RONT RANGE GIZMO CORPORATION / Case Study

FRONT RANGE GIZMO CORPORATION

Front Range Gizmo Corporation has been a leading domestic gizmo manufacturer for more than thirty years. It is currently the third largest firm in the industry. Its gizmos are incorporated as components in a variety of products manufactured by its customers for both consumer and industrial use. In line with the rest of the industry, Front Range Gizmo sells only to other manufacturers, as there is little retail market for gizmos.
Floyd Flywheel has been CEO of Front Range Gizmo for seven years. Like all his predecessors, he is an engineer by training, and has worked his way up through the ranks. He is particularly proud of the firmas reputation for product innovation and quality. His tenure has seen the firm almost double its sales.
Despite the increase in sales, net income has risen only about 30% in that time. Because of dissatisfaction on the Board of Directors with the level of profit, a new CFO, Wilbur (a?Reda?) Inkster was hired two years ago. Inkster is a CPA, and former audit manager for Front Rangeas outside auditors, PriceCoopersDeloitteErnst& Soforth. He immediately began a program to cut fixed costs, primarily through staff reductions in engineering and through outsourcing of various activities. Operating results for 2002 showed an increase of almost 6% in net income and over 8% in sales over the previous year.
Much of the outsourcing has come from the division of Stephanie (a?Stepha?) Staff, VP of Administration. This includes outsourcing of employee food service, security, and janitorial and groundskeeping. She still has four departments reporting to her: Human Resources, Purchasing, Receiving/Storekeeping, and Warehousing/Shipping. She is quick to point out that most of the cost savings from outsourcing have been offset by increased costs in Purchasing and Storekeeping. These costs are largely due to the increased number of specialized parts required in recent years, according to Purchasing Director Hiram (a?Hia?) Price. a?Of the time we spend on purchasing parts, about one-quarter is for standard parts, and the rest for specialized parts,a? says Price.
Reporting directly to Red Inkster are the corporate treasurer, who handles the cash management and investment functions, and the controller, Otto Balantz. The Controlleras division is organized into four departments: invoice processing; order processing (including billing and receivables); cost accounting; and general accounting and information systems maintenance. The payroll function has been outsourced. Balantz has also noticed an increase in his costs, particularly invoice processing, which varies directly with purchasing costs. Order processing costs have also grown. Balantz is of the opinion that they are directly related to the number of orders processed. His other costs have increased only modestly, and are generally unrelated to volume of activity.
The company produces five product lines. Lines M1 and M2 consist of standard products that are produced for stock and sold in a broad but highly competitive market. Sales of these lines have been declining in recent years. However, this decline has not severely affected profits since, according to Marvin Gardens, VP of Marketing, they are the least profitable lines. Production costs have been increasing, and margins have eroded despite price increases. Line M3 consists of products from Line M2 that receive further work to customize them to customer specifications. Line M4 consists of a variety of specialty gizmos that are produced to customer order. Line M5 is a relatively new line, introduced about three years ago. At the time it was considered highly innovative, and quickly captured a large part of the specialty gizmo market. It is produced to order. Because it is highly profitable, sales personnel have been spending about 40% of their time on this line, according to Gardens. About 10% of sales effort is spent on each of M1 and M2, and 20% each on M3 and M4.
Sales personnel are compensated on a salary basis, plus a commission equal to 5% of sales. Some large, long-standing accounts are a?house accountsa? on which no commission is paid. These accounts have been decreasing in number and volume, according to Gardens. The modest advertising and promotional budget is set by the Executive Committee each year as part of the budgeting process. Advertising is limited to a few trade publications, as direct sales contact is regarded by Gardens and Flywheel as more cost effective in creating sales. Promotional expense consists primarily of mugs, calendars, pens, etc. printed with Front Range Gizmoas distinctive logo, which are given away by sales personnel at trade shows and sales calls.
When Flywheel assumed the CEO position, he hired Cash LaPoudre to take his old job as VP of Operations. Together they planned and implemented a radical change in Front Range Gizmoas manufacturing processes. Computer-controlled flexible manufacturing equipment was purchased, and the factory was reorganized on cellular lines. Although the cost (largely debt-financed) was enormous, it has been worth it, according to LaPoudre. a?Without it, we would not be competitive,a? he says. a?We have cut throughput time by 40%, and achieved 92% on-time delivery rates. It allows us to make our high-profit products to order, eliminating the costs and risks of maintaining a finished goods inventory for them.a?
The factory, housed in a single facility, is organized into four cells. According to Gary Gears, plant superintendent, all product lines receive processing in Cells A and B. Line M3 receives its additional processing in Cell C. Lines M4 and M5 are processed further in Cells C and D, and receive relatively less processing in A and B. All production is done in batches, whether for stock or to order. There is no formal inspection department. All direct labor workers inspect product in the course of production. Because of the nature of the product and processes, inspection effort is about the same for each batch, regardless of size. Gears estimates that about 10% of direct labor is spent on inspection.
In addition to the plant superintendant, LaPoudre has four other departments reporting to him: Engineering, Facilities/Machine Maintenance, Production Routing, and Materials Handling. Production Routing schedules production batches, giving consideration to available resources, customer orders, and stock needs. Materials Handling moves raw materials into production for each batch, and moves finished batches into the finished goods storage facility (stock items) or the shipping area (custom orders). Maintenance performs both routine and non-scheduled maintenance on buildings and factory equipment.
The Engineering Department performs a variety of tasks, according to Chief Engineer Carl Quant. About 48% of their time is spent on design issues related to custom orders and customer engineering changes. This time is spent on lines M3, M4, and M5, roughly in the proportion 1:4:3. Another 20% is spent on customer technical support, and 10% on administration and supervision. The remaining 22% is spent on new product development, about half of the proportion of five years ago. Quant attributes the decline to Inksteras cost-cutting, and to an increase in change orders and technical support demands. Because of its innovative design, line M5 requires about half of the technical support. Of the remainder, lines M1, M2, and M3 require about equal amounts, and M4 double that amount.
While the Board of Directors is pleased with the overall increase in sales, it is not happy with the stagnation of the lines that have traditionally been the firmas strength. It is also not pleased with the small increase in profits relative to the rest of the industry over the past several a?booma? years, nor with the fact that Front Range Gizmo is lagging the industry in profit margin.
One of the members of the Board is Carl Clever, CEO of Great Plains Thingummy and D