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ACCT 551 case study slay steel

Slay Steel is a 75 year old, family business. It is a job shop specializing in steel castings, which is an industry in decline at the present time. The Raw Castings Department has been one of the most affected by the decline. Jobs in the industry are physically demanding, and terrible working conditions, including intense heat, make the jobs undesirable. Despite the working conditions, worker compensation is relatively low because no special skills are required to do the work. These conditions result in an employee turnover rate that averages 50% in the industry.

  • The average hourly wage rate in the department is approximately $7.70, and
  • the fringe-benefit package is 20% of paid wages.
  • The base wage rate for entry-level employees is $7.50/ hour, and
  • there is a $1.00 per hour raise after four months (bringing pay for more experienced workers to $8.50).
  • The normal production crew (full capacity) is 125 men on each of 2 shifts, (250 men in total).
    • However, on average, 3 of the 125 scheduled workers fail to come to work during any given shift.
    • Each worker that shows up still works only 40 hours (state law limits workers in this industry to 40 hrs/week).

Profit margins at Slay have been steadily declining in recent years and are now at a dangerously low point. Steel foundries are closing at an alarming rate due to lost market share, the move to lighter materials, and the move to new manufacturing technologies in the U.S. auto industry. Those foundries that remain open have significant backlogs of work due to increases in volume driven by the the closing of other foundries. However, attempts to raise prices have only increased the rate at which customers defect from the industry...reducing market size and exacerbating the problem. For firms that want to stay in business, the trick is to accept steel prices as they are (or maybe even cut them) and learn how to make a profit in spite of price, by reducing costs.

Gregg Slay, the son of the founder, has just returned home from business school and is convinced that new management ideas can turn the company around. Gregg would like the company to switch from an hourly pay system to a performance-based pay system for the foundry’s workers. Gregg tries to convince his father that this change in the firm’s compensation scheme would not cost the company a penny. He argues the following:

  1. Workers do not currently have a financial incentive to increase efficiency. Being paid for each good unit produced, rather than by the hour, will improve efficiency and production.
  2. A rate of $20.00 for every unit that passes inspection should replace the current system as it would increase profitability without having to raise selling prices, and the increase in productivity would more than offset any increase in labor cost.
  3. The present pay rate of is much too low given the terrible working conditions. Many employees dont even last 3 weeks.
    1. Consequently, the payroll department shows that 1,250 different production employees were paid during the most recent yea The firm operates 52 weeks per year.
    2. Gregg believes this 400% annual labor turnover rate is a major problem, which must be corrected. State unemployment offices send a steady stream of new applicants every week. However, these applicants are typically the least employable among the unemployed.
  4. Gregg claims that the proposed incentive pay of $20.00 per unit represents only a 13% increase over the current cost per hour, which he calculates as follows:

Most Recent Year

Total Labor Hours (from information system) 507,520

Good Units Produced & Sold (from information system) ÷220,660

2.30 hours/unit

Suggested Pay per Unit $20.00

Labor Hours Per Unit ÷ 2.30

Per hour equivalent of piece-rate system (rounded) $ 8.70

Pay Increase (rounded) 13%

  1. Gregg expects the increase in pay attributable to the incentive system to reduce the turnover problem to 20% of current levels and thus save the company money by
    1. Savings in training costs will offset the wages per unit increase shown above. Reducing the wasted time from training new workers will save the company in labor productivity.
      1. Gregg claims the incentive system combined with the reduction in turnover will reduce the current 2.3 labor hours required to produce one good unit to 2 hours on average, which is a 13% reduction in labor cost per unit.
    2. In addition, Gregg claims that the reduction in turnover will save the cost of equipping so many new workers with safety gear. The reduction in equipment costs would save an additional 6% of the amount currently being spent on direct labor Gregg provides the following supporting calculations.

