Based on her analysis of the high-end chocolate market she presently served, she realized that she had a fair amount of excess machine capacity; and this situation was expected to continue for a few years. The question was what to do with the excess capacity. She had three mutually exclusive options:

1) Branch out into creating high-end artisan pieces. This would entail using moulds to create various chocolate pieces that would then be assembled into edible, ornamental shapes. This strategy would simply add to the image of the company, as she envisioned highly artistic pieces for special occasions, possibly filled with her chocolates. For example, given the seemingly continuous increase in the number of people with gluten allergies, this could offer a reasonable alternative to the traditional wedding cake. Among other costs, going in this direction would require the hiring of a highly qualified pastry/chocolate chef. While the company would provide a set number of designs using only two or three chocolate formulations, thereby limiting setup changes and the associated costs, the nature of this type of production would entail the use of considerable machine time (15 minutes per artisan piece) to get the pieces just right to enable proper production and assembly that met the quality standards for the artisan pieces.

2) She had been approached by another company, Chocolate Promotions Inc., which mass produced chocolate for school and charity fundraising. These products tended to use chocolate that was at the lower end of the quality spectrum. As a result, relative to the other two options, there would be considerable savings in terms of the cost of chocolate. In addition, given the large quantities needed combined with the limited number of flavours/types of chocolate pieces the company offered its customers, the machines could run for long stretches and would require a reduced number of setups. However, the downside was also twofold. First, Katherine was concerned about the possible impact on her image and, by extension, her regular sales if word got out that she was producing low-end chocolate. Second, while the setups were minimal when switching from one product to another, whenever the machine was switched back to Katherine’s regular production extensive time and money would have to be spent flushing the lower grade chocolate out of the machines. On the plus side, this was only a stop gap measure for Chocolate Promotions in that they were waiting for their new plant to come online in two years, and they would no longer need Katherine’s Chocolate Kompany after that.

3) She could produce small, expensive, exotic-flavoured chocolate bars like White Chocolate with Pink Peppercorns. Similar to the artisan piece option, this would be a natural strategic extension to her existing products. On the downside, some of the flavours she had developed relied on high-end chocolate from tiny villages in some of the poorest countries in the world. While this inevitably led to high prices, she also knew that the villagers were being short changed by the cocoa buyers. She also recently became aware that, in addition to not giving the villagers their fair share, cocoa buyers were purposely avoiding sharing technological advances that could increase cocoa production in an attempt to keep production low and prices high while simultaneously keeping the villagers “in their place.” Obviously this did not sit well with Katherine, especially in light of her company’s desire to pursue corporate social responsibility initiatives. Perhaps getting involved in the downstream value chain would allow Katherine to address her lack of attention to what was supposed to be one of the company’s strategic initiatives, as well as apply the concept of target costing, which she learned about in her intermediate management accounting class, to drive down production costs and share the savings with the villagers. While producing the bars would require more setups than either of the other two options, the nature of the process would mean less cleaning than the Chocolate Promotions Inc. option. An additional downside was the prospect that, unlike the artisan pieces, which were envisioned as enhancing sales of truffles and regular chocolates, it was believed that making and selling these high-end chocolate bars would inevitably cannibalize regular chocolates and truffles. In the case of the artisan pieces, they would be used for special occasions and/or as a replacement for a high-end pastry (i.e., wedding cakes) such that quality and not cost was the bigger issue. In the case of the small chocolate bars, if people were coming in for a decadent high cost, high caloric treat, they might choose to spend only a certain amount or purchase a given amount of calories such that they might choose the bar or chocolates/truffles, but not both. Costs and related information with regard to the three choices are given in Exhibit #1.

Option #1 – Artisan Pieces The target price for the artisan pieces is $120 each. In addition, Katherine anticipates that many customers will purchase regular chocolates to fill the sculpture and/or place them around the piece. The additional sale of chocolates/truffles are forecast to generate an additional $24 of margin per artisan piece sold. Due to the short supply of pastry chefs, Katherine can only get a half-time pastry chef for 1,000 hours per year at a cost of $40,000. Each piece should take the chef approximately 30 minutes to complete. Aside from the pastry chef, a skilled tradesperson will be hired to run the machine; he or she will cost $25,000 per year for 1,000 hours. While there is no shortage of this type of labour, Katherine believes that the total hours required will be the same as the pastry chef. The chocolate has to be of relatively high quality and it is estimated that each sculpture will require roughly 5 pounds of chocolate at a cost of $8 per pound. Other annual variable costs include $10,000 for specialty moulds and $6,000 for decorative candy. In addition, there will be a one-time cost of $10,000 for sculpting tools.

Option #2 – Chocolate Promotions Inc. The price that Chocolate Promotions Inc. is willing to pay for each box of chocolates is $3. They would require 200,000 boxes each year. As with the artisan pieces, a skilled tradesperson will be required to run the machine at a cost of $25,000 for 1,000 hours. In addition, cleaning costs will amount to $9,000 per year, of which approximately $8,000 will be labour; the remaining amount is an estimate of the cleaning supplies and tools required each year. Each box will contain half a pound of chocolate, but the quality required is substantially lower such that the cost per pound will be only $3.50. Other annual variable costs include $6,000 for moulds, $8,000 for flavours, $4,000 for cream, and $10,000 for the boxes.

