Select Hardwood Veneer Company*

The sales manager of Select Hardwood Veneer Company received an offer from Fine Furniture
Company to buy one million feet per month of sound “backs” of 1/24-inch birch veneer 1 at $20
per thousand surface feet. The sales manager wanted to accept the offer, but the production
manager argued that it should not be accepted because the cost of production was at least $24 per
thousand feet and probably more.

Select Hardwood manufactured rotary-cut birch veneer from high-grade logs bought in British
Columbia. Selected sections called blocks were cut out of those logs, the length of the block
varying form 84 inches to 98 inches. These blocks, as cut for the lathe, cost an average of $440
per thousand board feet. A thousand board feet, log measure, was an amount of logs which,
being sawed, would produce a thousand board feet of lumber. (A board foot is 1 square foot 1
inch thick.) After being cut, the blocks were put in vats filled with hot water and left there for 24
to 48 hours until the entire log was heated through.

The furniture-making industry was quite competitive. However, it was dominated by a few large
manufacturers. Successful furniture manufacturers typically used the same providers of veneer.
To be successful it was imperative to maintain quality and provide timely shipping. The quality
required for faces 2 was established by specifications of the industry. The dividing line between
sound backs and waste was similarly established.

Manufacturing Process

In the rotary veneer process a block was put in a lathe that had a heavy frame, guide bars, and
pressure bars where a knife longer than the block was brought against its side so that it cut off a
thin slice of wood the entire length of the block. The process was similar to unrolling a large roll
of paper held on a horizontal shaft. The process could be controlled with skilful operation, so it
would produce veneer of uniform thickness. Select Hardwood produced principally 1/24-inch
veneer, and for the purposes of this case it may be assumed that all of its product was 1/24-inch.

The sheet of veneer from the lathe, for instance from a 98-inch block, was brought onto a
clipping table approximately 60 feet long. This table had rubber belts on its upper surface that
moved the veneer along to the clipper. At this point the veneer was like a long sheet of paper
moving along the table, the veneer being 98 inches along the grain. The clipper was a long knife
extending entirely across the table. The clipper operator was one of the most highly skilled
workers in the plant.

* The case was is copyrighted by the President and Fellows of Harvard Business School with adaptation by
Barbara Sainty.
1
Veneer is a term applied to thin leaves or layers of wood. Generally, veneer is made of valuable wood and
is laid over a core of inferior wood.
2
Faces and backs are terms used to define quality of veneer. More complete definitions are provided later
in the case.
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Constantly inspecting the sheet of veneer, the operator first took one cut to get a straight edge. If
the next section of the sheet was a high quality, the operator advanced the sheet not over 3 feet 8
inches, depending on customer’s requirements. If the sheet showed a defect withing 3 feet 8
inches, the operator made the cut just short of the defect. A worker called the “off bearer” piled
these sheets on a hand truck reserved for high-grade or “face” veneer. If the defect was a knot,
the clipper operator then advanced the sheet enough to clear the knot and took another cut,
making a piece of waste possibly 3 inches wide. If the operator decided that a section of the
sheet was not a face quality, it was cut off for “backs,” either 3 feet 8 inches or in lesser widths.
Backs were put on another hand truck.

The clipper operator thus separated the whole sheet of veneer into faces, backs, and waste. The
faces consisted of pieces of veneer 98 inches long along the grain and anywhere from 6 inches to
3 feet 8 inches wide. The sound backs were of the same size. The waste went to a chipper and
was then burned. The term faces came from the fact that these veneer sheets were substantially
perfect and could be used on the exposed parts of furniture or on the best face of plywood. 3 The
backs had minor defect and were so called because they were used on the back of plywood
panels. Select Hardwood had a reputation for using high-grade logs and for producing a high
grade of veneer both on faces and backs.

Fine Furniture Company’s Offer

Fine Furniture Company’s product design department had developed two new lines of furniture,
one in blond modern and one in colonial, in which the table tops, dresser tops and panels, drawer
fronts, and other exposed parts were of birch veneer over lower-grade birch or poplar cores, with
table legs, dresser frames, and so on, of solid birch. Fine Furniture’s people knew that while all
sheets of backs contained defects, 50 to 60 percent of the area of backs as produced by Select
Hardwood were of face quality. They had discovered that by buying backs 84 inches to 98
inches long, they could cut clear face-quality veneer into lengths that would match their use
requirements: enough 54-inch lengths for their longest dresser tops and enough of other lengths
down to 14-inch drawer fronts. The remainder of the veneer that was not of face quality could
be used for such purposes as making plywood for drawer bottoms. The methods developed in
the product design department had been tested by cutting up several carloads of back bought
from Select Hardwood and by the manufacture and sale of the furniture.

On the basis of this experience, Fine Furniture Company offered Select Hardwood $20 per
thousand feet for 1 million feet per month of sound backs in 1/24-inch birch veneer for the next
12 months.

3
Veneer is a single thin sheet of wood. Plywood consists of several sheets (three, five, or nine) glued
together with the grain of alternate courses at right angles to add to the strength.

2
Cost Information

Select Hardwood cut an average of 12,000 board feet of logs a day in one eight-hour shift. With
the high quality of logs it bought, it got a yield of 18,000 surface feet of 1/24-inch veneer per
1,000 board feet cut; this graded on the average 50 percent faces and 50 percent backs.

Labour and factory overhead costs together averaged $24 per thousand surface feet of veneer;
selling costs averaged $4. Both the cost of the blocks and operating costs for the heating, lathe
turning, and clipping operations were joint costs; backs had to be produced in order to get the
faces. The remaining operations in drying, a slight amount of reclipping, storing, and shipping
were in a sense separate costs as the operations were done on both faces and backs separately,
although with the same equipment. The labour and factory overhead costs through clipping
averaged $20.25 per 1,000 surface feet of veneer; those for drying and later operations, $3.75.

