Table of Contents Introduction The objective of this report is to provide Mr.. Paul Harvey, president with the detailed reasoning for the decisions recommended and also to figure out which products are losing money. As the company is operating in an oligopoly and has somewhat medium market share, setting our own prices is not an option. The giant Samara announces the prices for the products annually, and the other eight companies in the industry follow the price. Problem The organization underwent management change in early 2004.
The company lost $690,000 (Refer to appendix 1) in that year, which resulted in a low morale of the employees. They have lost faith in the management and have low motivation level. So, a decision has to be made regarding the production of three products I. E. 101, 102 and 103. Recently the giant in the industry Samara decided to lower the selling price for the product 101 and a final decision has to be made, if the organization should lower the selling price or not? Key Success Factors Looking at the share of industry sales rate, for product 101 its 12%, for 102 its 8% and for 103 its 10%.
The company has to increase its market share to be able to generate positive income. The second most important aspect is costs. As all the products are manufactured in separate factories and they operate below capacity, it’s hard to control the costs especially the fixed costs. Even though all the factories are horizontally integrated with shared production process facilities, it doesn’t help keeping the costs in check. The employees seem to be disappointed with the new management and have a low morale. They are not exactly motivated to try harder to make a positive impact.
Operating in an oligopoly, where prices are controlled by another firm, Superior has no control over the selling prices so, the company should Ochs on keeping costs minimum and increasing their industry sales rate. There is no compensation and reward system to Judge the performance of employees. Situation Analysis I started off with analyzing income statement for 2004 to get a better understanding of the situation and to figure out which products are generating profit and which ones are responsible for the loss.
After reviewing the data from 2004 it was found that only the product 101 is generating income and the other two products 102 and 103 are losing money (Refer to appendix 1 . 1). As I wanted to be ere that the information provided was accurate I took the liberty of following contribution margin income statement. Also I found a couple of additions errors in the 2004 and 2005 income statement. I have highlighted the mistakes in red in appendix 1. 1 and appendix 2.
Decision Regarding Dropping Products After categorizing all the costs into fixed and variable costs based on the information provided by the accounting department, I came to find out the fixed costs for factory 101 ,102 and 103 are $1 and respectively (Refer to appendix 1 . 1). The respective factories will have to incur these costs even if they continue the production. The contribution margins for factories 101, 102 and 103 are and respectively. So, even if products 102 and 103 are losing money they are still contributing to fixed costs by the same amount as their contribution.
This suggests that if the production is discontinued the company would be incurring an extra loss of Thus, I tend to agree with Mr.. Harvey decision of continuing production of product 103 and the other two products. For further details please refer to appendix 1. 1 . Appendix 1. 2 shows that if 113,766 additional units are sold for product 102 and 162,41 5 units of product 103. The company would of have made a profit of $2,999,000. The reason for not meeting the targets could be because of low morale of the employees. If we compare the predicted income statement for 2005 and the actual performance (Refer to appendixes 1. And 2). The Variances of rent, indirect labor and depreciation are $259,000 $213,000 and $642,000 respectively are all favorable. It’s safe to say that these three costs, which are all fixed costs, are the main factors for the improvement in profitability during the period January 1 to June 30, 2005. In a nutshell if fixed costs are controlled the company can do really well (Refer o appendix 1. 3 and appendix 2). Decision Regarding the Price for Product 101 The decision regarding the price of product 101 is based on the income statement of 2005 from January 1st to June 30th (Refer to appendix 3. ). The appendix has both income statement with selling price set as $24. 5 and $22. 5. It has been forecasted that if the price is dropped to $22. 5, the organization would be able to sell 1 million units. On the other hand if the organization decides to continue with the same that they are following at the moment, 750,000 units can be sold for first six months of year 2006. Here I would like to point out that these forecasts are not accurate and there may be a difference between what is predicted and the actual sales but for now I think that’s an appropriate estimation as any.
The forecasted income statements are based on the unit price per 100 lbs from first half of 2005 income statement. It is noted that the income statement with the price $22. 5 gives a higher contribution margin (10,468,490. 86) compared to the one with price $24. 5 (11,979,587. 82). These figures include the 5 percent reduction in the prices of materials and supplies and the discount on selling prices. The income statement shows that a higher operating income can be generated if the selling price set by Samara is followed (Refer to appendix 3. 2). The reason for that is the fixed costs will remain constant within the relevant range.
So, I have decided to take the fixed costs from the 2005 Unary I-June 30) income statement. Since with the selling price $22. 5 gives a higher contribution margin, the company will lose less money (- $334,043. 07) to be exact (Refer to appendix 3. 2). Also if 31,803 additional units are sold, the company can breakable for product 101 . On the other hand 135,459 additional units would be required to breakable if the current price is kept. Also it doesn’t seem a good idea keeping the prices higher than the rest of the seven firms, costumer might not appreciate and it’s of utmost important the company maintains its market share if not improve.
Conclusion & Recommendation Since it has been established that dropping any of the products doesn’t benefit the company in any way, I would like to suggest keeping all the products. The company could do really well if the sales target are met and for that the motivation level of the employees needs to be high. So, my recommendation to motivate employees would be to set up a performance based reward and compensation system, which would keep the employees motivated, especially the sales force to do better.
Another thing that can be done is rather than paying the sales force a fixed salary, they should be paid a commission based salary which would give rise to a sense of competition for sales people to do better and based on their sales they could be properly rewarded. For product 101, my analysis suggests that, the price set by Samara should be follow not Just because the organization will save itself from heavy losses but also its essential for the company to maintain its current industry sales share and having a higher price than the other firms could draw the customer away and then the organization would have bigger problems.
Fixed costs need to be controlled and monitor strictly. All the factories are operating under capacity which doesn’t help the organization in achieving its goals. One way to keep the costs in control in my opinion would be to assign specific tasks to specific factories so that they can operate efficiently rather than dedicating a whole factory to a product line. As the three reduces have somewhat similar manufacturing procedures.
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