Thermo-Chem, Inc.*
*This case was written by Ramzi Haddad, Lehigh University.
Thermo-Chem, Inc. manufactures a specialized pressure vessel designed to keep chemicals heated to at least 190 degrees Fahrenheit while in transit to the point of use. The vessels are guaranteed to keep the chemicals at this temperature and in a liquid state for at least 21 days, thus allowing the chemicals to be transported over long distances. The high temperature is required for certain chemicals that must be transported in a liquid state or they will solidify in the container, forcing additional procedures and equipment for unloading the vessel.
As an example, the chemical toluene, which is used in making urethane foam and sheet plastics, is in a liquid state above 190 degrees Fahrenheit. Below this temperature, toluene solidifies and must be returned to the liquid state to be removed from its container. The traditional method of carrying this chemical to a customer’s site is to transport it in a Teflon-lined stainless steel container. The chemical turns quickly into its solid state once in the vessel and remains in that state until it is delivered to the customer’s site. Once there, steam is circulated through heating coils that are wrapped around the vessel. This procedure, called heat soaking, requires the steam to be applied for three days to re-liquefy the chemical. A steam source must be readily available at or near the user’s site, requiring additional investment in equipment. Once in a liquid state, the unloading process requires six hours.
In the early 1980s, Global Chemicals, Inc. developed a new method that improved costs and reduced cycle time related to delivering toluene to user sites. The new design uses a thin-walled stainless steel inner vessel that is wrapped in special composite insulating materials and encased inside a vacuum chamber. Both the insulation materials and the vacuum space provide insulating properties, which maintain the chemical in its liquid state during transport. In addition, internal steam heating coils are built into the vessel to allow for heat soaking should the vessel be in transit for longer than 21 days or should it fail. The advantages of the new design include saving 3 days in delivery time through the elimination of the heat soaking process, unloading the vessel in one hour instead of the traditional six hours, and eliminating the need to provide equipment for the steam heating step.
Thermo-Chem, Inc. was started in 1990 by the two chemists who had worked for Global Chemicals, Inc. and developed the new method. The chemists, Dr. James Andersen and his wife, Dr. Christine Andersen, saw an opportunity to extend this technology to other industries as well. The concept of keeping liquids within a certain temperature range had applications in transporting beer, wine, fruit juices, chocolates, and various food and pharmaceutical ingredients. After studying the market and determining that no one was even considering producing this kind of vessel, the Andersens decided to leave Global and go into production as a privately held company located in Chicago.
It was not long before customers from many industries were buying vessels from Thermo-Chem. The company has enjoyed steady growth over the past five years, despite stiff competition from Global in the chemicals market. Thermo-Chem’s vessels are priced at around $50,000. Trade terms currently being extended to customers are as follows: 20 percent of the order price is required at the signing of the contract, with the outstanding balance becoming due on a net 30 basis.
The company supplies its vessels to countries worldwide and prides itself on its ability to custom-design the vessels to meet customer needs. While the basic design and thermal technology applied is essentially the same, Thermo-Chem customizes the vessels for approximately 90 percent of all its customer orders. With competition only from Global in the chemicals market, the entire organization has not been pushed to keep up with current technology, to be cost-competitive, or to provide on-time deliveries. As a consequence, most of its customers in the foods and pharmaceuticals industries would readily go to another supplier if one were available.
The current business atmosphere has changed in recent months and competition is looming on the horizon. A small Canadian firm, adept in plastics technology, has developed a special polymer tank that touts the same functionality and guarantee for 21-day travel. The prime costs, direct labor and materials, are substantially lower than those required to build Thermo-Chem’s vessels. In addition, they are lighter and easier to transport, thus allowing the vessel sizes to be larger and increasing the quantity of liquid product that can be shipped at one time.
Thermo-Chem’s vessels are fabricated from stainless steel, requiring hours of welding and incurring long raw materials lead time. The cycle time from order placement to customer delivery is between 28 and 32 weeks. This includes 8 weeks for design, 12 weeks for materials lead time, and 8 weeks for manufacturing. The new Canadian tanks have a much shorter cycle time of 20 weeks. They achieve this through shorter materials lead times and the use of concurrent engineering, and by focusing on standard designs rather than on custom made-to-order vessels. Although focused on standard designs, the Canadian firm does also produce a small volume of custom made-to-order vessels.
Financial Data for Thermo-Chem (In thousands):
1995 1994 1993
Sales 24,950 23,150 21,850
Cost of Goods Sold 19,211 16,668 14,421
Gross Profit 5,739 6,482 7,429
General & Administrative Expenses 2,994 3,009 2,622
Selling Expenses 998 1,041 874
Earnings before Income Taxes 1,747 2,432 3,933
Provision for Income Taxes 681 948 1,533
Net Income 1,066 1,484 2400
Analysis of Manufacturing Costs (In thousands):
I.Direct Materials
Flexible Budget:
Actual Costs Flexible Budget: Flexible Budget: Standard Inputs
Incurred: Actual Inputs × Actual Inputs × Allowed for
Actual Inputs × Standard Rate Standard Rate Actual Outputs ×
Period Actual Price (Purchases) (Usage) Standard Rate
1st Q 1993 1,755 1,798 1,658 1,785
2nd Q 1993 2,358 2,359 2,109 2,214
3rd Q 1993 2,557 2,558 2,478 2,499
4th Q 1993 1,968 1,954 1,971 1,969
1st Q 1994 2,104 2,103 2,099 2,046
2nd Q 1994 2,548 2,450 2,458 2,346
3rd Q 1994 2,807 2,688 2,688 2,456
4th Q 1994 2,200 2,109 2,256 2,095
1st Q 1995 2,813 2,601 2,785 2,569
2nd Q 1995 2,922 2,788 2,666 2,459
3rd Q 1995 3,065 2,955 2,872 2,548
4th Q 1995 2,712 2,488 2,771 2,398
II.Direct Labor
Actual Costs Flexible Budget:
Incurred: Flexible Budget: Standard Inputs Allowed
Actual Inputs × Actual Inputs × for Actual Outputs ×
Period Actual Price Standard Rate Standard Rate
1st Q 1993 923 981 994
2nd Q 1993 992 1,006 1,020
3rd Q 1993 1,081 1,093 1,121
4th Q 1993 970 968 973
1st Q 1994 978 966 1,098
2nd Q 1994 1,178 1,091 1,088
3rd Q 1994 1,310 1,226 1,227
4th Q 1994 1,069 1,003 1,005
1st Q 1995 1,366 1,276 1,279
2nd Q 1995 1,412 1,305 1,325
3rd Q 1995 1,551 1,439 1,422
4th Q 1995 1,319 1,233 1,231
If Thermo-Chem expects to be competitive in the very near future, it needs to reevaluate all aspects of its business. Recently, Thermo-Chem has engaged the services of a business consulting firm to review its organizational structure, policies, and procedures. The following is the summary of the consulting firm’s findings.