The selling price for 1/24-inch birch faces 84 inches to 98 inches long was $88 per thousand
surface feet. Face veneer 84 inches to 98 inches had a high price because it could be used on
large surfaces, such as flush birch doors that require lengths up to 8 feet. The veneer shorter in
length along the grain, made from recutting backs, had a somewhat lower price because it could
not be used for these purposes. Unlike faces, the price of backs fluctuated widely. Sometimes
Select Hardwood could get $25 per thousand feet, but the insistence of the production manager
on $25 had led to the accumulation of a heavy inventory of backs. Select Hardwood Veneer sold
its faces to most of the leading furniture manufacturers. The faces were easy to sell and were
shipped as fast as they were produced.

More effort was required to sell backs than to sell faces, although both were sold to the same
customers by the same sales force. Sometimes buyers of faces were required to take a
percentage of back in order to get a carload of faces. For these reasons Fine Furniture’s offer
was attractive to the sales manager.

Discussion of Offer

When the production manager was first informed by the sales manager of the offer of $20 per
thousand surface feet, the production manager contended that “Your salespersons are so lazy,
they would give veneer away if nobody watched them.” The production manager went on to
say:

If a birch block cost $440 per thousand and we get 18,000 feet of 1/24-inch-thick
veneer from every thousand board feet of the block, the cost of the block to be
allocated to a thousand feet of veneer, whether backs or faces, is $440 divided by
18,000 feet, or about $24.44 per thousand feet. Simple arithmetic proves that
selling backs at $20 per thousand doesn’t even pay for the material, let alone
labour and overhead.

The sales manager countered that this argument was fallacious:

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 Allocating the cost of the block to the veneer in this manner implies that backs are
as valuable as faces, which is not the case. The $24.44 material figure for a
thousand feet of veneer that you get is merely an average of the value of faces and
backs. The material for faces is worth considerably more per thousand feet than
this figure; the material for backs is worth considerably less.

The sales manager suggested that the proper procedure was to allocate the cost of the block to
faces and back in proportion to the amounts for which the products were sold. Using this
method, the ratio that the revenue of one of the two grades of veneer bore to the revenue received
from both grades of veneer would be applied to the total cost of the block, the result representing
the cost to be allocated to that particular grade. To illustrate this method, assume a block of a
thousand board feet cost $440, and the selling prices and quantities of faces and backs are as
shown in the following table:

1/24-Inch Sales Cost

Veneer Revenue Net Percent Applicable
Grade in Feet per 1,000 Feet Value of Total to Each
Faces 9,000 $88 $792 81.5 $358.52
Backs. 9,000 20 180 18.5 81.48
18,000 $972 100.0 $440.00

The material cost applicable to each product, then, per thousand feet of 1/24-inch veneer would
be $358.52/9,000 feet * 1,000 feet, or $39.84 for faces: and $81.48/9,000 feet * 1,000 feet or
$9.05 for backs.

The production manager again argued that this did not represent the true material cost, which
was the same for both products, and added:

Under your method the material cost allocated to either faces or backs would be a
function of their relative selling prices. If the selling price of faces fell from $88
per thousand to $44 per thousand and the price of backs remained the same, you
would then charge much more material cost to backs, and much less to faces.
Your method of allocating cost doesn’t make sense.

The sales manager at this point said:

OK, if you don’t think that method is justified, then let’s treat backs as a by-
product. I think you’ll agree that we would prefer to be making faces all the time,
yet we can’t. As long as we manufacture faces, we’re going to produce backs as
an undesirable consequence.

Now if we consider backs as a by-product, we can charge all block costs to faces.
The net proceeds from the sale of backs, after allowing for all conversion, selling,
4
 and administrative expenses, can be credited to the raw material cost of faces. All
profits and losses of the business would be borne by the main product.

The production manager, however, pointed out again that the cost of material allocated to faces
would still be a function of the selling price of backs and, furthermore, there would be some
difficulty in trying to value inventories at the end of an accounting period. Any profits arising
from the sale of backs would be hidden, since they would be included in the credit to faces. “It is
important to determine the profit or loss being realized on the sale of backs so we can establish a
firm sales policy,” the production manager asserted.

Because of their inability to resolve this question, the production manager and the sales manager
consulted Select Hardwood’s president, who in turn asked the controller to examine the cost
situation to determine whether the $20 per thousand surface feet of 1/24-inch backs would result
in a profit or not.

Questions

1. Prepare a situational analysis and determine the key success factors for Select Hardwood
Veneer.

2. As controller, what method of allocating raw material costs would you recommend?
What similarities and differences would be encountered in allocating labour and overhead
costs as compared to material costs?

3. If a group of blocks containing 1,000 board feet costs $450, what would be the cost
applicable to faces and backs under each of the methods of allocating costs described in
the case, and other methods that you devise, if the following conditions existed:

a) The current market price of 1/24-inch faces is $88 per thousand feet; 1/24-inch
backs are currently selling at $22 per thousand.

b) 10,000 feet of 1/24-inch faces and 8,000 feet of 1/24-inch backs were produced
from a group of blocks.

c) Factory labour and overhead cost averaged $24 per thousand feet of veneer
($20.25 for operations through clipping and $3.75 for drying and later operations).
Selling costs averaged $4 per thousand feet of veneer. If backs were not
manufactured (i.e., if they were treated the same as waste) all costs to process
backs after the split-off point might be saved.

4. Should the sales manager accept Fine Furniture’s $20 per thousand feet offer for the
1/24-inch backs?