Cushions Pty Ltd. is specialised in manufacturing pillows. The pillows are branded as a product of Australia, meaning that all materials come from Australia; and all the manufacturing has been carried out in Australia. Cushions Pty Ltd. has excess capacity, and the sales manager is approached by a potential new customer to fulfil a one-time-only special order for a large batch of pillows similar to what is offered to regular customers. The following per unit data apply for sales to regular customers: Direct material cost $10 Direct labour cost $3 Variable manufacturing overhead cost $2 Fixed manufacturing overhead cost $5 Total product cost $20 Markup $10 Targeted selling price $30 The new customer wants the pillows stuffed with imported Dutch goose feathers rather than the standard Australian duck feathers, so direct material costs will increase to $18 per unit. The average marketing cost of Cushions Pty Ltd. is $7 per unit.
Cushions Pty Ltd. is a well-established manufacturer of high-quality pillows, proudly branding their products as made in Australia. Their manufacturing process, from sourcing materials to production, is entirely based in Australia. However, the company now faces a unique opportunity – a one-time-only special order for a large batch of pillows that deviates from their standard production in terms of materials used. In this essay, we will explore whether Cushions Pty Ltd. should accept this special order, considering the changes in cost and potential benefits.
To make an informed decision, it is essential to analyze the current cost structure of the pillows produced for regular customers. For each pillow, the following costs apply:
Direct Material Cost: $10
Direct Labour Cost: $3
Variable Manufacturing Overhead Cost: $2
Fixed Manufacturing Overhead Cost: $5
Summing up these costs, the total product cost for a standard pillow is $20. To ensure profitability and cover other operational expenses, Cushions Pty Ltd. marks up the product by $10, setting the targeted selling price at $30.
The special order in question necessitates a change in the standard materials used. Instead of the usual Australian duck feathers, the new customer requests Dutch goose feathers. As a result, the direct material cost per unit increases from $10 to $18. This change significantly impacts the cost structure, making the special order less profitable under the standard pricing model.
To decide whether to accept this special order, we must consider the cost and revenue implications. The average marketing cost for Cushions Pty Ltd. is $7 per unit, which remains constant whether the order is for regular pillows or the special batch.
Given that the direct material cost for the special order is $18, the updated cost structure for a special order pillow is as follows:
Direct Material Cost: $18
Direct Labour Cost: $3
Variable Manufacturing Overhead Cost: $2
Fixed Manufacturing Overhead Cost: $5
Marketing Cost: $7
The total cost for a special order pillow is $35. To maintain profitability, Cushions Pty Ltd. would typically mark up this cost by $10, resulting in a selling price of $45.
The decision to accept or reject the special order hinges on various factors. The primary consideration is the willingness of the new customer to pay the higher selling price of $45 per pillow. This will cover the increased cost of direct materials and still leave room for a $10 markup, in line with the standard pricing strategy.
It is crucial for Cushions Pty Ltd. to evaluate whether the new customer values the “Made in Australia” brand and is willing to pay a premium for it. If the customer is price-sensitive and unwilling to accept the higher selling price, the special order may not be economically viable, as it would not generate a reasonable profit margin.
The decision to accept a one-time-only special order for a large batch of pillows necessitates a comprehensive analysis of the cost and revenue implications. While the change in direct materials can increase the cost per unit, a higher selling price could still make the special order profitable. However, the willingness of the customer to accept the price change and value the Australian brand is a critical factor in making this decision.
Cushions Pty Ltd. should carefully weigh these factors and consider their long-term brand reputation before proceeding with the special order, ensuring that it aligns with their strategic goals and financial interests
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