Northline Plastics: Idle Capacity and a Discounted Order
Northline Plastics runs one injection-molding line with 40,000 machine hours of practical capacity per year; current demand for its standard product, Part A, uses 28,000 hours. Part A sells for $30, has variable cost of $16 (including the 5% sales commission), and requires 1.5 machine hours. Demand for Part A is firm and cannot be expanded. A customer offers a one-time order for 15,000 units of a modified part at $22 per unit. Each modified unit requires 2.0 machine hours, and the order would require $40,000 of one-time tooling with no alternative use. Sales of Part A would continue at current levels under any scenario. The plant manager wants to accept because "we have idle capacity and $22 beats our $16 variable cost."
1. Perform the relevant-cost analysis. Should Northline accept the order?
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Step 1 - Capacity test. Idle hours = 40,000 − 28,000 = 12,000. Hours required = 15,000 × 2.0 = 30,000. Shortfall = 18,000 hours, so the order is not fully covered by idle capacity.
Step 2 - Opportunity cost. 18,000 hours must come out of Part A production: 18,000 / 1.5 = 12,000 units of Part A displaced. Lost contribution = 12,000 × ($30 − $16) = $168,000.
Step 3 - Incremental analysis
| Item | Amount |
|---|---|
| Incremental revenue (15,000 × $22) | +$330,000 |
| Incremental variable cost (15,000 × $16) | −$240,000 |
| One-time tooling (avoidable, incremental) | −$40,000 |
| Lost contribution margin on Part A | −$168,000 |
| Net effect on operating income | −$118,000 |
Reject the order. The plant manager's error is treating the hourly cost of the order as if capacity were free. Once the constraint binds, the relevant cost per unit is variable cost plus the contribution forgone - the order's CM of $6 per unit on 2.0 hours ($3.00 per machine hour) is far below Part A's $14 on 1.5 hours ($9.33 per machine hour).
2. At what unit price would the order become economically acceptable? What if the order were resized to fit the idle hours exactly?
Read the worked answer
Break-even price for 15,000 units: Set 15,000 × (P − 16) − 40,000 = 168,000 → 15,000(P − 16) = 208,000 → P − 16 = $13.87 → P ≈ $29.87
At $29.87 the customer is paying essentially the full Part A price for a part that consumes 33% more machine time - which destroys the commercial rationale for the order. There is no viable discount here.
Resized order: 12,000 idle hours ÷ 2.0 = 6,000 units. Break-even: 6,000 × (P − 16) = 40,000 → P − 16 = $6.67 → P ≈ $22.67
At the offered $22, the 6,000-unit version still loses money: 6,000 × $6 = $36,000 CM against $40,000 of tooling = −$4,000.
Interpretation: the tooling charge is what kills the small version, and the displaced Part A margin is what kills the large version. The order only works if the tooling can be amortized over a much longer production run at close to full price, or if the tooling cost can be recovered from the customer.
3. Beyond the arithmetic, what qualitative and strategic factors should management weigh, and what counter-offer would you authorize the sales team to make?
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Qualitative factors
- Precedent and price discipline. A $22 price, once known in the market, anchors future negotiations with existing customers who pay $30. This is often worth more than the order's margin.
- Customer relationship value. Is this a strategic account with follow-on volume at normal prices? If the one-time order leads to a recurring program, the lifetime value - not this order - is the relevant test, and it should be contracted, not assumed.
- Learning and capability. Is the modified part a route into a new segment? If yes, value it explicitly rather than smuggling it into the bid.
- Execution risk. Tooling overruns, scrap and rework on a new part, overtime, and quality-validation time all raise the effective variable cost; a $6 margin per unit can vanish with 4% scrap.
- Alternative uses of the 12,000 idle hours. Is there any lower-value product, maintenance work, or employee training that beats zero? Those hours are not free even when unused.
Counter-offer to authorize
- Price the order at no less than $29.87, or
- Reduce scope to 6,000 units at ≥ $22.67 with the $40,000 tooling billed separately as a customer-owned asset, and
- Require a signed commitment on follow-on volume at ≥ $29 before investing in the tooling.
If the customer will not move, decline. Doing nothing earns $0; this order destroys $118,000 of value.