Harvard Business School 9-191-053

Rev. June 28, 1994

Catawba Industrial Company

Marge McPhee, general manager of the compressor manufacturing department of Catawba
Industrial Company, quickly spotted the reports that she had been waiting for in the pile of mail that
had accumulated during her trip to a West Coast industrial equipment trade show. A sales forecast
and a cost tabulation for a proposed new, light-weight compressor provided her with the information
she needed to ascertain whether or not to introduce it, what volume to produce, and what price to
charge.

Catawba Industrial Company, located west of Charlotte, North Carolina, was a major
supplier of automatic industrial paint systems (used for painting newly manufactured goods such as
agricultural machinery, metal furniture, and appliances) and related industrial equipment. The
compressor department manufactured a standard compressor for use in the company's paint systems
and for a wide variety of other purposes as well. Marge McPhee, who had earned a Bachelor of
Mechanical Engineering Degree from Georgia Tech., was recently promoted to her present position in
recognition of her strong technical and managerial capabilities. The company employed almost 1,200
persons and had more than $200 million in sales.

The marketing department's sales forecast for the new product, see Table 1, looked promising.
The numbers seemed to indicate an upper price limit of $7,500 to $8,000 and a maximum demand of
approximately 30 units per week. While the lower weight and size made ~e new compre~sor
attractive for certain applications, it was less rugged than the standard urut. It also reqmred
customers with standard units to carry another set of spare parts.

Table 1

Sales Forecast Light Weight Compressor

Price* Units per Week
$5,500 31
$6,000 30
$6,500 28
$7,000 24
$7,500 17
$8,000 10
* Compressors were priced at $500 increments only.

• J A ·z r prepared. this. case. as the basis for class discussion rather than to illustrate either effective or
Professor Francis . guz a . .
ineffective handling of an admzmstrative situatwn. .
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 191-053
Catawba Industrial Company

The cost figures for the new product that had been prepared by the production engineering
department (see Exhibit 1) were higher than Marge had anticipated. This was of some concern to her
since the compressor department was operating at full capacity, and the new unit therefore would
have to generate a higher return than the standard product to justify displacement.

Standard Compressors

The compressor plant, capable of producing four standard compressors per day, operated
two shifts for six days weekly. (The union contract restricted Catawba from running a third shift.
This time, however, could be used for routine maintenance and special repairs.) Ten of the 24 units
produced each week were required as a component for the automatic paint systems sold by the
company. The remaining units were sold on the open market through industrial distributors to meet
whatever demand there might be for this common product. The 50 direct labor men and women
averaged $20 per hour in wages and benefits during the normal week. They received time-and-one-
half on Saturday and double-time on Sunday. The plant was closed on Sunday because the higher
labor costs resulted in an operating loss for each unit produced. See Exhibit 2 for the standard model
compressor costs.

Light Weight Compressors

Because of its design, the new compressor could be manufactured on Catawba's new
numerical control machinery instead of the older equipment used to make the standard unit. As a
result, each unit required only 62.5 hours of direct labor as compared to the 100 hours for the
standard model. The cost savings in labor and materials were partly offset by the higher depreciation
charges resulting from the use of more expensive machinery. The company had added certain
features to the machinery center to accommodate the manufacturing process for the new compressor.
The extra hardware and hoists already installed had cost $417,000. Additional jigs, sensors, and
software were expected to add another $218,000 to this total. Both these amounts had been taken into
account in calculating the depreciation charge for the new compressors.

As Marge prepared to analyze the numbers, she was relieved to see that despite the high
costs for the new compressor, it could still generate a higher profit than the standard unit. With that
bit of encouragement, she set out to calculate the price and volume for the new compressor that
would result in the best financial return. Because of practical difficulties in changing purchasing
orders, production scheduling, and price lists, Catawba had a policy of limiting any changes to
manufacturing and marketing plans to twice a year. Revisions were normally made in November
and May. Exceptions could be made, but were embarrassing to the managers making such requests.

2
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 Catawba Industrial Company
191-053

Exhibit 1
Light Weight Compressor Per Unit Cost Estimate

MEMORANDUM

TO: Marge McPhee, General Manager, CMD

FROM: Larry Salin, Production Engineering
SUBJECT: Light Weight Compressor Per Unit Cost Estimate
DATE: November 27, 1990

Direct Labor $1,250 (wages and benefits)

Material 1,463
Other Direct Charges 137 (power, materials handling, etc.)
Depreciation 1,406
Other Mfg. Overheads 152 (insurance, security, heat, etc.)

Cost of Goods Sold $4,408

Sales 1,102 (~5% of COGS)

General & Administrative __w_ ( 10% of COGS)

Total Cost Per Unit Wit

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 191-053
Catawba Industrial Company

Exhibit 2
Standard Model Compressor Profit and Loss

Weekdays Saturday Sunday

Price $10,000
Direct Labor $2,000 $3,000 $4,000
Materials 3,244 3,244 3,244
Other Direct Charges 156 156 156
Depreciation 497 497 497
Other Mfg. Overheads _J]]_ _J]]_ _J]]_
Cost of Goods Sold $6,074 $7,074 $8,074
Sales 1,519 1,769 2,019
General & Admin. 607 707 807
Total Cost $ 8.200 $9,550 $10.900
Profit per Unit $ 1,800 $ 450 ($900)
Return on Sales 18% 4.5% Negative

Compressor Department Profit (Weekly)

Monday - Friday 20 units x$1,800 = $36,000

Saturday 4 units x 450 = 1,800
Sunday None = __O

Departmental Profits per week = $37,800