Kestrel Composites: A Special Order in a Bottleneck
Kestrel Composites moulds carbon-fibre panels through a single autoclave with 120,000 machine hours a year; 108,000 hours are committed to two products. Panel X sells for $120, has variable cost of $66 and takes three autoclave hours. Panel Y sells for $80, has variable cost of $38 and takes two hours. Fixed costs are $2.4 million a year and the plant runs at practical capacity. An overseas distributor, with whom Kestrel has never traded, offers to buy 8,000 units of a simplified panel at $62 each. The order needs three autoclave hours per unit (24,000 hours), $24,000 of special tooling that has no other use, and $2 per unit of export packing and freight. Variable production cost for the simplified panel is $38. The sales director says the spare 12,000 hours make the order 'free capacity' and the contribution of $24 a unit is worth having; the operations manager says the plant is already too full to promise delivery dates.
1. Prepare a relevant cost analysis of the order and recommend accept or reject. Show the minimum acceptable price.
Read the worked answer
The decision is not 'price versus variable cost'. The order needs 24,000 autoclave hours and only 12,000 are idle, so 12,000 hours must be taken from existing production - a real opportunity cost.
Which product to displace: contribution per autoclave hour is X $54 ÷ 3 = $18.00 and Y $42 ÷ 2 = $21.00. Displacing X is the cheaper sacrifice.
Relevant cost of the order:
| Item | Calculation | $ |
|---|---|---|
| Variable production | 8,000 × $38 | 304,000 |
| Special tooling (no alternative use; incremental) | 24,000 | |
| Export packing and freight | 8,000 × $2 | 16,000 |
| Opportunity cost of displaced X | 12,000 hrs ÷ 3 = 4,000 units × $54 | 216,000 |
| Total relevant cost | 560,000 | |
| Revenue | 8,000 × $62 | 496,000 |
| Net effect | (64,000) |
Relevant cost per unit = $38 + $3 tooling + $2 freight + $27 opportunity cost = $70, against a price of $62, so the order reduces profit by $64,000. Reject.
The allocated fixed cost of $20 per autoclave hour ($2.4m ÷ 120,000) is irrelevant - it does not change - and the sales director's '$24 contribution' ignores the $27 of displaced contribution. The minimum acceptable price is $70; the distributor is $8 a unit short.
2. How would your answer change if Kestrel's forecast for Panel X showed a 5,000-unit decline next year? State the break-even condition.
Read the worked answer
A 5,000-unit decline in X releases 15,000 autoclave hours. Combined with the 12,000 idle hours, 27,000 hours are available against the order's 24,000, so no sale need be displaced and the opportunity cost falls to zero.
Relevant cost per unit becomes $38 + $3 tooling + $2 freight = $43, and at $62 the order contributes $19 a unit, or $152,000 over 8,000 units - accept.
Three qualifications before signing:
- Verify the decline. If the 5,000-unit forecast is a planning assumption rather than confirmed lost orders, the displaced-contribution analysis returns. Orders that 'might not arrive' are not spare capacity.
- Check alternative uses of the released hours. If a third product or a productivity project could earn more than $19 a unit of contribution per hour used, the order still fails the test.
- Consider timing. The autoclave may be seasonally underloaded; if the order can be scheduled into a trough where hours are genuinely idle, the opportunity cost is zero for that period without any forecast decline.
The general rule: the minimum price equals incremental cost plus the contribution forgone per unit of the constrained resource, and the forgone contribution is zero only when demand is genuinely below capacity.
3. Identify the qualitative and strategic factors the board should weigh, and the contractual protections you would seek if the order is accepted.
Read the worked answer
Price leakage and cannibalisation. $62 is roughly 48% below the $120 domestic price for a comparable panel. If the distributor resells into Kestrel's home market, domestic customers will demand the same basis; that risk is worth far more than the $152,000 gain. Require a territory restriction, a no-resale clause and product marking.
Customer risk. A first-time overseas buyer is an unknown credit and performance risk; use a letter of credit, a deposit, and milestone payments tied to tooling.
Capability and learning. The order may be a low-cost route into a new segment or a platform for a longer relationship; if so, the value of the option, not the $19 a unit, drives the decision. Conversely, if the simplified panel is a commodity that any competitor can make, accepting teaches Kestrel nothing and anchors a low reference price.
Operational credibility. The operations manager's concern about delivery dates is a real cost: squeezing an 8,000-unit order into a loaded plant raises overtime, scrap and late deliveries to existing customers. Price the disruption into the order or schedule it into a trough.
Capacity strategy. If export demand proves repeatable, the right answer is not a marginal order but a capacity decision - evaluate a second autoclave against the 12% capital charge, not against this one order.
Trade and compliance. Check rules of origin, export controls on carbon-fibre material, and any anti-dumping exposure in the destination market.
A defensible position: reject at $62 on the current load; authorise the sales team to negotiate at or above $70 with a territory restriction, or to accept at $62 only against a confirmed, documented fall in Panel X demand.