Importance of Lifecyle Report for Profitability Analysis and Recommendations for Improvement

Explanation of Lifecycle Report Importance

(a) Explain why it is important to produce and review this type of lifecycle report for individual products, rather than to rely on more traditional quarterly or annual income statements. 
 
A whole lifecycle report for individual products is more useful than an income statement based on arbitrary accounting periods as it discloses the products financial performance over its entire life. Quarterly and annual reports will be distorted and hard to interpret accurately because the profitability of products will vary considerably over their lifecycle.  
 
Before production starts products inevitably make large losses due to upfront R&D and design costs. They may still make losses when production starts if volumes are not able to cover fixed costs, including high initial marketing costs. Products should be highly profitable when they achieve a high volume and market share but profitability will fall as they reach their decline stage.  
 
 Reviewing, and comparing between products, the % split of expenditures between categories along the whole value chain is likely to give insights into why some products turned out to be more profitable than others.  Management can learn from such insights to determine a more appropriate allocation of resources and hence improve the profitability of future products.         
 
(b) Analyse your lifecycle report and offer possible explanations for the difference in profitability of the two products. On the basis of these explanations make recommendations to the directors of MowFast regarding how the firm’s profitability might be improved in future. 
 
 Why was the Turbo much less profitable than the Sprite? 

 It is likely that the rush to get the Turbo to market quickly and the cut in R&D and design expenditures adversely affected overall profitability of the Turbo. For the Sprite, the proportion of total expenditure spent on R&D and design was 16.1% and 7.5% respectively, a total of 23.6%. For the Turbo, R&D was only 7.6% of total cost and design only 3.5%, a total of 11.1% and hence a dramatically lower proportion than was spent at the design and development stage for the Sprite. This lower upfront expenditure appears to have been a false economy resulting in the premature launch of an inferior product.  

There is evidence in the case for this as Harry complained that the development time was shortened too much, and Sally pointed to problems in manufacturing and subsequent quality and hence warranty issues. This is borne out by the figures. The Turbo’s manufacturing costs were 60% of total costs compared to the Sprite at 57%. Moreover, customer service costs were a much higher proportion for the Turbo at 16.1% compared to 9.9% for the Sprite, no doubt due to dealing with complaints and warranty issues. Having to send out replacements will have pushed up warranty costs to 7.8% for the Turbo compared to 5.9% for the Sprite. Also, Sally mentions a re-launch of the Turbo and this is probably what caused its higher proportion of marketing costs at 5% compared to 3.6% for the Sprite extra marketing needed to convince customers that the quality problems were solved.  
 
(c) In summary, the savings made in R&D and design do appear to have been swamped by the extra costs incurred later in the value chain, i.e. in production, marketing, distribution, and customer service. The inevitable reduction in sales volumes and the need to discount the price will have also contributed to the overall fall in profitability of the Turbo. 
 
To improve profitability in the future MowFast needs to learn lessons from this analysis and ensure that enough time and money is invested upfront in research and development and design of products. 80 to 85% of costs are locked in at the design stage and starting production prematurely, through missed opportunities to improve design and choose the most appropriate production methods, can lead to serious production and quality problems and the resultant higher costs. 

Profitability Analysis for Two Products

(d) Explain how target costing provides management with useful information for a decision about the proposed introduction of the President mower and advise management (in general terms and with specific examples) what they should do if in this case the target cost calculated does not initially appear to be achievable. 

 
Target costing encourages management to focus on the market and hence starts with the price customers are willing to pay for the proposed product and the quantity that is likely to be sold over the product’s life. From this expected revenue is deducted the desired profit to arrive at a total target cost from which the unit target cost can be calculated. Comparing this to the expected unit cost, disclosed by the products lifecycle budget, enables management to assess whether the new product is likely to meet the desired profit target or not.  
 
In this case the target cost is below the estimated average cost per unit if current production methods are used. This indicates that MowFast should not go ahead with the President mower unless it can discover ways of reducing its costs, e.g. through a redesign or revised production methods. The excess cost that needs to be eliminated is called the ‘drift’ cost and in this case a 5.3% reduction in budgeted cost is needed.  
 
MowFast could investigate the following possible methods to eliminate the drift cost of $25.25 per mower: 

• Redesign of the President to make it cheaper whilst still giving customers what they want. Look for simplifications to make it easier to manufacture and/or by eliminating unique parts and instead using parts used in other products and bought more cheaply (e.g. due to quantity discounts). 

• Seek alternative, cheaper production methods for the President as currently designed or redesign for more efficient production processes. 

• Seek cheaper supplies of key components, either by negotiation with current suppliers and/or perhaps outsourcing sub-assemblies that can be made cheaper by suppliers or by finding alternative, cheaper suppliers. 

• Apply some of the learning from reviewing life cycle reports on past products. Can more up-front expenditure on development or design significantly reduce production cost e.g. by reducing the likelihood of a quality problem? Improved quality may also reduce customer service costs and any other costs associated with returns and rework (including distribution costs).     
      
If it is not possible to identify ways of removing the drift cost using the suggestions above the Directors might consider it prudent to abandon plans to introduce the President and concentrate on more favourable products. Note, however, that there may be strategic reasons for proceeding with the President. For example, it may be championing new discoveries that will benefit later products. Moreover, even if it is not considered certain that the whole of the drift cost can be eliminated before production starts there may be enough favourable evidence to support a decision to introduce the President mower. This would only be advisable if the Directors were either willing to accept a slightly lower return on sales or were confident that any remaining drift cost was small enough to be eliminated after production commenced by using Kaizen Costing techniques.