Variable Cost and Flexible Budget

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9-913-525
SEPTEMBER 28, 2012

WILLIAM BRUNS JULIE H. HERTENSTEIN KELVIN LIU

Danshui Plant No. 2
In August 2010, Wentao Chen, manager of Danshui Plant No. 2 in southern China, was anxious. The plant was in the third month of a 12-month contract to assemble the Apple iPhone 4. The contract called for Danshui to assemble 2.4 million iPhones in the period between June 1, 2010, and May 31, 2011, but now in the third month of the contract, production was only 180,000 units per month. Chen called Jianye Ma, the plant controller, to request a summary of monthly operations for August as soon after the end of the month as possible. Danshui was a contract manufacturer that assembled electronic products for companies wishing to save labor costs by locating in southern China where semiskilled labor was available for less than one dollar an hour. Manufacturers like Danshui assembled parts in large plants using assembly line techniques according to specifications of the international companies that contracted with them for assembly and final testing. The largest contract manufacturer in China was Foxconn, a division of the Hon Hai Group of Taiwan, with more than 800,000 workers in China alone and contracts to supply Apple, Dell, and Hewlett Packard among others. In expectation of high demand for the iPhone 4, Apple had contracted with Danshui to assemble iPhones in Plant No. 2, which had been assembling computer hard drives on a contract that was fulfilled at the end of May 2010. Although the assembly of hard drives was different than assembly of iPhones, Danshui was confident that its workers would adapt to the new assembly tasks and that it could hire and train the additional workers as needed. Chen’s job was to get Plant No. 2 up to speed to fulfill the Apple contract and earn a profit for Danshui’s parent company, located in Hong Kong, China. Danshui Plant No. 2 was a profit center that was credited for each iPhone produced and shipped, and charged for parts, labor, overhead, and shipping. Because the contract was for a year, an annual budget was established soon after the iPhone contract was signed. This budget was divided by 12 to establish equal monthly budgets to which actual revenues and expenses could be compared. All budgeting and monthly reporting was done in U.S. dollars.

________________________________________________________________________________________________________________ Professor Emeritus William J. Bruns of the Harvard Business School and Associate Professor Julie H. Hertenstein and Assistant Professor Kelvin Liu of Northeastern University prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. Despite occasional references to actual companies, this case is fictitious and any resemblance to actual persons or entities is coincidental. Copyright © 2012 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

913-525 | Danshui Plant No. 2

As the plant manager, Wentao Chen was responsible for control of all costs in his plant. Materials, labor, and overhead were his responsibility. This was done to provide incentive to control all costs whether caused by use waste, damage, theft, or inefficiencies.

The Apple iPhone 4
The iPhone 4 contained more than 100 components manufactured in plants located in Europe, Asia, and the United States. For examples, Samsung supplied flash memories and application processors, and Infineon (a German chip maker) supplied chips that send and receive phone calls and data. A gyroscope, new to the iPhone 4, came from STMicroelectronics, based in Geneva,...
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