Protective equipment for new employees $ 300 per worker

New employees annually x 1,000 new workers/yr

Current annual equipment cost for new employees $ 300,000

Savings on equipment as a percent of current wage cost 6% (rounded)

Gregg’s father, Curtis Slay, sees the piece-rate idea from an entirely different perspective. Based on data from their standard costing system, he thinks the proposal is a bad idea. He rebuts Gregg’s argument as follows:

  1. The proposal represents a huge increase in labor cost, as follows:

Current Standard Cost (Standard hrs per unit 2.1 x Standard Rate $7.70) $16.17 per unit

Proposed piece rate $20.00

Increase in per unit labor cost 24%

  1. The increased productivity and decreased turnover are pure speculation without evidence. There is no evidence that suggest increasing pay would significantly decrease turnover. It’s still miserable work, and that’s what drives the turnover. Slay tells Gregg that he tried a profit sharing plan for workers in the past and it did not work.
  1. Admittedly, this company has a high labor turnover rate. Foundry jobs are not attractive and higher pay isn’t going to change that. The reality is that the jobs are low pay for low value-added work. It is not a “” People will still come and go every day. The savings due to equipping and training fewer new employees are wishful thinking.
  1. The company is already experiencing declining profits. Any increases could well put the company, as well as the employees, out of business. If anything, a pay cut is more in order!
  2. Slay also feels that the company cannot afford the pay increase from a balance sheet perspective. Higher wages would mean reduced cash flow and thus more pressure on working capital. Therefore, he does not want to expand capacity despite there being excess demand at the moment.

Gregg and Curtis do agree on some things:

  • Annual demand is currently running about 250,000 to 300,000 units, spread fairly evenly over the year.
  • Castings can be stocked (stored) if necessary.
  • Production has varied between 215,000 and 250,000 good units in the past three years.
  • The present backlog of orders is 150,000 units.
    • Deliveries are running behind schedule by several weeks, but that is a normal occurrence.
  • There are enough workstations in the Castings Department for a maximum of 125 people per shift.
    • On average about 3 men fail to show up for a scheduled shift, so 122 are working.
  • A third shift is not possible because the furnaces need substantial daily cleanup and maintenance.
  • The production process is subject to an approximate 77% learning curve following the “incremental unit time learning model”.
    • A new worker spends the entire first day (8 hours) producing one good unit.
    • Maximum efficiency of approximately 1.67 hrs. per unit is achievable after roughly 64 units have been produced in total. This “learning curve” can be summarized as follows:
      • Some hard-working, experienced workers can sometimes do even better than 1.67 hrs/unit, but this isn’t normal. On a typical shift, 10 workers of the 122 might average 26 or 27 good castings per week, but many others would average fewer than 20.
    • Using the “standard” productivity measure of 2.1 labor hours per unit, approximately 241,676 units should be produced each year (assuming 122 workers per shift).
      • Management uses 2.1 hrs/unit as the norm for production scheduling and product costing purposes, but this was not presented to the workers as an acceptable level of productivity. Yet, many of the workers seem to have figured out that as long as they average close to 19 good units per week, they are not challenged by the foremen for poor performance.
    • Of the 122 people working on the shop floor during an average shift, about 40 are still in the five week learning curve
    • Of the 82 workers who on a shift who have lasted beyond week five,
      • 72 level off at about 17 to 20 units per week versus the “standard” of 19 [40 hours ÷ 1 hours/unit], and they leave between six weeks and six months.
      • The other ten are “high output/low pay” anomalies that stay long-term for unknown reasons.
    • All units are inspected before leaving the department and many are rejected as inadequate and melted down for scap.
    • Direct material, direct labor, and fringe benefits are considered the only variable cost of operations.
      • Direct labor cost (excluding fringe benefits) is 23% of sales.
      • Direct material is 25% of sales.

Questions:

Gregg and his father are genuinely perplexed about this labor productivity problem. Can the company expect a better result if it manages compensation better? Or, is low productivity a fact of life for which low pay is the consequence of being in a business where “committed and motivated” workers are just not necessary?

Your assignment is to evaluate the various claims and counterclaims and to recommend a course of action. Do not blindly trust the calculations in the case; evaluate the legitimacy of the calculations for yourself. You must evaluate all claims for yourself. Be sure your analysis includes, but is not limited to, the following:

  1. Comment on all the arguments presented by Gregg Slay in support of a $20 piece rate.
  2. Comment on all the counter-arguments by Gregg’s father, Curtis, in support of the current pay system or against Gregg’s proposal.
  3. What are your recommendations and why do you make them?
    1. Do you think Slay Steel can afford a wage increase if productivity increased to match Gregg’s projections?
    2. Do you think Slay Steel can afford a wage increase if productivity increased to meet the standard labor hours found in the standard cost system?

Support your evaluations quantitatively to the extent possible.

Explain all the calculations useful in supporting your answers to all the questions above.

In other words, find as much information in the data as is useful for refuting some positions and supporting others.