I. Situation Summary
The Ringo Rag Company ( Ringo ) purchases rags from multiple sources and recycles them into smaller clean handy rags in a continuous process. Ringo s obtains its raw materials from three suppliers: junk dealers, textile convertors, and laundries. Ringo uses a standardized manufacturing process for the old rags that includes washing and drying, inspecting and grading, cutting, and packaging. Although Ringo uses a standardized manufacturing process, rags obtained from the laundries forego the washing and drying process. Additionally, Ringo only cuts and packages rags obtained from textile convertors because they come cleaned and graded. The new rags receive one of three grades, A, B, or C, with A being the best grade, based on the rags absorption ability. Ringo packages them according to their grade into 5, 10, 20 and 50-pound cartons.
The purpose of this report is to analyze the cost of manufacturing three different grades of rags from three different suppliers. This report will analyze the different manufacturing costs associated with each supplier. Additionally, the report will discuss various issues Ringo faces in determining its actual manufacturing cost. Finally, the report will provide multiple recommendations that Ringo can implement to increase profits.
II. Core Problems
A. Sales Mix
Ringo cannot properly price its cartons because Ringo only tracks monthly sales by grade as opposed to tracking the percent of sales by carton size. Without tracking the percentage of sales of the 5lb, 10lb, 20lb, and 50lb cartons, Ringo is unable to calculate the sales dollars per pound and the contribution margin by product. For example, the 5lb cartons have a higher contribution margin than the larger size cartons. (See Exhibit I) Thus, if Ringo sells more 5lb cartons, they will increase their net sales and profits. Without knowing the percentage of sales based on carton size, Ringo is cannot properly price the cartons. Accordingly, tracking and identifying the percentage of sales by carton size is crucial for Ringo to increase its profitability.
B. Labor Hours
Ringo cannot accurately determine the cost of manufacturing because its current labor expenses are inaccurate. Ringo employs five (5) women at $1.10 an hour. The prior month’s time cards show the women spend 1,000 hours grading, 3,000 hours cutting, and 600 hours packing. Thus, the total amount of time recorded for the women was 4,600 hours. At this rate, each women would have to work 920 hours, which equates to 29.6 hours a day assuming a thirty-one (31) day month. Without having accurate labor costs, it is difficult for Ringo to determine the cost associated to each manufacturing department.
C. “Loss Factor”
The loses Ringo experiences from stripping the rags of all foreign matter and cutting them into squares of 1 to 1 ½ feet prior to packaging increases the cost per cwt. During the cutting process, Ringo burns any material that contains holes, is too small, or unusable for any other reason. Ringo refers to the burning of excess material as a “loss factor.” Not only is this process wasteful, it increases the cost per cwt. For example, last month Ringo purchased 43,700 pounds of Grade A rags at a cost of $6.00 per cwt from textile convertors. Ringo loses 20% of the quantity it purchases from textile convertors during the cutting process. Factoring in the “loss factor,” Ringo’s cost per cwt for Grade A rags increased from $6.00 per cwt to $7.50 per cwt, a 25% percent increase in cost, because the output for said rages was decreased from 43,700lbs to 35,000lbs. (See Exhibit C).
Furthermore, Ringo’s largest loses are contributable to rags supplied by junk dealers. Initially, rags purchased from junk dealers are appealing because of their low cost of $1 per cwt. However, Ringo loses 50% of the rags supplied from junk dealers in the cutting process. The 50% loss of junk rags increases the net cost per cwt to $2. Thus, the “loss factor” increases the cost of junk rags by 100%. Moreover, the actual losses Ringo suffers from the “loss factor” of junk rags is higher because it costs Ringo to store, wash, dry, clean and grade 25,000lbs of rags that are burned. (See Exhibit C).
D. Excess Inventory
Ringo’s use of their building creates unnecessary overhead because ½ of the building stores inventory. Ringo pays $3600 a month to lease its only building. Ringo uses ¼ of the building to store 200,000lbs of unprocessed rags. Additionally, Ringo uses ¼ of the building to store 150,000lbs of boxed rags. In sum, ½ of Ringo’s building stores approximately 350,000lbs of inventory. Accordingly, Ringo has unnecessarily high overhead because of its decision to allocate such a tremendous amount of space to Work in Process (“WIP”).
III. Short Term Solutions
A. Sales Mix
Ringo needs to have its bookkeepers record the box size of the sales. With this information Ringo will be able to determine its product mix and accurately calculate its contribution margin. Ringo’s purchasing department can determine the lowest cost provider taking into account the quantity and quality of rags being demanded. Product contribution margin data would enable the partners to determine the optimal mix of box sizes that they should sell to maximize profits.
