ISSN 1940-204X
Kates Cycle Components
Thomas Albright Bryan Hudgens
Naval Postgraduate School Naval Postgraduate School
INTRODUCTION: COMPANY, PRODUCT, AND
SUPPLY CHAIN
Kates Cycle Components (KCC) is a high-end specialty
fabricator that manufactures one product with many variants.
The basic product is known as a rolling chassis, a key
component used in manufacturing motorcycles. While there
are variations across the industry, a rolling chassis typically
consists of a motorcycle frame, front forks, wheels and tires,
and handlebars.1
KCC is a first-tier supplier to an original equipment
manufacturer (OEM) that produces motorcycles in three
versions: Sport, Cruising, and Retro. The OEM purchases KCC
product and attaches its well-known proprietary engine and
gearbox, wiring and gauges, seat, fenders, various components,
and gas tank with iconic emblem. The OEM is KCCs sole
customer as it essentially requires KCCs full capacity.
KCC manufactures each frame from steel tubing but
purchases a variety of parts from suppliers. Workers at
KCC attach these parts to the frame to complete the rolling
chassis. Figure 1 illustrates the supply chain. The suppliers
of wheels, front forks, and handlebars are second-tier
suppliers. These vendors provide parts that are ready to be
attached to the frame. The tire vendor is considered a third-
tier supplier. The company that builds the wheels acquires
tires (that meet contract specifications directly negotiated by
the OEM) and provides a complete wheel assembly ready to
be attached to the front fork and rear frame.
IM A ED U C ATIO NA L C A S E JOURNAL
Paul Juras Bill Petty
Babson College The University of Alabama
KCC has had numerous problems with delivery
and quality over the past several years. Because the
problems have been so acute, the company has employed
four different plant managers in the last five years.
Management acknowledges the supply chain has difficulties;
unfortunately, there is virtually no room for error in meeting
delivery schedules and product quality targets. Further, KCC
has been under increased scrutiny from its stockholders
because earnings have deteriorated over the past three years.
See Tables 1-4 for KCCs financial information (income
statement, balance sheet, statement of cash flows, and unit
cost information).
The economic recession that ended around the summer
of 2009 has enabled the OEM to expand production and
sales. The companys sales have increased by 1,000 units
per year since 2010. By 2015, KCC was delivering 30,000
units to the OEM; management believes this level of output
represents capacity. Thus, production above 30,000 units
is not possible without staff overtime or an investment
in additional plant resources that will increase hourly
throughput. Management at KCC has received notice that
the OEM plans to increase production by 3,750 units next
year (12.5%) and to demand price concessions of $200 per
unit as specified in the contract.
1 VOL. 9, N O. 2, ART. 3, JUNE 2016 2 0 1 6 I MA
THE PRODUCT MIX AND OUTSOURCED PARTS Recently, the OEM has complained to KCC about chassis
that vibrate and exhibit poor handling qualities when the
The OEM produces motorcycles for three different market completed motorcycle is test driven. Engineers at KCC have
niches; therefore, KCC produces three distinctly different traced the source of the problem to the tire manufacturer. A
frame geometries as follows: wheel/tire combination that is not balanced properly causes
vibration and is a control and safety issue. The solution
Sport bikes emphasize speed and agility. Customers

requires placing the wheel/tire set on a machine to determine
expect rapid acceleration and responsive handling.
the location of the imperfection causing the imbalance.
Cruising bikes emphasize power and comfort. They allow

