This case deals with cost analysis for assessing the economics of a product transition facing Reichard Maschinen, but it also involves the broader spectrum of business issues related to the transition. At one level, the economics of the situation need to be brought into focus; fixed costs, marginal costs, and sunk costs must be separated and evaluated for their "relevance" to the decision. At another level, when the marketing and manufacturing issues are considered, the complexity of the decision becomes apparent. Financial signals say that steel rings are more profitable; marketing signals say that the future belongs to plastic rings; manufacturing signals say we should perhaps "buy" rather than "make." The main dilemma of the case is "How long can the firm stay with the substantially more profitable, but technologically obsolete, steel rings while still holding to its strategy of being a top quality producer at a fair price?"
The case is a very good classroom vehicle for illustrating several different layers of sophistication in terms of relevant cost analysis.
The following issues and concepts are likely to arise during classroom discussion.
1. The concept of eliminating applied fixed overhead in a short run, relevant cost analysis.
2. The concept of sunk costs in a relevant cost analysis.
3. The concept of the "product substitution" aspects of contribution analysis.
4. The use of the above analysis as a numerical framework for a partial view of the pricing decision.
This case teaches very well early in the required managerial accounting course in the first year of the MBA program. This case can be comprehensively covered in one 90-minute class period.
This teaching commentary was prepared by Professor John K. Shank of the Amos Tuck School of Business. This teaching note includes ideas and insights from previous teaching notes...