a. and b.
| Income Statement| New contract changes| Dollar impact of new contract| Income with new contract| Sales revenue| $ 1,500,000 | $ 200,000 | $ 200,000 | $ 1,700,000 | Costs| | | | |
Labor| 700,000 | 175,000 | 175,000 | 875,000 | Equipment lease| 104,000 | 12%| 12,480 | 116,480 | Rent| 120,000 | - | - | 120,000 | Supplies| 60,000 | 15%| 9,000 | 69,000 | Officers' salaries| 400,000 | - | - | 400,000 | Other costs| 50,000 | 15%| 7,500 | 57,500 | Total costs| 1,434,000 | | 203,980 | 1,637,980 | Operating profit (loss)| $ 66,000 | | $ (3,980)| $ 62,020 |
Technically, the new contract reduces profit of the company by $3,980. By itself, this one-year contract appears not to be worth the effort of hiring and training new, part-time consultants. c. Other considerations include (1) whether this will enable the company to get into a new, profitable line of business, (2) what other opportunities the company has for expansion, (3) whether the contract will provide for more revenues in the future, and (4) what obligations the company makes to its employees. In short, the company should consider both short and long run costs and benefits of its decisions. SOLUTIONS TO CASES
1-41 (40 min) Analyze strategic decision
a. The following spreadsheet computes customer profitability. If the lower portion of the spreadsheet (rows 8 – 17) contains only formulas, you can test the sensitivity of the profit estimates to changes in the parameters (rows 2 – 7). | A| B| C|
1| Annual Average Data| Large Customer| Small customer| 2| Number of orders per year| 2000| 200|
3| Sales value of supplies per order in dollars| $1,000 | $600 | 4| Cost of supplies to Corporate Express as a percent of sales| 80%| 75%| 5| Processing cost per order| $25 | $25 |
6| Delivery cost per order as a percent of sales| 8%| 8%| 7| Cost to create and maintain Internet access per customer per year| $3,000 | $3,000 | 8| Annual Customer profitability| | |
9| Revenues (B2*B3, C2*C3)| $2,000,000 | $120,000 |
10| Cost of supplies (B4*B9, C4*C9)| 1,600,000 | 90,000 | 11| Gross margin (B9-B10, C9-C10)| 400,000 | 30,000 |
12| Operating costs| | |
13| Ordering costs (B2*B5, C2*C5)| 50,000 | 5,000 |
14| Delivery costs (B6*B9, C6*C9)| 160,000 | 9,600 |
15| Internet access costs (B7, C7)| 3,000 | 3,000 |
16| Total operating costs (SUM(B13:B15), SUM(C13:C15)| 213,000 | 17,600 | 17| Customer profit (B11-B16, C11-C16)| $187,000 | $12,400 |
b.Assuming that Corporate Express has constrained order processing capacity, simply displacing one large customer to serve ten small customers would have an adverse impact on profits because Corporate Express would lose $187,000 profit while gaining only 10 x $12,400 = $124,000 profit. Unless Corporate Express feels that these companies will grow to be more profitable than its current average customer, this can be an unwise tradeoff. In fact, Corporate Express has decided to restrict its services to larger companies because it believes smaller companies are unprofitable to serve.
c.On average, each small customer would have to increase its profitability from $12,400 to $18,700 by increasing the value of its orders, by paying a premium for services, by demanding less costly service, or a combination of these actions. On the face of it, these might be likely, and if Corporate Express can identify promising new customers, it may...