B. Labor Hours
Ringo needs to implement a new method for tracking labor hours. By instituting a new time management system, Ringo will be able to accurately record its labor cost. Once it accurately records its labor costs, Ringo can then apportion the appropriate amount of cost to each step of the manufacturing process. Once this is done, Ringo will then be able to accurately analyze their manufacturing line and determine what changes, if any, need to be made.
C. Eliminating Junk Rags
Ringo can increase its profitability by increasing its investment in rags from laundries and eliminating junk rags from its suppliers mix. Although the raw material cost for the junk rags is only $2.00 per cwt, the conversion costs associated with junk rags makes them unprofitable. By eliminating junk rags, Ringo will eliminate $226.66 in overhead related to gas, electricity, detergent, and depreciation each month. (See Exhibit F). Additionally, eliminating junk rags reduce excess inventory because the foremen would have additional time to spend getting shipments ready. In sum, by eliminating the junk rags Ringo will decrease its cost of goods sold from $8,589.89 to $7,465.61. (See Exhibits A, B, G, and H).
IV. Long Term Solutions
A. Just in Time Processing
Because sales usually follow production closely, Ringo should work on eliminating excess inventory by implementing a just-in-time inventory system. Using ½ of their building to store 350,000lbs of rags takes up costly storage space, increases insurance and taxes, and adds to the product handling costs. Alternatively, a just-in-time inventory system would consist eliminating all stored inventory and only purchasing new inventory on an as needed basis.
Additionally, Mr. Ringo should request that rags be delivered once a week instead of once a month. This would cut down tremendously on the amount of unprocessed rags and free up money to use elsewhere.
B. Compressing Unprocessed Rags
If Ringo is unable to reduce the quantity of processed rags by implementing a just in time inventory system, they should compress the processed rags in plastic instead of using cardboard boxes. The compressed plastic containers will free up additional space and save Ringo in storage expenses.
C. Change the Production Order and Eliminate the Grading Process
If Ringo continues to manufacture junk rags, Ringo should change its manufacturing process. First, Ringo should cut the rags into the appropriate size squares before they wash and dry the rags. This will ensure they are not wasting hours washing, drying, and grading materials that is going to ultimately be thrown away due to the loss factor that occurs during the cutting process. By changing the manufacturing process, Ringo would reduce its inventory, increased storage space, eliminate the unnecessary expense of washing rags that are burned, and increase profits.
Additionally, if Ringo choose to change its production order and continue purchasing junk rags, it could increase profits by eliminating the grading process. This option would require that Ringo sell all of the rags it purchases from junk dealers and laundries as Grade C and wold save 193.60 a month by eliminating all grading costs. (See Exhibit D and F).
Exhibit 1 Assumptions
The 5 women labor hours: We are assuming for all calculations that those hours are per year.
Adjustments to Supplier: We are assuming that the suppliers will be able to meet any of our demands for raw materials.
Unaccounted wages: We are assuming that the partners and their wives are not taking wages for our profit calculations.
No Potential Bottlenecks: We are assuming that there is no bottleneck in the system. With all of the information on washing and drying the current mix of suppliers does not constrain washing and drying or the system as a whole.
Sales and production Numbers: Because sale numbers “closely follow production numbers with only minor fluctuations,” we are assuming that the normal sales volume for grades A, B, and C are 50,000; 50,000; and 25,000 respectively.
Scrap and Grade Percentages: We are assuming that the percentages given for scrapped material from each dealer and absorption quality (A,B,C) from each dealer is accurate and doesn’t change.
Smaller Batch Deliveries: We are assuming that they receive all of the rags in one shipment at the beginning of the month ( 200,000lbs at beginning of process is approximately equal to sum of all suppliers; 43,750+25,000+6,250+60,000 +50,000). We are also assuming that 200,000lbs is an average meaning that they have an excess of unprocessed rags in their raw material inventory. We are assuming that he also holds onto rags for the whole month, because if ¼ of the warehouse was used to store 200,000 unprocessed rags, then ¼ of the warehouse can also hold 200,000 processed rags.
1. The Ringo Company is a partnership that is operating without a partnership agreement. Accordingly, the partners split the profits of Ringo Rag 50/50 instead of drawing a salary.
2. The $2,400 spent on the half-time bookkeepers is the amount paid to the wives for their secretarial duties.