Competitive Situation for Wilkerson Case
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Competitive Situation
The competitive situation for Wilkerson differs for each of its products. The companies first made product, the valve, has a very different competitive market than the flow controls and pumps. The valve is a standard product that is made and shipped in large batches. Wilkerson is known as the quality leader producing a uniquely designed valve that has generated a loyal customer base. There is potential in the marketplace that this quality leadership could be jeopardized, yet at this time no one has gone after their market share by cutting prices. Although, this has yet to happen the company should be prepared for this in the future. Pumps are considered a commodity product where price competition is severe. The flow controls on the other hand, are a customized product which is built to customer specifications. This is a less competitive market with the company noticing an inelastic demand with the current price points. With the current pricing of pumps and the potential for valve pricing competition, it is important for Wilkerson to take a look at overhead costs and potentially make some adjustments in cost allocations in order to be prepared for future price competition.
Existing Cost System
While there are some issues with the companys current cost allocation methods, it would not be suggested to completely abandon overhead assignments to products completely. It is important to look at the resources being put into each of the products in order to better distribute where the costs are being incurred. If one product takes 5 hours to produce and the other 10, overhead costs should not be distributed equally as they are now with a volume-based cost allocation. With overhead costs at 300%, it is important that those costs are allocated appropriately based on resources used for each production run. For example, this could potentially help out margins in the valve department since it is a standard production run that probably does not require as much set up and therefore costs.
Activity-based Costing
A good alternative for the Wilkerson Company would be the activity-based costing (ABC) approach. This will help the company to trace indirect costs back to the appropriate products. With the current use of the more traditional volume-based costing, all goods are allocated an equal share of overhead costs. Due to the nature of Wilkersons business, this is not the best method. With an activity-based costing approach it is possible to trace volumes of production to specific overhead costs for each product. This approach uses cost pools, which can then be properly allocated to products based on certain cost drivers.
Based on the information provided by the controller, Wilkerson should use the following categories to create their cost pools: machine-related expenses, setup labor, receiving and production control, engineering, and packaging and shipping. From here, it is time to decide which of the cost drivers belong in each of these categories, remembering that there must be some sort of relationship between the volume of production and the amount of overhead.
Below is a diagram explaining the suggested allocations for an ABC approach:
Cost Pool
Machine-related expenses
Setup labor
Receiving and Production Control
Engineering
Packaging
and Shipping
$336,000
$40,000
$180,000
$100,000
$150,000
Cost Driver
Machine
Hours
Production
Production
Hours of
Eng. Work
Number of
Shipments
11,200
1,250
Cost Driver
Per machine hr
Per run
Per run
Per hour
Per shipment
$1,125
Example of product costs using the ABC method: