Trim Trends Case

INTRODUCTION

The fitness equipment market has increased drastically in the past few years, and the market is projected to at least sustain its size at the least, and possibly continue its growth. Sadly, TRIM has not mirrored the market’s growth. The public requires newer and more robust equipment than what TRIM currently offers, and TRIM is paying the price by losing market share to its competitors. Luckily, this reality is not set in stone for the future. TRIM has adapted to the issue by creating two brand new products, the Waste Line Reduction Machine and the Bicep Builder. The major problem with the introduction of these products is deciding whether they will be profitable and how to integrate the new products with both each other and existing offerings. These particular problems, as well as others, are brought forth and solved in this report.

ANALYSIS

The WLRM has a material cost of $60 and a target cost of $75 (75% of the $100 target price) meaning that only $15 of value can be added if target profits are to be met. The first analysis using ABC costing to integrate the resources required by the 7,500 units shows that over $44 of value is added, bringing the total cost of the WLRM to roughly $104. Additionally, using the same cost allocation process, 10,000 units of the WLRM requires over $41 of value added on top of the materials for a final cost of $101.63 per unit (see Appendix I, extrapolate that the 7,500 unit results are correct though there is no supporting appendix). The production of 20,000 units of the Bicep Builder can be seen to cost almost $15 in resources in addition to the $15 material cost, arriving at a $29.95 cost, fetching a 40% profit margin on target price of $50. Under this analysis, one would see that the choice is obvious: Build to meet maximum demand for the Bicep Builder and ignore the WLRM altogether. This decision is wrong, however, because the analysis is flawed. The ABC allocation ignores existing excess capacity within TRIM’s production line. This fatal error results in very inaccurate projections. Consider that the practical capacity of TRIM’s resources is the amount that is paid for in the given period. Whether or not the entire capacity is used, the same costs are incurred. Producing 7,500 units of the WLRM incurs no actual cost (other than the $60 for materials) that did not exist before. That is, the incremental cost of producing 7,500 WLRMs is the $450,000 material cost as shown in Appendix II. Examining the incremental costs only, we see that a profit of $300,000 is made on $750,000 of revenue – a %40 profit margin. The main point here being that if the WLRMs were not produced and sold, the excess capacity would be wasted and the resources would still be costed. Capacity utilization rises to 93.4% (Appendix II) meaning TRIM’s production line is essentially wasting fewer resources that it has already paid for. Producing and selling 7,500 WLRMs can now easily be seen as profitable. The next question is whether it would be more profitable to meet the entire market demand of 10,000 units. By viewing Appendix III, we see that indeed total profit drops by $160,000 and the profit margin on the WLRM falls to 14%. The main cause of this drastic drop in profits is that the

10,000 units require purchasing additional setup hours and labour hours at a total cost of $260,000. While revenue increases by $250,000 less material costs, it is not enough to cover the additional costs incurred by the steps up in equipment setup and labour. This conclusion is supported further when we examine the capacity utilization under this scenario (Appendix III). Notice that capacity utilization has dropped to 90% and specifically that Setup Hours and Labour Hours utilization has fallen drastically. This alternative is far less profitable than the former. The next alternative involves producing the full demand of Bicep Builders and no WLRMs. The next step of additional labour must be purchased to facilitate the 20,000 BBs. Referring to Appendix IV, we see that the Bicep Builder’s profit margin is extremely large – 58% – and TRIM realizes a hefty $580,000 profit. Upon further inspection, we notice that the capacity utilization is actually below the previous two scenarios yet the profit is higher. The explanation for this is simply that the Bicep Builder commands such a large margin that it outweighs the loss. This is the most attractive option thus far regarding profits. The next alternatives involve producing both the BB and the WLRM, bettering TRIM’s product mix, helping to improve brand equity and image. These alternatives also serve to satiate (at least partially) market demand for TRIM’s products, whereas the previous scenarios did not. Before analyzing the profitability, it should be stated that in some cases, a specific product mix or meeting certain demand outweighs higher profits in the long-run and such possibilities should be investigated. The next alternative involves meeting the full demand for the Bicep Builder and 75% of the demand for the WLRM while the following scenario increases the WLRM production to meet full demand as well. Appendix V shows the incremental revenue, cost, and profit data for alternative four. Notice that the only incremental cost from the previous scenario is the $200,000 for equipment setup (excluding material costs) while revenues increase by $750,000. The result is an increase in profit of $100,000. If we look at alternative 5 (Appendix VI) see that the additional WLRMs brought forth a step cost of $25,000 for machine hours but this is offset with additional revenue, yielding a profit increase of $15,000 to $695,000. Alternative 5 dominates alternative 4. If we look closer at capacity utilization we are at first puzzled: Capacity utilization for alternative 4 appears to be higher than for alternative 5. The