Option #3 – Expensive High-End Chocolate Bars Katherine anticipates that she can sell 250,000 of these bars at a price of $4 each. However, since these may be viewed as a substitute for her regular chocolates and truffles, she anticipates cannibalization will result in a contribution margin loss of $36,000 annually. The processes involved in making these high-end chocolate bars and maintaining their quality, in terms of both taste and appearance, requires the use of a pastry chef subject to the same supply limitations and costs as mentioned for the artisan pieces. This strict attention to process also means that a skilled tradesperson will be required to produce the bars and perform the required setups. Again, as with the artisan pieces, it is anticipated that this person will be used for the same amount of time as the pastry chef. Given the high-end nature of these bars, the type or quality of chocolate required is extremely expensive and will cost approximately $12 per pound, with each bar requiring a quarter of a pound. Other annual costs will include moulds of $4,000 and flavours costing $15,000.

Multiple-Choice

Questions 1. Given a three-year time horizon and ignoring the time value of money, which option provides the highest contribution, and what is the value of this contribution?

a) Artisan pieces – $381,000

b) High-end bars – $390,000

c) Chocolate Promotions Inc. – $564,000

d) High-end bars – $400,000

2. Assume that there was no excess “normal” capacity, as well as the following:

i. Katherine could still produce the artisan pieces if she purchased additional machinery costing $100,000 with a salvage value of $15,000. Unfortunately, this machine would need to be replaced every two years. The alternative was buying a sturdier piece of machinery that costs $500,000 and would have a useful life of 10 years and a $50,000 salvage value.

ii. Katherine could still produce the Chocolate Promotions Inc. orders by running the machines after hours. This would require a 25% premium in labour costs as well as an additional $20,000 per year in maintenance if the useful life of the machinery was to be maintained.

iii. Katherine could still produce the high-end bars if she purchased a $200,000 machine with a useful life of four years and no salvage value. Given a four-year time horizon and ignoring the time value of money, which option provides the highest contribution, and what is the value of the contribution?

a) Chocolate Promotions Inc. – $349,750

b) Artisan pieces – $201,000

c) Chocolate Promotions Inc. – $347,750

d) Chocolate Promotions Inc. – $356,000

3) Market research by Katherine’s Chocolate Kompany indicates that sales of high-end chocolate bars will double if the price is reduced by $1. In addition, the annual cost of cannibalization will decrease by two-thirds. This doubling of sales will result in the doubling of mould and flavour costs, but this will be offset by reduced labour costs as a pastry chef will no longer be required. Instead, a highly skilled tradesperson that has also received training in chocolate making and production will be able to run the new machine. The machine costs $200,000, has a 10-year useful life, and no salvage value. The tradesperson will cost $55,000 per year. If Katherine decides to introduce target costing and wishes to generate a 15% return on sales based on the lower price and increased demand, what will be the target cost of chocolate to obtain this result considering only variable costs?

a) $9.360 per pound

b) $9.280 per pound

c) $9.120 per pound

d) $9.456 per pound

4. Corporate social responsibility is a key element of the company’s strategy that Katherine needs to pursue. As such, Katherine did some preliminary investigation and has determined that there are indeed opportunities to work with some of the poorer chocolate farmers to significantly bolster their cocoa yields by introducing much better crop management processes. It would be Katherine’s intention to approach the situation much like Toyota did, whereby Katherine’s Chocolate Kompany employees would work directly with the farmers and the financial gains made through these initiatives would be split equally between the farmers and Katherine’s Chocolate Kompany. In examining the feasibility of this initiative, Katherine worked with agricultural engineers, as well as business and agricultural economics faculty at the University of Guelph, and determined that hitting the target price for this specialty chocolate was imminently possible. The big question was exactly when it would happen and, subsequently, how long it would take the farmers and the company to realize the benefits of this initiative. Estimates suggest that the target price could be hit anywhere from the third year through the eighth year of the envisioned 10-year project. If part of Katherine’s remuneration already includes a bonus for company profitability, what makes the most sense in terms of ensuring Katherine pursues this corporate responsibility initiative?

a) Provide an incentive based on hitting the estimated annual profit for the project.

b) Provide an incentive based on hitting the estimated annual cost for the project.

c) Provide an incentive based on the year-over-year increase in the standard of living of the farmers.

d) Provide an incentive that will pay Katherine a “super bonus” if she attains the estimated profit at the end of 10 years.

e) Provide an incentive based on an annual survey of the farmers’ satisfaction with Katherine’s Chocolate Kompany.

f) Provide an incentive based on hitting the estimated annual cost per pound for chocolate for the project

Answer rating: 100% (QA)

ANSWERS 1 a Artisan pieces 381000 Time puts distance between you and your liquidity and that creates costs that take away from value The more time there is the larger its effect on the value of wealth ... View the full answer