THE MURPHY SHIRT CO. INTRODUCTION

Transcription

1 THE MURPHY SHIRT CO. INTRODUCTION The Irish clothing industry has changed beyond recognition over the past 15 years. High cost structures have forced many indigenous and multinational clothing companies to close down their operations and those that survived have had to find ways of gaining a competitive advantage. Some have achieved this through switching to niche markets, while others have begun to outsource garment production to cheaper overseas locations. Such alternatives have been vital in ensuring the survival of the Irish clothing industry. Ireland was, traditionally, an outsource location itself, especially for US multinationals looking for a European manufacturing base with access to the European Economic Community (now, the European Union). While a small number of multinational companies remain in Ireland, many have closed and moved on as cost structures made them uncompetitive. Morocco, Asian and Eastern European countries are becoming key outsource locations. Employment in the clothing industry in Ireland currently stands at about 8,000, which compares with an all-time high for the sector of approximately 15,000 ten years ago. The Murphy Shirt Co. was established in Ireland about a decade ago by its American parent. It is a wholly owed subsidiary. At that time the Republic of Ireland had an abundant supply of cheap, well-educated and English-speaking labour. In addition, it had the lowest corporate tax rate in the European Union and a regulatory regime that was unambiguously pro-business. The political system was stable and the population had strong links to the US the primary source of foreign direct investment (FDI) in Ireland. The company manufactures polo-type sports shirts for the growing worldwide sports shirt market. (The company presented former US president, Bill Clinton, with one of its shirts, on his recent visit to Ireland, which included a game of golf in Ballybunion). They are called sports shirts because their most popular use is for various sporting activities including major sporting events such as the British Open, Ryder Cup, Super Bowl, Wimbledon, etc. In addition to being sold to spectators at each event, they are also used to promote the specific event itself. The company is located in a small provincial town on the outskirts of Dublin. It is a medium sized firm (by Irish standards) with annual sales of just under 16 million and an investment base (i.e. net assets) of some 3 million. For the most recent fiscal year (2007), the company budgeted for and generated a small loss. A small profit was budgeted for and reported for the previous year. The CEO of the US parent has already issued warnings about the continued operation of the company in Ireland due to its precarious financial position. Obtaining a significant amount of interest-free, short-term loans from its parent company recently averted a cash flow crisis. If nothing else, everyone knew that making losses in a low tax regime was bad tax management for the Group! (The average return on sales is about 4 percent for similar companies in Ireland). The Company has a modern knitting plant and is currently operating at 70 percent capacity. There are approximately 100 employees, and most of these are female machine operatives who are paid on an hourly basis. The weekly payroll calculations consume a great deal of resources since they are done manually. Because of the high investment in capital equipment in previous years, 1

2 together with the loss reported for the current year, no provision for taxation need be made. MANUFACTURING The Murphy Shirt Co. knits (i.e. manufactures) all its shirts. The basic product produced by the company is a white sports shirt (in different sizes). Shirts are made in three men s sizes: medium, large and extra large (XL). The company does not manufacture small sized shirts as it considers this size to be suitable only for children and it believes this market segment to be rather small. The normal production cycle for an order of white shirts is five days. Depending on the client requirements, the shirt may be customised to order. Customisation involves three processes although each process is not, necessarily, required for each shirt. The three processes are, in sequence, dyeing, stamping or, alternatively printing, and embroidery. Nearly two-thirds of the shirts are dyed in various colours. This increases the production cost and extends the production cycle of an order by about three days. In addition, a characteristic feature of the sports shirt is the promotional text and/or logo that is added to each shirt. The promotional text and/or logo can be either printed on or machine embroidered. In the majority of cases, the text is usually printed and this is referred to as the printing process. The technical term used is that of stamping whereby the appropriate text/logo is added to each sports shirt using a special printing machine. Recently, the firm has had some difficulty with the staying power of the material printed on these shirts. Customers have complained that the ink eventually cracks and peels off. A small but increasing number of shirts (about 15%) have the text or logo of the sports event embroidered rather than stamped. This embroidery work adds enormously to the appeal of the product. The company tries to product each order well in advance of dispatch so that there will always be a certain amount of finished goods in stock at the end of each fiscal period. CUSTOMERS The Company s sales are all on credit and are predominantly made to England and the United States countries that are outside the Euro zone. (To avoid foreign exchange fluctuations, the company invoices all its sales in Euro). Typically, customers take about 60 days to pay their account. Currently, the company has 986 active customers. These customers differ primarily in the volume and type of their purchase order, so management classifies each customer in one of three groups - priority (8), team (154) and shop (824). Priority customers are typically the large, international sports events that generate a great deal of TV coverage. Typical examples are the British Open, Wimbledon, Super Bowl etc. Shop customers are single shop operations (such as pro shops at golf courses), and team customers are typically associated with specific teams or clubs. It is company policy to conduct a full credit check on new customers to avoid the potential of bad debts. As a result, the amount of bad debts incurred has been insignificant in recent times. The low amount of bad debts is also partly due to the speed by which invoices are issued to customers, together with a regular and frequent follow-up of all unpaid invoices. Table 1 gives product and customer classification statistics for

