, the larger part of her bonus is based on factory total profitability. Big Box, however, will not pay over $15 for each of the cell phones, which are based on the $20 per unit Alpha model, lessening Kendra's enthusiasm.

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Table 1.

Unit Profitability Report
Alpha model Beta model
Price per unit 20 30
Variable cost per unit 8 12
Fixed overhead 9 10
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