A small weight is attached to the wheel to offset the tire
riders to enjoy long-distance touring.
imperfection and to remove the vibration. Because of pressure
Retro bikes appeal to customers who appreciate classic

from the OEM to deliver a quality chassis, KCC purchased a
designs. They are typically smaller than cruising bikes
wheel balancing machine and tested each set before installing
and more stable than sport bikes.
it on their chassis. The quality delivered to the OEM has
For each frame geometry, the OEM offers three possible improved, but management at KCC is unhappy because the
handlebar types. Because riders are various sizes, handlebars OEM refuses to increase the contract price to help offset
can be configured in a variety of heights, widths, and lengths KCCs additional cost of equipment and labor.
(straight bars or bars pulled back toward the rider). The supply chain has additional complications. One
The OEM offers three different wheel set possibilities. of KCCs suppliers (a second-tier supplier that produces
Wheel sets consist of one front wheel and one rear wheel. handlebars) is also a subsidiary of the holding company that
The different wheel designs are: owns KCC. This supplier has contracts with manufacturers of
bicycles, scooters, and power chairs. On several occasions, this
Chrome spokes.
supplier has missed scheduled deliveries. When confronted,
Cast aluminum polished (silver) alloy wheels.
management explained they had external customers whose
Cast aluminum anodized (black) alloy wheels.
orders must be filled. At certain times of the year, demand
The OEM offers four unique tire choices for each frame exceeds the suppliers ability to meet it. As a result, KCC
type. Thus, KCC could purchase as many as 12 different tire management has scrambled to find suitable suppliers (at much
models to meet market demand (three frame types x four greater cost) in order to meet their own delivery schedules.
different tires per frame). Factors that differentiate the
tires include: PROCESS DESCRIPTION
Bias-ply (characterized by a round profile and tall

KCC receives an order from the OEM exactly three hours
sidewalls).
before the specific chassis is needed on the OEMs assembly
Radial (characterized by a flat profile and short sidewalls).

line. The company employs four production line workers
Grip (softbetter road grip but shorter tread life; hard

who are cross-trained to perform multiple functions.
poorer road grip, but longer tread life).
Figure 2 illustrates the manufacturing process for KCC, a
Tread design (differences in the number of grooves in the

manufacturing cell that includes the following processes:
tire pattern).
Number of layers (known as plies) from which the tire is
 Step 1. Tube cutting and assembly. Steel tubes arrive by
constructed; using more layers results in a stiffer tire. forklift at Step 1, the cutting and welding process.
Cutting. Using a computer numerically controlled (CNC)
The OEM contracts directly with the tire manufacturer
machine, steel tubes are bent and cut to proper angles and
to supply specific tires to the wheel manufacturer. Much
lengths that match the engineering design specifications for
engineering effort has gone into identifying the proper tires and
each frame typeSport, Cruising, or Retro.
wheels for each type of motorcycle. The wheel vendor receives
and mounts the appropriate tire on the wheel set and then Welding. After the tubes are cut, they are clamped to a jig
delivers the set to KCC. The tire manufacturer sells its products that holds them stationary at the proper angle for welding.
to different OEMs, as well as to aftermarket customers. A robot tack-welds each joint, which is a temporary weld
to hold the assembly in preparation for final welding. Once
the frame is completely assembled by tack welds, the robot
permanently welds the joints.