3 The Company has a different marketing approach to customers in each of its three categories. A small group of in-house sales-people sells directly to buyers in the priority customer category. Independent salespersons, paid on a commission only basis, call on the licensing agent of customers classified in the team category. Advertisements placed in regional magazines and newspapers target customers primarily in the "shop" customer segment, who telephone or post in their orders. Not surprisingly, a significant cost for all categories is the provision of sample shirts to potential clients. INFORMATION & PERFORMANCE In an attempt to start some sort of strategic planning exercise within the Irish plant, senior managers recently identified its main competitive strengths and weaknesses. Management believes that the critical strength of the company is in the quality of the product, and that the weakness in recent years has been in customer service, particularly in meeting scheduled deliveries. A mission statement for the company was recently circulated for discussion by the Irish Board and read to provide a reasonable return to shareholders by providing high quality products to customers, delivered on time and at the lowest cost. However, due to more pressing matters no discussion took place. Thus, little progress has been made in modifying the management accounting and information system to monitor progress in relation to these critical success factors. Production costs are accumulated as outlined below in Exhibit 1. Exhibit 1: Production and cost accumulation process Production process Cost information Basic manufacture of white shirt Direct material (per unit) Direct labour (per unit) Manufacturing overhead (per unit) Customisation of shirt (a) Dyeing (about 63% of shirts) = Direct costs (outsourcing) (b) Stamping/printing (about 85% of shirts) = Conversion cost (per unit) (c) Embroidery (about 15% of shirts) = Conversion cost (per unit) Costs are accumulated separately for the basic manufacturing process i.e. the manufacture of white shirts, and also for the customisation process. The former process accumulates costs as direct materials, direct labour or manufacturing overhead. In this process, production overheads are absorbed on the basis of direct labour cost and this approach has been in use for a number of years. Costs associated with customising shirts are accumulated separately under the heading of direct costs (for dyeing) and conversion costs for stamping/printing or, alternatively for embroidery. Table 2 shows the firm s unit costs and sales price for various items for the most recent period. The typical monthly management-reporting package consists of a summarised profit and loss account and summarised balance sheet (Table 3), together with a detailed schedule of aged accounts receivable. The profit and loss account in Table 3 shows the reported loss for the recent fiscal year. 3

4 In order to restore profitability to the company, management would first like to ascertain the profitability of the customers in its three customer categories priority, team and shop. At the moment, management has no basis for assessing customer profitability. Yet, it is intuitive that some customers generate high profits while others do not generate enough revenues to cover the expenses to support them. The basic problem here is that different customers demand different levels of support. Management is aware that the use of ABC information would enable a type of customer profitability analysis to be applied. They have recently obtained data on how the selling and distribution, and administrative expenses could be incorporated into a customer profitability analysis by identifying cost pools and cost drivers for various customer related activities (Tables 4a/4b). RECENT DEVELOPMENTS Two recent developments that may have an impact on the company should be noted. First, in the present climate, the Murphy Shirt Co. can only afford to reduce its prices if it can cut costs. The Sales Director suggests that the company can lower its quality inspection costs by reducing inspections, which will improve on-time delivery rates. This proposal is to be discussed at the next Board meeting. Second, last week, the Sales Director proposed that the company should enter the American market for women s sports shirts, where comparable shirts sell for the equivalent of This is considered to be an excellent selling price, given the small size of the shirt involved. Overall production costs would be similar to medium-sized shirts and normal selling, distribution and administration costs would amount to 3 per unit. Each shirt would require dyeing and also normal embroidery. A marketing consultant has obtained information about specific features required for the lady wearer. Working in conjunction with the firm s cost accountant, he has presented information on these features and approximate cost as follows: Feature required by the lady wearer Cost (per unit) to add Importance ranking (5 = most important) Hanger (on inside of collar) Hanger (on outside of shoulder) Patch (breast) pocket Embroidery on single sleeve Double stitching (on V-neck etc.) It is anticipated that the Murphy Shirt Co. will sell these products through an agent, with whom they have never dealt but who would like to place an order for 100,000 shirts this year. The company recognises that this (new) market will require additional selling costs in the US, equivalent to 1 per shirt. The Murphy Shirt Co. requires a contribution of 2 per unit but the goods are to be invoiced in US dollars unlike current sales that are invoiced in Euro. 4

