dansk minox av oct 2010

28
Dansk 1 A/S Dansk Minox Dr Ashish Varma Ph.D, FICWA, PGDBM Assistant Professor Accounts and Finance IMT, Raj Nagar Ghaziabad. Email: [email protected], [email protected]

Upload: ravibhambhani

Post on 22-Nov-2014

624 views

Category:

Documents


26 download

TRANSCRIPT

Page 1: Dansk Minox Av Oct 2010

Dansk 1

A/S Dansk Minox

Dr Ashish VarmaPh.D, FICWA, PGDBM

Assistant ProfessorAccounts and Finance

IMT, Raj NagarGhaziabad.

Email: [email protected], [email protected]

Page 2: Dansk Minox Av Oct 2010

Dansk 2

The Setting• A processed foods manufacturer in Denmark• 30 products……Hmm…• Solid market position• Entering a higher growth phase:• Late 60’s - Working mothers

- “Convenience” foods- More disposable income- More income spent on food- Growth of “imaginative” food products

• One current product is vacuum-packed, cooked pork w/gravy• A big Danish traditional meal is pork with red cabbage salad• There are beginning to be packaged red cabbage salad products in

the stores• Our idea—A “complete meal” package• A pork package and cabbage package, together in one box, as our

first “complete meal”

Dansk Minox

Page 3: Dansk Minox Av Oct 2010

Dansk 3

1. Finance says price must be 8.20 to earn a fair profit (5.26 price for Dansk Minox).

2. Marketing says too high! Price should be 6.85 for good penetration and good growth (4.40 price for DM).

3. Finance says we lose money at 6.85.

4. Introduce “CM” in 1966 at 8.20 with sales budget of 85,000 kg.

5. Sales are only 30,000 kg. Marketing says sales of 85,000 kg are likely at 6.85.

6. What to do now?

Page 4: Dansk Minox Av Oct 2010

Dansk 4

Exhibit AA/S Dansk Minox

Contribution Analysis

At a Retail Price of 8.20Price to Dansk Minox D.Cr. 5.26Incremental Cost 3.23Less: Transportation, storage (.20)

Labor (.50) 2.53Profit Contribution 2.73Volume 30 tons (30,000 Kg)Total Contribution ( 2.73 x 30,000) D.Cr. 81,900

At a Retail Price of 6.85Price to Dansk Minox D.Cr. 4.40Incremental Cost 3.23Less: Transportation, storage (.20)

Labor (.50) 2.53Profit Contribution 1.87Volume 85 tons (85,000 Kg)Total Contribution (1.87 x 85,000) D.Cr. 158,950

THE INCREMENTAL PROFIT IS HIGHER AT THE D. CR. 6.85 PRICE BY 77,050 (158,950 - 81,900).

Page 5: Dansk Minox Av Oct 2010

Dansk 5

The key idea embodied in Exhibit A is that, in the short run, the impact on profits between the two prices is identical to the change in contribution (158,950 - 81,900 = 77,050).

The lower price yields more profit contribution, given the volume estimates.

Page 6: Dansk Minox Av Oct 2010

Dansk 6

Thus, the low price yields more contribution as long as DM can sell more than 44 tons, which is only 52% of projected sales of 85 tons.

Remembering that 30 tons were sold at the 8.20 price, it is quite probable that at least 44 tons can be sold at D.Cr. 6.85.

Total Contributionat 8.20 Price

81,900

ContributionMargin per Unitat the 6.85 Price

1.87

÷

÷

43,800 Kg

Break-even Volume at 6.85 Price

Page 7: Dansk Minox Av Oct 2010

Dansk 7

The best case for the low price, high volume approach (D.Cr.

6.85 price), as proposed by the marketing department, can be summarized as follows:

1. It produces good incremental contribution to profits. Since there is excess capacity, we should take advantage of it.

The fixed costs are already being covered.

Is it possible / feasible to increase the prices soon after the product is launched?

Will the customer realize that earlier they were billed on marginal cost and now they are being billed on full cost.

Page 8: Dansk Minox Av Oct 2010

Dansk 8

2. The contribution is much better at D.Cr. 6.85 than at D.Cr. 8.20 because of the larger sales demand at the lower price.