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Step 2. Weld cleanup and preparation. The welded metal
frame advances to the next process where the welds are
smoothed and polished, then to a cleaning bath where the
frame is cleansed of oils and surface contamination prior to
the powder coating process.
Step 3. Powder coating. KCC powder coats, rather than
paints, the frames. Consistent with environmental
sustainability issues, the powder coating process emits
almost zero volatile organic compounds (VOCs). In addition,
any overspray can be captured and reused. Powder coating
is a dry powder that does not require a solvent. The powder
coating is robotically sprayed within a booth by a nozzle
that imparts a negative electrical charge to the powder. The
powder electrostatically adheres to the grounded frame. The
frame is heated to approximately 400 degrees Fahrenheit
for around three minutes to melt the powder that flows to
produce a smooth, strong, glossy finish.
Step 4. Fork assembly. The forks are manually attached to the
frame.
Step 5. Tire balancing. The wheel/tire set is tested for balance,
and any necessary modifications are made.
Step 6. Wheel/tire assembly. The wheel/tire assembly is
manually attached to the frame.
Step 7. Handlebar mounting. The handlebars are mounted on
the frame.
Step 8. Loading the frames. The frames are carefully loaded
into a cargo trailer for transport.
KCCS JUST-IN-TIME/ JUST-IN-SEQUENCE
INVENTORY SYSTEM
The OEM produces motorcycles for eight hours each
weekday. KCC makes eight deliveries (once per hour)
during this period. The frames are delivered just-in-time
(JIT) and just-in-sequence (JIS). JIS delivery implies
the first frame unloaded from the truck is the next frame
needed for production by the OEM. KCC is linked to the
OEMs production information system via an electronic data
interchange system. The system identifies the appropriate
frame geometry, handlebar type, wheel type, and tire
specifications for each order.
Management at KCC has been working to improve
operating efficiency and profitability. Because KCC operates
according to Lean principles, the company strives to hold
minimal parts inventory. Thus, on-time delivery and the quality
IM A ED U C ATIO NA L C A S E JOURNAL
of purchased parts are crucial to keep production lines operating
at desired output levels. If KCC causes the OEM to stop its line
because of delivery or quality problems, the contract allows the
OEM to bill KCC for lost production time at a rate of $2,000
per minute.2 The OEM believes this clause is justified because
it loses contribution margin if production is brought to a halt.
In some cases, KCC has passed these costs along to second-tier
suppliers that caused KCC to miss a delivery.
KCC has met on several occasions with its suppliers to try
to resolve supply issues. Vendors have been frustrated by the
Lean system demanded by KCC. To reduce their exposure to
line stoppage costs, some second-tier suppliers have responded
by increasing inventory levels. Additionally, some suppliers
have purchased redundant manufacturing equipment on key
production processes that can be used if the primary equipment
fails, further adding to manufacturing costs.
Management at the OEM believes in developing long-term
strategic partnerships with its suppliers. Thus, each supplier is
rewarded with a multiyear contract. The OEM prefers to use a
single supplier for each component, rather than to contract with
two (or more) different companies for a component. KCC has
the exclusive contract to produce rolling chassis for the OEM,
and has recently been awarded the next contract covering
five years of production. As a result, KCC made significant
investments in retooling and plant modernization during the
current year. Unfortunately, the investments did not increase
KCCs capacity sufficiently to meet expected demand.
THE MANAGEMENT DILEMMA
KCCs management operates as one participant in a complex
supply chain. They are managing relationships involving
multitier suppliers and a demanding delivery schedule. Further,
stockholders are expressing concern over KCCs declining
profitability in recent years. Management has not developed
a plan for addressing the increase in production required by
the OEM, nor have they developed an understanding of the
financial consequences of accepting the new contract.
ENDNOTES
For an example of a company that produces rolling chassis, visit
1
www.thompsonchoppers.com/rolling-motorcycle-chassis/
While KCC is a fictional company, delivery penalties of $3,000-
2
$4,000 per minute are not uncommon in some manufacturing
industries.
3 VOL. 9, N O. 2, ART. 3, JUNE 2016
Figure 1: Supply Chain

Third Tier Tires

Front Powder-
Wheels Handlebars coating Steel
Second Tier fork tubing
supplies

First Tier Kates Cycle Components

Direct Contract
OEM

Table 1: Kates Custom Cycles

Income Statement Years Ended December 31
2015 2014 2013
Sales $111,000,000 $113,100,000 $112,000,000
Cost of goods sold 81,000,000 79,025,000 76,720,000
Gross margin 30,000,000 34,075,000 35,280,000

Operating expenses
Freight-out 4,900,000 4,500,000 4,000,000
Research and development 2,800,000 3,000,000 3,700,000
General and administrative 8,500,000 9,000,000 9,500,000
Total operating expenses 16,200,000 16,500,000 17,200,000

Operating income 13,800,000 17,575,000 18,080,000

Nonoperating expenses: Interest 1,100,000 1,100,000 1,100,000

Income before taxes 12,700,000 16,475,000 16,980,000

Provision for income taxes 4,229,100 5,486,175 5,654,340
Net income $8,470,900 $10,988,825 $11,325,660

Basic net income per share $0.278 $0.360 $0.371

Diluted net income per share $0.267 $0.346 $0.357

Weighted average shares outstanding:

Basic 30,500,000 30,500,000 30,500,000
Diluted 31,750,000 31,750,000 31,750,000

Dividends per share $0.22 $0.23 $0.25

Average selling price $3,700 $3,900 $4,000

Units produced and sold 30,000** 29,000 28,000
Average unit cost $2,700 $2,725 $2,740
** Management believes this quantity represents existing capacity.