Vendors
Over the past five years Thermo-Chem has depended upon a dozen suppliers for all of the materials needed in its manufacturing processes. However, lately the production manager has been exclusively dealing with two companies on the West Coast, despite the fact that there are many cost-competitive companies within a 90-mile radius of the plant. All suppliers have a net 30 agreement with Thermo-Chem.
The Current Information System
Thermo-Chem’s current information system is primarily manual with the exception of the accounting department, which utilizes a personal computer for record keeping tasks. The accounting department owns a 386 SX PC, which is used to perform general ledger, accounts receivable, accounts payable and payroll functions for record keeping tasks. Access to the PCs is restricted by a password code to ensure that unauthorized users will not access the company’s records. Only the accounting department’s employees have the password to access the PCs. Once a month, the hard drives of the PCs are backed up to magnetic tape to reduce the risk of data loss.
The Organization’s Management
The Andersens own the business; however, health problems in recent years have forced them to spend less time with the business. They appointed a general manager in 1992 to manage the operation. The general manager, Steve Crawford, has been basically left on his own to run the business. He and the product design manager, John Preston, control all operations and consult with each other when making most decisions. Whenever in doubt, Crawford always defers to Preston because of his technical expertise. Crawford feels that Preston will always make decisions that will protect the company’s proprietary information, thus ensuring that Thermo-Chem will maintain market exclusivity. Unfortunately, Preston has concentrated solely on metals and has not expanded his knowledge into alternative materials such as plastics. In addition, Preston “sets his own agenda,” follows his own timetables, and only pursues internal projects of personal interest to him. This has caused much conflict with the other groups in the organization, especially in the manufacturing area.
The following functions report directly to the general manager:
n Product design manager—John Preston (4 engineers and 6 draftsmen)
n Sales manager—Scott Hayes (1 salesman)
n Controller—Larry Feldman (2 accountants, accounts payable clerk, accounts receivable clerk, billing clerk, mail room clerk, payroll clerk, shipping clerk, receiving clerk)
n Production manager—Ed Franklin (4 supervisors, 55 hourly workers, 1 stockroom clerk)
n Manager of support services—Patrick Delany (1 safety, 1 MIS)
The total number of employees is 95 and production is a two-shift operation.
Sales Department
The sales department is in a unique position: customers seek out Thermo-Chem because it has cornered the market with virtually no competition except in the chemicals market. Therefore, only limited sales effort is expended to promote its products. The sales department employs one sales representative, who is compensated on a commission basis. When a customer wishes to place an order, the sales representative arranges for a meeting to discuss the customer’s needs and requirements. After determining the customer’s needs, the sales representative meets with the product design engineering staff to brief them on the customer’s specific design requirements. Product design then proceeds to create a bill of materials and a cost estimate for the entire project. Two copies of the bill of materials are created: the first is filed in the product design department and the other is sent with the cost estimate to the sales representative. The sales representative then applies a profit mark-up to the cost estimate as he sees fit, and then provides a written quote to the client. When the client accepts the quote, a signed copy of the quote is remitted back to the sales representative, who uses it to approve the customer’s credit and to create a multicopy sales order. The sales order is distributed as follows:
Sales Order Copies:
1. File copy filed in sales office in open sales order file
2. Customer sent to customer
3. Invoice sent to billing department
4. Shipping notice sent to shipping department
5. Packing slip sent to production with bill of materials
6. Ledger copy sent to billing department
Production
In order to facilitate efficient materials management and purchasing, the raw materials records are placed under the direct control of the production manager. In addition, the production manager is also responsible for the storeroom function.
The production manager relies on the bill of materials to check for the availability of raw materials. If the needed items are on hand, the production manager completes a work order form, signs it, and gives it to the storeroom clerk. The work order is the document that authorizes the storeroom clerk to release the required raw materials to the production employees. The production manager then posts the transaction to the raw materials records. In the case where excess materials are required for the same batch under production, no other formal documents are needed. If materials are not available, the production manager selects a supplier, completes a purchase order (four copies), signs it, and distributes it as follows:
1. First copy is sent to the supplier
2. Second copy is sent to accounts payable
3. Third copy is filed in the production department
4. Fourth copy is sent to the receiving department
A production clerk is responsible for keeping track of direct labor, raw materials, and overhead costs for each batch of vessels produced. When the product is completed, the cost data is sent to the accounting department, where it is posted to the general ledger accounts by an accounting clerk.
Once the project is completed, the employees who worked on the job inspect their work, test and approve it, and enclose the packing slip with the finished product. The finished vessel is then transferred to the shipping department.