Culinarian Cookware produces premium performance cookware. It occupied 6.5% market share, which is the highest among the premium lines. There is a challenge between sales department and marketing department. The sales manger wants to implement the price promotion, because she believes that discount can increase commitment and brand awareness. However, the VP of marketing cannot accept price promotion. He worries that the discount will hurt brand image as premium products. Furthermore, marketing’s consultants also think that discount has a negative impact on company’s profit. The argument between two departments focuses on the contribution margin. As a result, contribution margin is the key to solving the problem in this case.
The consultant and sales manger use two ways to calculate the variable cost (VC). The consultant (Exhibit 1) added all the expense together, including direct labor cost; raw material cost; administrative cost; manufacturing overhead; advertising & promotion expense and selling expense. However, the sales manager’s variable cost (Exhibit 2) just kept the first two cost of consultant’s. Obviously, the VC of sales manger is much lower than the consultant’s. Then they applied the formula “(actual units * actual contribution) - (forecast units * normal contribution) = incremental contribution impact”. According to this formula, consultant (Exhibit 3) concluded that the promotion in 2004 lost $ 469,489 in contribution, while the sales mangers boosted that there was an increase up to $ 2, 397,994 in contribution.
Which calculation is correct? Neither is right. The key point is that neither of them uses the correct way to calculate the variable cost. The wrong variable cost will lead to an overestimated or underestimated contribution. The Consultant’ VC included a lot of fixed cost, which should not be added in the VC. For example, advertising & promotion expense usually are seen as fixed cost. It shouldn’t be calculated...
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