1. What are the issues and problems that confront the organization when there was a
loss for the first time as EXHIBIT shows from the case?
Ans:
After the death of the founder, Mr. Richard Hanson, the company made losses for the first
time ever, even in a good business year,
a) The less experienced Mr. Paul Hanson took several poor decisions as the president of
the company, that results in loss of $100,000
b) The Exhibit 1 shows, Income before interest was $186,312. The total Interest
($290,166) in that year was much more than the total income. Which is why the
company making an overall loss. So, Capital Structure of Hanson was not well
formulated.
c) The Exhibit 2 shows, product 101 was only the profit-making product, where product
102 & 103 caused excess loss. As a result, Mr. Paul Hanson suggested to drop product
103 and stressed on economies of scale for the product 102. All this happened
because of wrong allocation of funds among all the 3 product lines.
d) Another reason of such a massive loss is the price dependency with competitors. The
market was so price elastic that, any kind of changes in product price would throw
the company out of the competition. So, Hanson couldn’t increase the product price
even after facing difficulties in making profit.
2. How did Herb Wesling the new CEO turned the loss into a significant profit in 6
months as he took office of the CEO. How will you do? What is the learning?
Ans:
Herb Wesling took over the Hanson Manufacturing company as the General Manager in
1974 as the company was not in good position. The company had a loss of $100,000 in a
good financial year and the employees started losing confidence at the new owner, Paul
Hanson.
Herb Wesling was able to turn the company into profit making in a matter of 6 months. The
following are the certain actions taken by Wesling:
Wesling opposed any immediate major changes, and took his time to analyze the
1973 operation and decided to wait till the first half of 1974.
He discussed in detail the expenses and earnings statements, and nature of costs
including their future behavior from the company’s accounting department (as given
in Exhibit 3).
He decided to oppose the idea of Paul Hanson to drop the product 103 and
continued the production of all three products, using the authority given to him.
He understood the costing structure and benchmarked the cost for each cost.
Monthly statements were made using standard costs from the analytical profit and
loss statement. On the basis of these monthly statements, Wesling made minor
marketing and production changes.
He kept a strict control on all the costs and observed if there were any variations
between the benchmarked cost and the cost incurred by his company (as shown in
exhibit 4), and would further analyze it if it were so.
What is my learning and what will I do?
- I as a CEO would also look forward to increase the profitability of the company by
all means.
- Cost is a sensitive item and there are many variables in the costing structure with
high positive variations. I will also look to reduce the fixed cost of items with high
negative variation.
- Also, we need to utilize the remaining excess capacity. In the short run, we can do
this by finding new customers who will willing to buy the products in large quantities
(wholesale) at a new cost, which will be lower than the current market price. The
new cost will be variable cost+ fixed markup cost, which will give us extra profits. This
will not only increase the profits of the company, but also help in utilizing the excess
capacity.
Key Learning from the case is that we may not be able to fully eliminate the fixed
costs, but we can implement methods that will help in reducing the variable costs
such that more profits can be made by the company.
3. Why Profit as determined by the Financial Accounting Requirements and info are not leading
to Profitability while you are competing for the future?
Profit and Profitability of a firm are two entirely different aspects. The profit of a firm is an
absolute number, given by the revenues less fixed and variable costs. However, profitability is a
relative measure that gauges the firm’s efficiency. It relates the scope of company’s profit to the
size of business. The net profit figure (bottom line) cannot help us in determining if the firm is
efficiently utilizing its resources. We should essentially consider profitability of a firm while
competing for the future.
Considering the Hanson Case, Exhibit 4 indicates a net positive profit figure of $160 thousand
during the first 6 months of Jan to June 1974. However, this considers both the fixed and variable
costs into consideration. Hence, it cannot provide us information about profitability of the firm.
We need to look at the product wise contribution margin rather than the final profit figure.
Item P101 P102 P103
Compensation Insurance 0.0606 0.0592 0.0697
Direct Labor 1.2126 1.1844 1.393
Power 0.021 0.0484 0.061
Materials 0.717 0.9152 0.9824
Supplies 0.049 0.0924 0.071
Repairs 0.0166 0.029 0.0206
Unit variable costs 2.0768 2.3286 2.5977
Price 4.9 5.15 5.5
Cash Discount 0.05292 0.11433 0.0946
Net Price 4.84708 5.03567 5.4054
Variable Cost 2.0768 2.3286 2.5977
Unit Contribution
Margin 2.7703 2.7071 2.8078
Volume 996859 712102 501276
Total Contribution
Margin
276154
9
192769
6
140745
8
The above table takes into account only the variable costs to calculate the unit and total
contribution margin. If there are any fixed costs exclusively traceable to each product, we need
to take that into consideration. Since all other costs mentioned in Exhibit 3 cannot be traced to a
single product, we omit them in calculations. We can gauge the profitability of the firm based on
the following scenarios.
1. Firm has excess capacity – In this case, profitability for the future should be gauged based on
the Total Contribution Margin of each product. Since the firm has excess capacity, it can go
ahead and produce all products as all of them have positive contribution margin.
2. Firm operates at full capacity – In this case, it is necessary to optimize volumes of
production of each product to maximize profitability. We look at the Unit contribution
margin of each product to see which product is the most profitable. Further, application of
linear programming can help us choose optimal volumes of each product to maximize
profitability.
3. Firm operates at full capacity and each product consumes a different share of scarce
resource – In this case, the yardstick will be contribution margin per unit per scarce
resource. Hanson case does not mention any such scarce resource.
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