5 TABLE 1: PRODUCT & CUSTOMER STATISTICS FOR 2007 Sales in units by customer category Shirt size: Priority Team Shop Total X large 272, , , ,000 Large 366, , , ,000 Medium 360, , ,000 1,510,000 Total units sold 998, ,000 1,168,500 2,709,000 Sales revenue ( ) 6,029,700 3,284,300 6,566,900 15,880,900 No. of units dyed 750, , ,000 1,700,000 No. of units stamped 698, ,000 1,138,500 2,309,000 No. of units embroidered 300,000 70,000 30, ,000 No. of orders received 2,330 11,450 57,909 71,689 No. of shipments made 1,470 9,230 49,286 59,986 TABLE 2: COST AND REVENUE DATA FOR 2007 Basic manufacture Quantity Average sales price Direct material Direct labour Manuf g overhead X large 544, Large 655, Medium 1,510, ,709,000 Customising Quantity Direct cost (unit) Conversion cost (unit) Total cost Dyeing 1,700, N/A 2,380,000 Stamping 2,309,000 N/A ,600 Embroidery 400,000 N/A ,000 3,823,600 5

6 TABLE 3: PROFIT AND LOSS ACCOUNT THE YEAR END 2007 units Sales: X large 544,000 3,590,400 Large 655,000 4,061,000 Medium 1,510,000 8,229,500 2,709,000 15,880,900 Less: Cost of goods manufactured Basic manufacturing costs 2,715,310 Customising 3,823,600 6,538,910 Gross profit 9,341,990 Less: Non-manufacturing overheads Selling and distribution expenses 5,761,600 Administration expenses 3,584,450 9,346,050 Net loss for year (4,060) Retained profit brought forward 1,537,810 Retained profit at end of year 1,533,750 BALANCE SHEET AT YEAR END 2007 Fixed assets Buildings (net) 2,450,000 Plant and equipment (net) 1,740,000 4,190,000 Current Assets Stock (inventory) 550,000 Debtors (accounts receivable) 2,600,000 3,150,000 Less: Current Liabilities Trade and other creditors (4,406,250) Net current assets (1,256,250) Total assets less current liabilities 2,933,750 Financed by: Ordinary share capital 1,400,000 Retained profits 1,533,750 Shareholders funds 2,933,750 6

7 TABLE 4A: THE ASSIGNMENT OF SELLING, DISTRIBUTION AND ADMINISTRATION COSTS TO CUSTOMER RELATED ACTIVITIES Percentage distribution to: Selling & distribution Administration Customer related activities Accounts maintenance Nil 70% Sales commission 5% Nil Shipping activities i.e. deliveries 50% 10% Sales visits 15% Nil Tracking misplaced/lost items 20% 20% Marketing/promotion 10% Nil 100% 100% TABLE 4B: CUSTOMER RELATED ACTIVITIES AND ASSUMED COST DRIVERS Customer related activity Assumed cost driver Accounts maintenance Number of orders received Sales commission Direct allocation to team customers only Shipping activities (i.e. deliveries) Number of shipments (deliveries) made Sales visits Direct allocation to priority customers only Tracking misplaced/lost items Number of units sold Marketing/promotion Management estimate 1 1 Decided as: 20% to team customers and 80% to shop customers 7