The difference in consumer price between the standard and the CM packs as proposed by the finance department implies that the consumer would have to pay D.Cr. 3.35 (8.20 - 4.85) for the red cabbage salad, since the sliced pork in gravy content of the two packs is the same.

Similarly, at the D.Cr. 6.85 price, the consumer pays D.Cr. 2.00 (6.85 - 4.85) for the cabbage salad.

There is a big market for packaged cabbage salad at D.Cr. 2.00, but there is a small market at D.Cr. 3.35. This makes sense because the consumer is unlikely to pay more than the market price for cabbage salad for the added convenience in a CM pack.

Page 9: Dansk Minox Av Oct 2010

Dansk 9

3. New products such as the complete meal are the wave of the future for the following reasons:

a. The convenience packs are rising in popularity.

b. Packaged cabbage is already here.c. CM fits the strategic thrust toward whole

meals vs. separate products.d. Competitors will be here soon if we don't

move quickly (Maybe?).

Page 10: Dansk Minox Av Oct 2010

Dansk 10

4. It is inappropriate to charge cabbage the same OH allocation as we charge pork. Charging OH based on weight is incorrect.

5.The value price for the complete meal is D.Cr. 6.85 (based on the D.Cr. 2.00 value price for the cabbage salad). That is the price at which the market potential is large.

6.Any cannibalization of the standard pork pack is irrelevant because our standard product is vulnerable already from competitors introducing the CM concept. It is better for us to replace the standard pack than for a competitor to do so.

Page 11: Dansk Minox Av Oct 2010

Dansk 11

Exhibit BA/S Dansk Minox

Alternate Methods of Allocating Fixed Overhead

1. Current Method (Allocate Fixed OH on Kilograms)Total Company Sales (kgs) = 1,260,000Total Company Fixed OH = 1,510,000

OH/kg = = 1.20/kg

A Complete Meal = 1 kg - 1.20 of OH

2. Alternate Method (Allocate Fixed OH on Labor Cost)Company Labor Cost = 700,000Total Company Fixed OH = 1,510,000

OH/Labor = = 2.16

A Complete Meal = .50 Labor - 2.16 x .50 = 1.08 of OH

3. Alternate Method (Allocate Fixed OH on # of Packages)Standard Pork Package = .450 kg. Assume this is average for the meat products.Company Sales in # of Packages = 1,260,000 ÷ .45 = 2,800,000 packagesTotal Company Fixed OH = 1,510,000

OH/Package = = .54

A Complete Meal = 2 packages - .54 x 2 = 1.08 of OH

1,510,0001,260,000

1,510,000700,000

1,510,0002,800,000

Page 12: Dansk Minox Av Oct 2010

Dansk 12

The basic idea on allocating PFE to products is the “cost driver” concept

ABC

1. What “activity” drives the PFE cost?

2. What share of that activity does “CM” consume?

NOTE:

If product moves through the factory in batches of a certain weight (cooking, slicing, mixing, packing), then assigning PFE per Kg may not be as silly as it at first appears!

Page 13: Dansk Minox Av Oct 2010

Dansk 13

Exhibit CA/S Dansk Minox

Full Cost Analysis — The Complete Meal

Price to Dansk Minox D.Cr. 4.40

Variable Cost (3.23)

Production Fixed Expense (1.20 per Kg) (1.20)

Product Specific Fixed Cost (Advertising) ( .30)

Selling, and Administrative Expense ( .19)

Loss ( .52)

Since the Pork Pack alone shows .13 profit, the loss is .65 ie (0.52 +0.13) on the Cabbage Salad Pack with .66 ie ( 1.2 – 0.54) PFE allocation.

Thus the Cabbage Salad can only support .01 of PFE!

Page 14: Dansk Minox Av Oct 2010

Dansk 14

The net conclusion of this analysis is that the choice of the best OH allocation scheme is really moot.

Irrespective of the basis of OH allocation, the CM product is a “loser” at the low price on a full cost basis.

Page 15: Dansk Minox Av Oct 2010

Dansk 15

Are fixed costs relevant for the decision?

1.Concerning the allocation of fixed overhead to the complete meal, the following can be noted:a. In the long run, the capacity really is not “free” in this market.b.Normal growth of our standard pack and other products will soon

fill up the factory without the CM product. In growing markets, capacity must be added ahead of sales. Excess capacity will thus always exist, but it is not “free.”

