2. Elkay Plumbing Products
Division
Founded in 1920 with the vision of “Making the best
sinks and providing the best customer service”.
Elkay ‘s PPD produced sinks, faucets, and fountains for
residential and commercial customers.
Its estimated sales are about $600 million.
3. Introducing a New Cost System.
John Hrudicka, vice president and controller for operations
planning and analysis joined the Co. in 2007 when its profit
had a started a severe decline.
The Co. Managers were responding slowly to the profit
decline.
One of the Co. managers recalled “ we treated some
products and customers as sacred cows, they are
untouchable ”
The Co. vice president explained “our costing system took
weeks to prepare customer P&L and the numbers weren’t
accurate. People didn’t believe them and wouldn’t act on
them.
4. Introducing a New Cost System.
Elkay was applying traditional standard costing
system.
Their system allocated factory overhead to products as
a percentage markup over direct labor cost and
corporate overhead as a percentage of sales.
Hrudicka thought that activity based costing (ABC)
would provide managers with more trusted and
actionable cost and profitability information.
5. Introducing a New Cost System.
He quickly documented several problems with their
existing standard costing system.
1) Standard costing system worked well for measuring
the direct costs of production, but could not trace the
large sales deductions and costs of serving individual
customers.
2) The standard costing system pooled these
deductions and costs into large expense buckets and
spread them to customers based on case volume or
sales.
6. Introducing a New Cost System.
3) Equipment costs were aggregated into the factory
overhead account and allocated to products through
arbitrary percentage markups over direct labor.
4) The standard costing approach did not reflect the
much higher changeover, quality control, and process
engineering costs triggered by an explosion in the
number of SKU’s.
5) Few of the Co. costs were short-term variable as
assumed by the standard cost system.
7. Introducing a New Cost System.
Hrudicka scheduled a presentation to the 10 members
of the company’s Corporate Executive Council.
Their reply “We tried this before, it did not work”
Hrudicka investigated alternative ABC software and
consulting companies, and selected Acron Systems
and Jack Haedicke of Arena consulting, an Acron
subject matter expert partner, to assist in the project.
Acron, a software and consulting company had
pioneered the application of time-driven ABC into
distribution, financial services, retailing and
manufacturing companies.
8. Introducing a New Cost System.
Finally the Co. approved applying Time-driven ABC.
He met with the company president to brief him on
the costing project, now called Discrete Product
Costing to differentiate it from the failed ABC project
in the mid-1990s
Elkay launched two pilot projects, one at Lumberton
production facility, which produced 60% of retail sink
products, and the other in the Bolingbrook
distribution center.
In each facility, training was made for supervisors,
managers, and executives.
9. Organizing the DPC Project
The team identified the costs associated with each
production activity .
Some of the costs could be easily assigned such as the cost
of labor and machinery dedicated for the activity.
In the next step, the team assigned each production
activity’s cost to the product’s processed by that activity..
Trough the ERP system, the cost system could then
download information on every production order during a
month.
By this, the cost of every SKU could be easily calculated.
The team assigned an action code for SKU Losses:
Redesign, reengineer, re-price, eliminate, or do nothing.
10. Questions
1) Why did Hrudicka believe that Elkay PPD needed a new
cost system?
Because he believed that there is a problem with the
pricing of their products. Their existing system could not
trace the large sales deductions and costs of serving
individual customers. There is a lot of more profitable and
more unprofitable customers. Activity Based Costing
would provide managers with more trusted and actionable
cost and profitability information. ABC is a costing
methodology that identifies activities in an organization
and assigns the cost of each activity with resources to all
products and services according to the actual consumption
by each.
11. Questions
2) What causes a product or customer to be highly
unprofitable? When would a product or customer be
highly profitable?
We think that the allocation of factory overhead to
products as a percentage markup over the direct labor
costs and the allocation of corporate overhead as a
percentage of sales are the main reasons for making
some customers unprofitable. The allocation of costs
in this arbitrary method results in an inaccurate
pricing. Products will be highly profitable when it is
accurately priced and sold in large volumes.
12. Questions
3) Why was the new cost system accepted so quickly by
Elkay managers?
Because they believed that they can’t make effective
business decisions with inaccurate costs. They believe
that they have a problem with their existing standard
costing system and that is why they searched for an
alternative.
13. Questions
4) What do you like in PPD’s new cost system? What
features could be improved?
What we like is that as previously stated is that Activity
Based Costing would provide managers with more
trusted and actionable cost and profitability
information. ABC is a costing methodology that
identifies activities in an organization and assigns the
cost of each activity with resources to all products and
services according to the actual consumption by each.
All the company processes will be improved.
14. Questions
5) What actions, if any, would you suggest Mark
Whittington take with Elkay’s most profitable
customers?
To try to increase sales volume with them through
making large discounts for example. These customers
contribute largely to the company profit and operating
income and enhancing the company cash flows.
15. Questions
6) What actions should Whittington take with Elkay’s
largest loss customers, in particular the two large
customers on the extreme right hand side of the
cumulative profitability curve on page 1 of the case?
They should advise them by their new costing system
and goes with them in fewer, larger orders. Also
seeking a more profitable product mix and a small
price increase.