reason alternative 5 is more profitable is because it better utilizes certain resources even though overall it creates more waste. Appendix IX contains a table showing the unit contribution per unit of resource for both the WLRM and the BB. The metrics are contribution per labour hour, setup hour, and machine hour. By maximizing the production of the product with the highest contribution per unit of constrained resource and using excess resources to produce the other product, we should maximize profits. Therefore, when setup or machine hours are constrained, BB production should be maximized, while WLRM production should be maximized when labour hours are constrained. The question is which resource to constrain. Notice that of the three, setup hours are the most expensive (over three times the price of labour hours and roughly 65x the prices of machine hours), then labour hours, then machine hours. Constraining the resource that is the most costly to expand will maximize profits. If Labour hours are used as the constraint, only 7,500 WLRMs will be produced (as in the very first scenario, Appendix II) because at this point all labour is being utilized. Notice the relatively high utilization of capacity while profit is only $300,000. This problem stems from the relatively high labour usage relative to other resources and their scarcity. If we expand Labour Hours to utilize 100% of 24,000 hours then we see the situation in which 7,500 WLRMs and 20,000 BBs are produced, increasing profit to $680,000 and capacity utilization to 95%. With Machine hours as a constraint, we maximize BBs produced. With 20,000 BBs there are 30,000 machine hours remaining. Using the given 3.5 machine hours per WLRM, we calculate that we should produce 8,571 WLRMs and this would yield a profit of $662,840. See Appendix VII for the incremental results of this combination. The capacity utilization of this scenario is the highest yet at 94.4% yet it has a relatively lower utilization of the more expensive resources (setup hours and labour hours). Using Setup hours as a constraint we maximize BBs and use the remaining 1,000 setup hours to build 4,000 WLRMs. Referring to Appendix VIII, we see that this is the most profitable combination yet, and theoretically should be as profitable as possible because we are constraining the most expensive resource. Profits for this scenario climb to $740,000 and the capacity utilization rises to 95.4%, the highest yet. The highest profitability

numbers and utilization numbers confirm that constraining setup hours yields the most profitable combination, which is 20,000 Bicep Builders and 4,000 Waste Line reduction Machines.

PROFITABILITY

Profits are increased when resources are utilized most efficiently and capacity remains unchanged. For any given level of capacity, constraining the most expensive resource (ensuring that it incurs the least waste) and producing products that provide the highest contribution per unit of constrained resource used will maximize profits. Referring to Appendix IX we see that Setup Hours are the most expensive resource and that the Bicep Builder provides the larges contribution per setup hour used. Following this, producing the maximum amount of Bicep Builders (to meet demand) and using excess capacity for WLRMs will maximize profits in the short run. This property will carry over to the long run as long as setup hours remain the constrained resource. Given a choice over which products are produced (ignoring market demands, product breadth requirements, etc), the products should be produced in the order of highest contributions per setup hours. This SUH constraint has many implications for TRIM and affects many different areas within the company.

RECCOMENDATIONS We recommend producing the Bicep Builder to meet the demand of 20,000 units, and producing 4,000 units of the Waste Line Reduction Machine. This mix will provide maximum profits over the next two years. If demand for the BB increases due to its performance, next year’s mix may lean more heavily to the BB if a more lopsided mix will not adversely affect brand equity and consumer perception of product breadth. We also feel that as a unique product to the market the WLRM should command a higher price. This depends on the ability of competitors to clone TRIM’s most innovative product, but at least one year of a higher price should be possible and will add nicely to profits. The performance of TRIM’s decision product mix can easily be tracked via several metrics.

By monitoring the change in total Contribution Margin, separate and aggregate expenses, and assets, TRIM can easily compare with past periods for growth and success. If the percentage increase in Contribution is greater than the increase in both expenses and assets, the company will have realized increased profits (the logic for this is that any excess contribution that is not expensed but does increase assets goes to the bottom line). The return on assets ratio as well as the inventory turnover metric should increase or remain stable over time. The ROA ratio will track how efficiently TRIM is utilizing its resources, however the capacity utilization % (demonstrated in appendices II - VIII) would better track utilization. In addition, tracking the specific utilization of setup hours and the specific product profits per setup our will ensure that the constrained resource is being used efficiently and that products are being produced in the proper mix. Resources that are no constrained should also be monitored so that costs may be reduced over the long-term by increasing efficiency and, if possible, reducing perpetually unused capacity.

Demand fluctuation should be monitored so that the product mix can be adjusted if necessary. Specifically, TRIM should be aware of cannibalism of current products by the BB and the WLRM. While new products should increase brand equity provided they are of good quality, the marketing team should continually assess TRIM’s brand and ensure that the proper product mix

is being used. Manufacturing lead time, shipping time, and order processing time need to be monitored to ensure that tightly constrained resources are not lowering service quality. Material inputs must also be monitored to guarantee product quality and line integrity.

THE CONSTRAINED RESOURCE The riskiness of the constrained resource – setup hours – should be monitored at all times. Any failure in or loss of this resource immediately lowers revenue and profits; there is no slack. TRIM needs to understand the likelihood that the resource will fail/undersupply, the time to restart upon failure, and how to recover from such a failure. Bringing the constraint under the company’s control (restricting production internally) versus using the market constraint (external demand) allows the company protection from market downturns (albeit only mild or cyclical ones) because of the demand buffer it has created.

TRIM’s future products need to provide an average level of contribution per unit of constrained resource (setup hours) in comparison to current products. If the contribution is not comparable, new product implementation will result in profits that are less than optimal. This problem can be ignored or remedied by requiring the production method of new products to either sparsely utilize setup hours or not require them altogether.