Kanthal Case

Kanthal Case

Executive Summary

Over the years Kanthal has used its traditional accounting management system to cost its products. In 1985, when Carl-Erik Ridderstrale became president he developed the Kanthal 90 plan to increase overall profitability. He quickly recognized that in order to implement this plan a new account management system was needed to supplement the new strategy. In lieu of this need a new account management system was devised.

Under the new cost system, two broad sources of costs were identified: manufacturing and SM&A. All costs within these categories were reclassified as either volume driven or order driven. Hence, four cost pools were set up.

The implementation of the new system had some limitations and challenges:

- The validity of the costing under the new cost system

- The market dynamics and how they would impact implementation

- Danger of losing customers for stocked items

- The applicability of the new system across borders

Moreover, the new cost system revealed that two large volume customers that were unprofitable. These customers were analyzed and recommendation made on the course of action.

Introduction

Kanthal is the largest of the six divisions in the Kanthal-Hoganas group of Sweden specializing in the production and sales of electronic resistance heating. Headquartered in a town near Stockholm, Kanthal has a product range consisting of 15,000 items supplying to about 10,000 customers. During the period of 1985 to 1987 it had steady sale revenue of SEK (Swedish Kroner) 850 million each year. Export sales accounted for 95% of total sales. Kanthal consisted of three divisions:

- Kanthal Heating Technology division supplied products like heating wire and ribbon, foil elements, machinery and precision wire. Kanthal was a world leader in supplying heating alloys with a market share of 25%.

- Kanthal Furnace Products produced a variety of heating elements for electric industrial furnaces. Kanthal was a prominent player within this market with a total market share of 40%.

- Kanthal Bimetals was one of the few companies at that time that manufactured fully integrated thermo-bimetals for use in the manufacturing of temperature controlling devices such as thermostats, circuit breakers and household appliances.

Over the years Kanthal has used its traditional accounting management system to cost its products. In 1985, when Carl-Erik Ridderstrale became president he developed the Kanthal 90 plan to increase overall profitability. He quickly recognized that in order to implement this plan a new account management system was needed to supplement the new strategy. In lieu of this need a new account management system was devised.

This paper will aim to analyze the old account management system as well as the need for a new system for Kanthal 90. It will also provide some of the limitations of the new system and key implementation guidelines. Finally, the paper will address some of the consequences of implementation and responses to those issues.

Old Account Management System and its problems:

Under the old cost system, Kanthal used a simplistic approach to allocate overhead costs. The sales, marketing and administrative costs (SM&A) were applied to each product as a fixed 34% of sales revenue. This yielded a simple cost function:

Cost of Product = Standard full cost of manufacturing + 34% (Sales revenue)

In effect, all overhead expenses attributed to SM&A were pooled together and allocated based on a volume based driver, sales revenue. According to this system, if a customer's sales price exceeded the full manufacturing cost plus the allocation for SM&A then that customer appeared to be profitable. Conversely, if the Sales price was lower than the sum of manufacturing costs and the allocated SM&A then the customer appeared to be unprofitable. This approach assumed that a product with higher sales revenue put a greater demand on SM&A resources than one with lower sales revenue. No attempt was made to link the SM&A costs directly to each customer order and gauge its individual impact on profitability. Under this system salespersons were compensated mostly on gross sales. Hence, under these conditions the sales and marketing effort put a lot of emphasis on sales volume rather than profits.

Upon analysis, it came to the fore that the current system had some obvious drawbacks which motivated the need for a new system. Under the old system, it was assumed that all customer orders placed the same demand on the resources of Kanthal. This was not accurate as customers differed by: the level of technical and commercial service they required, whether they demanded standard or non-standard products and by their ability to forecast their demand. Because of these discrepancies, under the old cost system an order which placed fewer demands on Kanthal's resources would be overcosted and appear to be unprofitable or less profitable than it was. This order would represent a hidden profit. Whereas, an order which placed a disproportionately large burden on the company's resources would appear to be more profitable than it was. This was a hidden loss order. Due to these hidden loss situations, many of Kanthal's resources were employed towards unprofitable products and customers.

New Account Management System: Motivation

When Carl-Erik Ridderstrale took over as president at Kanthal, he put forward his vision for the company. He recognized that gone were the days when Kanthal would be satisfied with any business from big customers. Now, Kanthal had become established and in order to achieve higher growth and profitability it needed to refocus its attention. Therefore, Ridderstrale devised Kanthal 90 which specified overall profit objectives by division, product line and market.

Kanthal 90 would seek to increase profits while maintaining a return on employed capital in excess of 20%. Ridderstrale wanted to achieve this without adding sales and administrative resources. He wanted to redeploy resources to more profitable uses. To achieve this, Ridderstrale recognized that it was important to distinguish customers according to the burden they put on the company's resources. For this to take place, the old accounting system was inadequate (outlined above).