Lehigh Steel Harvard Case Solution & Analysis

COMPANY BACKGROUND

Lehigh Steel is the manufacturer of premium quality high strength specialty steels in a wide variety of grades, shapes and finishes. Firm incurred record losses in 1991 after making record profits only three years earlier. Lehigh needed to return to profitability soon. To do so management turned their focus on costs to identify true profitability of each product and decide on appropriate product mix going forward. A review was initiated to calculate and analyses product profitability and determine right product mix for the future.

PROBLEMS AND ISSUES

Recession and Business Climate

In 1991 U.S. was hit with a recession resulting in industry-wide decline in business. To combat this downturn, specialty steel companies increasingly turned to niche products to fill the demand gap. Result was limited margins with small orders of increased complexity products while costs continued to rise squeezing profitability even further. Only 18 customers spent in excess of $1 million with majority spending less than a thousand dollars.

Costs and Revenues of Specialty Steel Industry

Steel industry was characterized by cyclic demand and significant capital investment costs. Customers were more knowledgeable and sophisticated about value of products and more price conscious while technical services were becoming increasingly important as a differentiator. A big portion of overall costs was fixed in nature while demand was highly elastic where even small increases in price had the potential to reduce customer orders. Long and continuous production runs were preferable for low unit costs as small orders prevented elimination of resource-consuming setup and changeover steps and resulted in low efficiency. Order size and lead time were the biggest two issues facing Lehigh resulting in high inventories buildup and increase in costs.

Constraints Faced By Lehigh

Rolling of steel into rods, flats, coils and bar was a very time consuming process as each shape changeover took significant amount of time consuming valuable resources. Only one Continuous Rolling Mill (CRM) was available due to a high capital investment of $50 million so adding another CRM to reduce impact of shape changeover time was not possible resulting in a major bottleneck in the manufacturing process. CRM constraint could not be removed in less than five years due to high capital costs.

Inadequate Costing System

Standard costing system employed at Lehigh ignored different complexity levels of each product and assumed that overheads incurred were same per weight for each product. Extra machine hours and related indirect expenses were averaged for all products resulting in a product cost that was inadequate for decision-making.

ANALYSIS

Lehigh’s Response to the Recession In 1991

Profits were dependent on prices, costs and order volume. During recession all three variables saw adverse changes with prices and premier orders declining; resulting in heavier reliance on small orders of niche products while costs continued to climb. This necessitated effective strategies to combat the losses. Much of marketing effort was directed towards sale of alloys as there was a small price premium on this product. Management initiated review of its existing systems and processes to adopt appropriate costing system that was better suited to firm’s needs. Lehigh’s managers were keen to adopt systems that would reduce inventories by adopting synchronous flow manufacturing.

Importance of product mix decision

Product mix decision was important for Lehigh as it had limited number of machine hours available for CRM and needed to know how best to utilize this limited resource and maximize profitability. Setup and changeover costs and time used was significant that necessitated products with large orders that would help reduce setup and changeover costs. By selecting appropriate mix of products, firm..................

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Lehigh Steel is a manufacturer of special steels, which have fallen from record profits in record losses in less than three years, because of the inability to distinguish between profitable and unprofitable business. The size and growth of service activities and overhead costs in an increasingly customized product line suggests that the activity-based costing (ABC) can unlock the secrets of profitability. However, the high fixed-cost structure suggests that the Theory of Constraints (TOC) may also be relevant. Lehigh must determine how to measure the return on the rationalization of production. "Hide  on VG Narayanan, Laura E. Donohue Source: Harvard Business School 15 pages. Publication Date: March 26, 1998. Prod. #: 198085-PDF-ENG

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