Halden Fasteners: Contribution Variances and a Dysfunctional Purchasing KPI
Halden Fasteners distributes two lines. The annual budget assumes 120,000 units: 80,000 stainless at $12 with a standard contribution of $5.00, and 40,000 zinc at $7 with $2.00. Actual volume was 112,000 units: 70,000 stainless at $12.60 and 42,000 zinc at $6.50, with unit variable costs as standard. The CEO is puzzled: contribution came in $25,000 below budget even though the sales team 'beat' the zinc volume target. Purchasing is paid a bonus tied to purchase price variance; last year the manager bought fourteen months of zinc at a 9% discount, warehouse days of cover rose from 45 to 78, and $180,000 of zinc was written off as obsolete after a specification change. Sales managers may discount up to 8% without approval to hit volume targets, and the zinc discount was granted in the final week of the year.
1. Reconcile budgeted to actual contribution using sales volume, sales mix and selling price variances. Explain what each variance reveals.
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Static budget contribution: (80,000 × $5) + (40,000 × $2) = $400,000 + $80,000 = $480,000. Budgeted weighted average contribution = $480,000 ÷ 120,000 = $4.00.
Actual contribution: stainless 70,000 × ($5.00 + $0.60) = $392,000; zinc 42,000 × ($2.00 − $0.50) = $63,000; total $455,000.
Sales volume contribution variance (total units at budgeted mix): (112,000 − 120,000) × $4.00 = $32,000 adverse.
Sales mix variance (actual units at actual mix vs budget mix, valued at standard contribution): (70,000 × $5 + 42,000 × $2) − (112,000 × $4) = $434,000 − $448,000 = $14,000 adverse. Zinc, the low-margin line, grew while stainless fell; the zinc 'win' is precisely what hurts.
Selling price variance: stainless ($12.60 − $12.00) × 70,000 = $42,000 favourable; zinc ($6.50 − $7.00) × 42,000 = $21,000 adverse; net $21,000 favourable.
Check: 480,000 − 32,000 − 14,000 + 21,000 = $455,000.
The net $21,000 favourable price variance conceals an adverse $21,000 on zinc bought with a year-end discount, and the mix variance shows the growth came from the weaker line. Reporting only a total contribution number hides both effects from the CEO.
2. Evaluate the purchasing manager's behaviour. Quantify the trade-off between the discount earned and the costs incurred.
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The KPI rewards purchase price variance only, so the manager optimises price paid and externalises holding, obsolescence and quality risk to the rest of the business. He is behaving rationally within the measure; the measure is the fault.
Approximate the economics: a 9% discount on a standard zinc cost of $6.00 is $0.54 a unit; on roughly 46,000 units purchased (42,000 sold plus stock build) that is about $24,800 of favourable variance. Against it:
- Obsolescence write-off of $180,000 after the specification change - roughly seven times the saving.
- Extra inventory: days of cover rose from 45 to 78, i.e. 33 extra days. At zinc purchases of about $250,000 a year, that is roughly $22,600 of extra stock; at an 18% carrying cost, about $4,100 a year, plus storage and handling.
- Not quantified in the data but real: quality risk from a discounted batch, and the cash tied up.
So a 'good' purchasing performance destroyed value. The same logic explains the sales side: an 8% unapproved discount authority plus a volume target produced a $21,000 adverse zinc price variance to buy 2,000 units of the lowest-margin line - extra contribution of about $4,000 against $21,000 given away.
The examinable point is that local optimality and goal congruence diverge whenever a measure captures one element of a multi-dimensional decision. The response is not exhortation but redesign.
3. Recommend how Halden should change its budgeting and performance reporting to prevent a recurrence.
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Replace purchase price variance with total cost of ownership for the purchasing scorecard: price, inbound freight, duty, quality rejects, expediting and a charge for inventory held (for example, landed cost × the 18% carrying rate × days of cover). Bulk-buying then shows as a cost, not a gain.
Add balance-sheet and flow metrics alongside the P&L variance: inventory days, obsolete and slow-moving stock as a percentage of inventory, and GMROI by product line, so purchasing cannot improve margin by loading the warehouse.
Constrain discount authority. Cap sales discounts by product and require margin approval above, say, 3% for zinc, and review any discount granted in the last two weeks of a period - a classic red flag for period-end gaming.
Report mix explicitly. A monthly contribution bridge showing volume, mix and price separately, by line, so the CEO sees that growth in a 29% margin line funded by decline in a 42% margin line is not growth.
Move to a rolling forecast. A fixed annual budget with a single volume target invites year-end behaviour. A 12-month rolling forecast with driver-based volumes (customers × units × price) and a quarterly review removes the cliff edge and lets purchasing plan against expected demand.
Separate the purchasing bonus from the sales bonus and add a shared company-level profit element, so each function has a stake in the other's costs.