.

Page 16: Dansk Minox Av Oct 2010

Dansk 16

c. Production fixed overhead at D.Cr. 1.51 million is large . We are a high fixed cost operation. A good product must be able to carry a fair share of that OH.

d.All allocation methods, as demonstrated in Exhibit B, show a fixed overhead allocation to CM of about D.Cr. 1.00 per pack or more. Further, as noted on Slide 10, allocating OH based on weight is defensible in this situation

Page 17: Dansk Minox Av Oct 2010

Dansk 17

2.This product cannot really support any manufacturing overhead at all. There is only D.Cr. 0.01 of margin to cover fixed production OH and a profit.

3.THUS, THE CABBAGE SALAD IS A “GOOD CONTRIBUTION/NO PROFIT” PRODUCT.

Page 18: Dansk Minox Av Oct 2010

Dansk 18

4. DM's current market positioning is based on high value/high price products, such as the standard pork package.

The complete meal does not fit that strategy. Our current products tend toward higher value/lower bulk, but cabbage salad is lower value/higher bulk:

a. Standard pack weighs .450 kg and sells for D.Cr. 3.11; but cabbage salad weighs .550 kg and sells only for D.Cr. 1.29. The complete meal mixes a high value/low bulk product (standard pork pack) and a low value/high bulk product (cabbage salad) together as if both are appropriate for our factory.

Page 19: Dansk Minox Av Oct 2010

Dansk 19

b. In a factory configured for processing meats, processing vegetables is very inefficient and expensive. Just because they are eaten together does not mean they should be packaged together.

c. Cabbage salad takes just as much labor time (a rough proxy for "value added") as pork—both require D.Cr. 0.25 of labor per unit. However, cabbage salad sells for much less than pork.

One inference is that DM is using very expensive labor (whose skill levels are needed to process meat products) to process cabbage. A factory solely geared to packaging vegetable products would no doubt employ much cheaper labor.

Thus, DM would be at a competitive disadvantage in their manufacturing operations by processing meat products and vegetable products in the same factory.

Page 20: Dansk Minox Av Oct 2010

Dansk 20

5. Cannibalization of standard pack sales by complete meal sales would be much more likely at D.Cr. 6.85 price (D.Cr. 2.00 for cabbage) than at D.Cr. 8.20 price (D.Cr. 3.35 for cabbage). At the D.Cr. 6.85 price, customers might well prefer our CM pack versus our standard pork pack with a competitor's packaged cabbage salad.

Thus our introduction of the complete meal at D.Cr. 6.85 will directly erode sales of the standard pack, substituting a low profit product for a higher profit one. Why cannibalize the standard pork pack with our own loser? It makes more sense to let someone else sell packaged cabbage to promote sales of our standard pork package.

Page 21: Dansk Minox Av Oct 2010

Dansk 21

6.The complete meal concept is not really likely to be the wave of the future.a.) It seems like a bad use of our factory at the D.Cr.

6.85 price (the value price); low value-added product not appropriate for our high fixed cost factory.

b.) It is low volume and low growth idea at the D.Cr. 8.20 price (full cost price).

c.) D.Cr. 8.20 is not even a high enough price because that uses .30 for advertising which presumes 85 tons. At 30 tons, advertising must be .85/kg, which implies a retail price of D.Cr. 9.99. Cutting advertising probably would reduce sales. Of course, at a 9.99 price, volume would fall still lower and we would have to adjust price upward again, and so on.

d.) The vegetable packers selling the cabbage pack are not likely to move into meat products (Different business for them.).

e.) It appears that meat product firms cannot make a profit at the value price of D.Cr. 6.85 (not enough value-added).

Page 22: Dansk Minox Av Oct 2010

Dansk 22

Recap of the Analysis

1. The marketing arguments for complete meal make sense only at the D.Cr. 6.85 price.

2. The D.Cr. 6.85 price is in conflict with our manufacturing strategy of low-bulk/high-value products.

3. Also, the D.Cr. 6.85 price is not financially attractive, given our factory composition and overhead structure.

4. Complete meal should be priced at D.Cr. 6.85, but that price is unprofitable for DM.

5. However, a price of D.Cr. 8.20, or even higher, would be unattractive to the consumer.

6. Hence, the CM concept of combining standard pork and cabbage salad is a bad idea, at our current cost structure.

Page 23: Dansk Minox Av Oct 2010

Dansk 23

7. Therefore, unless someone can figure out how to restructure the cost chain, the complete meal idea is unlikely to create a big wave of anything!

