Anagene Case Solution

Anagene – case report

Anagene, Inc. is a genomics instruments company, which had a major scientific achievement of completion of the sequencing of the human genome in 2000. Scientists continued with the research and discovering new technologies, resulting in a large market for DNA microarrays. The DNA microarray market was growing and because of the enormous potential payoff, many companies had entered the market. Despite the fierce competition, Anagene’s product was strong enough to beat its competitors. Their cartridges produced very accurate results and the company expected the demand for its product to increase rapidly.

In the fall of 2000, Anagene’s board approved the company’s 2001 budget, which forecast 50,000 cartridges to be sold in the next year. However, the genome field was relatively still new with many technical uncertainties, which could significantly influence the results. Following the sales, that were slower than expected, the board had to adjust the cartridge volume of 26,000 units as a revised estimate for 2001. The main problem Anagene had to deal with were sudden increases in costs and the fluctuation of monthly gross margins. Standard costs of the catridges increased by 40%  and gross margins dropped from 65% to 45%. In addition, the lower cartridge production had caused the overhead cost per cartridge to increase from $26 to $50. The issues faced by Anagene made it difficult for board members and analysts to understand profitability. Finally, Anagene began to investigate and search for the solution.

The initial problem is with the Ananege’s standard cost system, which estimates variable costs per unit – materials, direct labor, outside processing, scrap – once a year. Overhead costs per unit are calculated by dividing the allocated overhead costs by budgeted production volumes. There are some alternative ways to solve this problem. Firstly, in short run, it should be recognized that some costs are going to be fixed and will not change as production volumes change. It is recommended to assign fixed overhead costs, because they influence the company’s profitability and by leaving out these fixed costs, the company would affect its pricing strategy. Secondly, overhead costs are currently updated once a year. Since Anagene is dealing with a developing market, where it is expected that forecasting sales is a difficult thing to do, it should create a cost system based on actual activity for a specific period. Thirdly, if management uses forecasted figures to calculate cost driver rates, it can lead to a death spiral. It means that if activity levels decline, for example due to a loss of a major customer, then the activity cost driver rate will increase. In other words, expenses, the numerator of the calculation, remain the same, while the cost driver quantity, the denominator, declines. As these costs are crucial for decisions making, higher cost driver rate could lead to setting higher prices which in turn would result in demand decrease. Finally, management should consider using the practical capacity of resources instead of budgeted manufacturing volumes when calculating standard costs. This could be done by better recognizing the capacity of the resources that are being supplied. The numerator in an activity cost driver rate calculation should represent costs of supplying resource capacity to do work and the denominator should represent the quantity of work the resources can perform. Using pracital capacity as the cost driver will allow Anagene to lower its allocated overhead costs, increase gross margins and maximize its profits, without the current prices being affected.