Faced with declining profits, Wilkerson Co. finds the roots and reasons why in one product line, the company experiences greater price competition while in another product line, it could raise prices without creating the same experience. Thus, the development of an activity-based cost model is recommended to understand the effect of the different demands that each product line brings on the organization's indirect and support resources.
Robert S. Kaplan
Harvard Business School (101-092)
Mar 7, 2001 (Revision: Aug 5, 2003)
Case questions answered:
- What is the competitive situation faced by Wilkerson Co.?
- Given the problems Wilkerson is having allocating overhead to products, should it consider abandoning overhead allocation altogether and switching to a direct costing or contribution margin approach (measuring profitability as price less direct materials and labor costs) with its products?
- How does Wilkerson’s existing cost system operate? Please be as specific as you can and outline the critical assumptions underlying this cost system.
- Do you think the existing cost system is helping make “good” decisions? Why or why not?
- How do you think this cost system can be improved to better serve Wilkerson’s strategic interests?
- Develop an alternative way to calculate costs that you think will result in better decision-making at Wilkerson.
- What are the limitations of your proposal in question 5 above? Is there any additional information that could help you address these limitations?
- Wilkerson Co. has been compensating salesmen with commissions based on sales revenues. Do you think such a compensation scheme is adequate? Why or why not?
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Case answers for Wilkerson Co.
1. What is the competitive situation faced by Wilkerson Co.?
The competitive situation that is faced by Wilkerson Co. is both to its advantage and disadvantage. One of the advantages held by Wilkerson is that its competitors overlooked the opportunity for profits on flow controllers. The competitive advantage maintained by Wilkerson is that they were innovative, and established a loyal customer base because of its high quality manufactured valves.
The disadvantages in the competitive landscape that face Wilkerson include the ability the competitors had to reduce the price of the pumps (Wilkerson’s major product line). Wilkerson Co. had seen no alternative other than following suit, and as a result, lowered the selling price of its pumps. This led to declining company profits.
2. Should Wilkerson consider abandoning overhead allocation altogether and switching to a direct costing or contribution margin approach with its products?
We believe that Wilkerson Co. should consider abandoning overhead allocation altogether and switch to a combination of the direct costing and contribution margin approaches.
3. How does Wilkerson’s existing cost system operate? Please be as specific as you can and outline the critical assumptions underlying this costing system.
As mentioned before, Wilkerson Co.’s existing cost system hinges on the assumption that the Manufacturing Overhead per product is about 300% higher than the direct labor cost. It uses a…