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Table 2: Kates Custom Cycles Table 3: Kates Custom Cycles
Balance Sheets as of December 31 Cash Flow Statement for Year Ended December 31, 2015

2015 2014 2015

ASSETS Operating cash flow:
Current Assets: Net income $8,470,900
Cash and cash equivalents $15,000,000 $13,900,000 Plus noncash expenses: Depreciation 16,500,000
Trade receivables, net 13,500,000 9,300,000 24,970,900
Inventory 9,700,000 7,200,000
Changes in current assets and liabilities:
Prepaid expenses 515,000 2,050,000
Increase in receivables (4,200,000)
Deferred tax assets 6,250,000 5,675,000
Increase in inventory (2,500,000)
Total current assets 44,965,000 38,125,000
Decrease in prepaid expenses 1,535,000
Property and Equipment: Increase in deferred tax assets (575,000)
Land and buildings 12,010,000 12,010,000 Increase in payables 500,000
Property and equipment 57,500,000 42,500,000 Increase in accrued expenses 3,500,000
less: Accumulated depreciation 39,000,000 22,500,000 Decrease in income taxes payable (550,000)
Total property and equipment 18,500,000 20,000,000 Change in cash from operations 22,680,900

Goodwill 5,000,000 5,000,000 Investing:

Total assets $80,475,000 $75,135,000 Investment in equipment (15,000,000)

LIABILITIES AND SHAREHOLDERS' EQUITY Financing:

Dividends (6,580,900)
Current liabilities:
(6,580,900)
Accounts payable $9,000,000 $8,500,000
Accrued expenses 25,000,000 21,500,000 Increase in cash $1,100,000

Income taxes payable 700,000 1,250,000

Total current liabilities 34,700,000 31,250,000

Notes payable 31,000,000 31,000,000

Total liabilities 65,700,000 62,250,000

Shareholders' equity:
Common stock 1,000,000 1,000,000
Retained earnings 13,775,000 11,885,000
Total shareholders' equity 14,775,000 12,885,000

Total liabilities and shareholders equity $80,475,000 $75,135,000

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5
Table 4: Unit Cost Information
2015
Costs that vary by individual unit (example of one product)

Materials:
Steel tubing $200.00
Front fork 650.00
Wheel set (front and rear) 700.00
Tires 350.00
Handlebars 125.00
$2,025.00

Direct labor:
(4 line workers x 40 hours per week x 50 weeks 13.33
per year x $50 per hour/ 30,000 units)

Overhead (generally varies in total with production, but is relatively

constant on a per-unit basis):
Welding rods flux $11.00
Degreasing chemicals and supplies 7.70
Powder coating materials 25.00
Electricity for machines 10.00
Heating and cooling building 8.50
Indirect labor: Plant supervision and plant maintenance 20.00
Materials, WIP, and FG inventory handling 30.30
$112.50

Depreciation (generally fixed in total):

Total per cash flow statement $16,500,000.00 $550.00

Total unit cost $2,700.83

Approximately $2,700.00

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Figure 2: Process Diagram for Kates Cycle Components (Time Shown in Minutes : Seconds)

Fork assembly Tire balancing

Process time 1:45 Process time 3:00
Step 4 Step 5

Powder coating Wheel assembly

Process time 3:00 Process time 2:15
Step 3 Step 6

Weld clean-up 2:00

Degrease and Handlebar mounting
powder coat prep :30 Process time 1:30
Step 2 Step 7

Cut tubing :30

Steel tubing Welding Transport to loading
delivered by Setup time (jig) :15 queue for JIT JIS
forklift delivery
Process time 3:15 Step 1 Step 8

To the OEM:
One delivery per hour

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