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SmartAuto Manufacturing is engaged in the production ofreplacement parts for automobiles. One plant specializes in theproduction of two parts: Part #127 and Part #234. Part #127produced the highest volume of activity, and for many years it wasthe only part produced by the plant. Five years ago, Part #234 wasadded. Part #234 was more difficult to manufacture and requiredspecial tooling and setups. Profits increased for the first threeyears after the addition of the new product. In the last two years,however, the plant faced intense competition, and its sales of Part#127 dropped. In fact, the plant showed a small loss in the mostrecent reporting period.

Much of the competition was from foreign sources, and the plantmanager was convinced that the foreign producers were guilty ofselling the part below the cost of producing it. The followingconversation between Patricia Wang, plant manager, and James Tin,divisional marketing manager, reflects the concerns of the divisionabout the future of the plant and its products.

JAMES:          You know, Patricia, the divisional manager is real concerned aboutthe plant's trend. He indicated that in this budgetary environment,we can't afford to carry plants that don't show a profit. We shutone down just last month because it couldn't handle thecompetition.

PATRICIA:     James, you and I both know that Part #127has a reputation for quality and value. It has been amainstay for years. I don't understand what's happening.

JAMES:          I justreceived a call from one of our major customers concerning Part#127. He said that a sales representative from another firm offeredthe part at $20 per unit – $11 less than what we charge. It's hardto compete with a price like that. Perhaps the plant is simplyobsolete.

PATRICIA:     No. I don't buy that. From my sources, I know we have goodtechnology. We are efficient.

And it's costing a little more than$21 to produce that part. I don't see how these companies canafford to sell it so cheaply. I'm not convinced that we should meetthe price. Perhaps a better strategy is to emphasize producing andselling more of Part #234. Our margin is high on this product, andwe have virtually no competition for it.

JAMES:          You may be right. I think we can increase the price significantlyand not lose business. I called a few customers to see how theywould react to a 25 percent increase in price, and they all saidthat they would still purchase the same quantity asbefore.

PATRICIA:     It sounds promising. However, before wemake a major commitment to Part #234, I think we had better exploreother possible explanations. I want to know how our productioncosts compare to those of our competitors. Perhaps we could be moreefficient and find a way to earn our normal return on Part #127.The market is so much bigger for this part. I'm not sure we cansurvive with only Part #234. Besides, my production people hatethat part. It's very difficult to produce.

After her meeting with James, Patricia requested aninvestigation of the production costs and comparative efficiency.She received approval to hire a consulting group to make anindependent investigation. After a three-month assessment, theconsulting group provided the following information on the plant'sproduction activities and costs associated with the twoproducts:

	Part #127	Part #234
Production	500,000	100,000
Selling price	$31.86	$24.00
Overhead per unit*	$12.83	$5.77
Prime cost per unit	$8.53	$6.26
Number of production runs	100	200
Receiving orders	400	1,000
Machine hours	125,000	60,000
Direct labor hours	250,000	22,500
Engineering hours	5,000	5,000
Material moves	500	400

* Calculated using a plantwide rate based on direct labor hours.This is the current way of assigning the plant's overhead to itsproducts.

The consulting group recommended switching the overheadassignment to an activity-based approach. It maintained thatactivity-based cost assignment is more accurate and will providebetter information for decision making. To facilitate thisrecommendation, it grouped the plant's activities into homogeneoussets with the following costs:

Overhead:
	Setup costs	$   240,000
	Machine costs	1,750,000
	Receiving costs	2,100,000
	Engineering costs	2,000,000
	Materials-handling costs	900,000
Total		$ 6,990,000

Required:

Should the company switch its emphasis from the high-volumeproduct to the low-volume product? Comment on the validity of theplant manager's concern that competitors are selling below the costof making Part #127.