8. Joint venture with a vegetable packing company?

∆ Shipping Cost & ∆ Convenience Package Cost vs. to Customer

A Good “Value Proposition”?

Page 24: Dansk Minox Av Oct 2010

Dansk 24

Exhibit D—A/S Dansk Minox

Target Cost for Cabbage Pack

Retail Price 2.00 Tax (.22) (12.5%)

Net to Retailer 1.78 Retailer Gross Margin (.38) (21.5%)Wholesale Price 1.40 Wholesale Gross Margin (.11) (8%)Price to DM 1.29 Normal Profit Margin (.05) (4%) ($.13 on $3.11 for Pork)

Total Allowable Cost 1.24

Non-Mfg. Cost:Advertising (.16)Transport/Storage (.11)G, S & A (4%) (.05) TOTAL (.32)

Allowable Mfg. Cost .92

Current Mfg. CostCabbage .50Labor .25Packaging .15Misc. .06PFE .66 1.62

*Must cut Mfg. Cost by .70 on 1.62 = 43%

Gross Margin: Allowable .37/1.29 = 29% Now Negative!

*

Page 25: Dansk Minox Av Oct 2010

Dansk 25

Exhibit EA/S Dansk Minox

Perspective on Decision Making

Marketing

ContributionMargin

Shorter

Yes

Manufac-turing

Full CostProfit

Longer

No

Business Perspective

Financial Metric

Time Frame

Decision toIntroduce CM?

What Constitutes “Good Thinking” Here?

Page 26: Dansk Minox Av Oct 2010

Dansk 26

The Basic Thought

Our view of what seems smart and what seems silly changes dramatically when we change the “lens” through which we see the problem:

• A financial analysis “lens”

• A business analysis “lens”

Page 27: Dansk Minox Av Oct 2010

Dansk 27

Case Exhibit 1Finance Department Proposal

Consumer PriceTurnover Tax (12.5%)Consumer Price Before TaxRetailer’s Gross Margin (21.5%) Wholesale PriceWholesaler’s Gross Margin (8%)Price to DM

Material: PorkLabor: PorkMaterial: CabbageLabor: CabbagePackagingTransportation and StorageSundry Variable Costs

Total Variable CostsProduction Fixed ExpensesAdvertising ExpenseSelling and Administrative Expense

Total CostProfit

CompleteMeal

PorkPack

Difference(Cabbage Salad)

8.20 .917.291.575.72 .465.261.67

.25

.50

.25

.26

.20 .103.231.20

.30 .234.96

.30

4.85 .544.31 .933.38 .273.111.67

.25

.11

.09 .042.16

.54

.14 .142.98

.13

3.35 .372.98 .642.34 .192.15

.50

.25

.15

.11 .061.07

.66

.16 .091.98

.17

Page 28: Dansk Minox Av Oct 2010

Dansk 28

Case Exhibit 2Marketing Department Proposal

Consumer PriceTurnover Tax (12.5%)Consumer Price Before TaxRetailer’s Gross Margin (21.5%) Wholesale PriceWholesaler’s Gross Margin (8%)Price to DM

Material: PorkLabor: PorkMaterial: CabbageLabor: CabbagePackagingTransportation, StorageSundry Variable Costs

Total Variable CostsProduction Fixed ExpensesAdvertising ExpenseSelling and Administrative Expense (4%)

Total CostProfit

CompleteMeal

PorkPack

Difference(Cabbage Salad)

6.85 .766.091.314.78 .384.401.67

.25

.50

.25

.26

.20 .103.23

.54

.30 .194.26

.14

4.85 .544.31 .933.38 .273.111.67

.25

.11

.09 .042.16

.54

.14 .142.98

.13

2.00 .221.78 .381.40 .111.29

.50

.25

.15

.11 .061.07

.16 .051.28

.01