The selling price for flow controllers increased more than 12% this past month while the selling price for pumps decreased more than 16%. The BBC analysis indicates that pumps still have the highest gross margin (40%) at the actual selling price. The gross margin would be 35% at a price of $75. 06, which would allow still further price cuts of $6. 20 per unit. Given the commodity pricing pressure on pumps, and if 35% is really Tab’s necessary gross margin before SAG expenses to earn an adequate rate of return, hen a further 5% decrease to approximately $75 can be made without harming the target gross margin.
This assumes the BBC costs per unit do not change. Cost Reduction (Re-engineering) for Pumps? There is a lot of buyer power in this market, so TAB must undertake cost reduction and re-engineering programs to be the low cost producer. The case says pumps require less precision manufacturing than valves. Pumps involve only one more component than valves. There are approximately 58 workers on board and average wage (plus benefits) is $16 per hour. At 25% benefits, an approximate wage rate is $13 per hour, which is on the sigh side for industrial manufacturing Jobs along the Mexican border at the time of the case.
Perhaps less skilled machinists could be used on the pumps (and flow controllers)? Although automation is touted by management, direct labor represents 12% of the total manufacturing costs. Again, some cost savings may be possible. Also, eight hours for a set-up?! How Are Valves Doing? Apparently, the one valve customer is pleased with our quality and competitive price. Competitors are not attempting price cuts. The case implies that automation and efficient production processes are helping control costs and efficiency. But is it good strategy for TAB to be dependent on a single customer for valves?
The BBC gross margin is 35% for valves so no action seems necessary to raise or lower prices. Company makes pumps and flow controllers to fill out the production capacity. Can we really continue long-run with 24% of sales in a no-growth market with a single customer? Teaching Strategy In class, I go through the questions in order, trying to save at least 20 minutes (in a 90-minute class) for question 8. Usually, questions 1 through 6 are pretty straightforward for students who are willing to spend about 3 hours in preparation or class.
The trick in class is Just to keep the discussion moving along. Question 7 is very difficult for students. Often, I have to take over the discussion and show students the analysis reproduced above. The question is a good “antidote” to the idea that KIT is always “good”–not when receiving and handling costs are as high as in this case. I believe it is important to spend at least 10 to 15 minutes or so on this question to reinforce the concept that BAM is a dynamic concept, based on cost management, whereas BBC is a static concept, based on cost measurement.
