WRITTEN ANALYSIS AND COMMUNICATION I

INDIAN INSTITUTE OF MANAGEMENT

AHMEDABAD

Assignment 2West Lake Home Furnishings Ltd.Evaluation of a proposal to reduce the retail price of the Signature line In partial fulfillment of the requirements of the course

Written Analysis and Communication IPresented to

Instructor: Prof. Rohini Patel

Academic Associate: Ms. Atmaja Shah

On

05 July 2008

by

24 May 2007From,XYZ,ABC

Students of WIMWITo,Mr. Charles Bowman

CEO, West Lake Home Furnishings Ltd.

Toronto, Ontario,

Canada

Re: Evaluation of a proposal to reduce the retail price of the signature line

Dear Charles,

We have analyzed the proposal by your wholesale customer to reduce the retail price of the signature line. Please find attached a report containing our evaluation of the proposal and recommendation.

Thanking You,Yours Sincerely,

XYZ,ABC

Executive SummaryWest Lake Home Furnishings Ltd. (WL) is a manufacturer of table lamps with modern designs at reasonable prices. One of its largest retailers has proposed a reduction in the price of its signature line, which accounts for 59.2% of its income, from $69.99 to $ 29.99; resulting in an expected fivefold increase in sales volume.

WL now needs to decide whether it should accept the proposal or decline. Both options have been evaluated in terms of the profitability, brand alignment and the reaction of its dealers. On the basis of this evaluation, it is recommended that WL should accept the proposal and reduce the price of its signature line.

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Contents1Situation Analysis

1Market Analysis

1Financial Performance

2The Signature Line and URC

2Problem Statement

2Available Options

3Criteria for Evaluation

3Evaluation of Options

3Accept the proposal

4Reject the proposal

5Recommendation

5Action Plan

6Exhibits

8References

Situation AnalysisWest Lake Home Furnishings Ltd. (WL) has positioned itself as a manufacturer of table lamps with modern designs at reasonable prices. It aims to increase customer recall while growing rates of 10 to 15% p.a. However, after three decades of operation, it has only a 1.24% market share and an annual growth rate of 1.8%, lower than the industry standards of 6.1%. Even its return on investment has decreased from 10.04% in 2005 to 8.98% in 2006. (See Exhibit 1)Market AnalysisThe market for table lamps is expected to continue its growth till 2011, when the baby boomers are expected to reach the age of 65 (Statistics Canada, 2006). The $0.9 billion market for table lamps is extremely fragmented while the retail market, its customer, is a $236 billion industry of which large chains accounted for about 33.33%. Thus these retailers have tremendous negotiation advantages over manufacturers, and could change suppliers frequently if their products did not sell well.

Manufacturers compete on product designs and prices, and WL faces increasing price competition from new entrants with similar designs, who are targeting its retail accounts. Financial PerformanceThe operating margin for wholesalers is 6.95%, accounting for 71.41% of total sales. (See Exhibit 2) Internet Sales, though with an attractive margin of 39.7% only accounts for 1.78% of total sales, thus not affecting the bottomline. The retail store is running at a loss with an operating margin of 10.74%. Thus wholesale revenues, though comprising of 71.41% of sales, contributes 178% to operating income underlining its importance to the overall profitability of the firm. The Signature Line and URC

The signature line of WL, retailed exclusively at a large US-based retail chain (URC), accounts for 33.33% of wholesale revenues, or 59.2% of operating income. This line, defining the brand of the firm, is currently priced at $69.99, which falls towards the lower range of the spectrum of WLs product prices of $45 to $195. Thus the signature product is priced as a price competitive product, reflecting the company positioning strategy rather than as a premium product.

URC is aware of the costs, specifications and details of the manufacturer in China for the signature line, thus giving it the ability to replicate it with a private label line. However, strong sales volume would discourage it from cannibalizing the sales of a product which contributes strongly to its own margins. Problem StatementA decision needs to be made on whether to accept the proposal by URC to decrease the price of the signature line from $69.99 to $29.99. Available OptionsThe options available are: Accept the proposal reduce the price of the signature line from $69.99 to $29.99 Reject the proposal attempt to retain status quoCriteria for EvaluationThe criteria for evaluation used, in order of importance, are:

Profitability and Liquidity maximize Return on Investment while maintaining liquidity using valid assumptions Alignment with Brand Image effect on brand from changes in the signature line Reaction of URC and other retailers impact on relationship with retailersEvaluation of OptionsAccept the proposal Profitability and Liquidity If the proposal is accepted, the revenue per unit is reduced from $48.99 to $25.49 per unit and operating margin decreases from 6.95% to 3.05%. (See Exhibits 3 and 4) However, if sales volume quintuples as expected, the overall operating income would increase by 8.4% to $339,310. The return on investment for WLs shareholders, whose maximization is the aim of any for-profit organization, would increase from 8.94% to 9.74%.

Inventory for retail products would increase by 30% however the overall inventory would only increase by 7.14%. (See Exhibit 5) This increase can be financed by a line of credit for $114, 286 whose interest payments would make no material difference to profitability.

Alignment with Brand ImageThe signature line is not priced as a premium product and decreasing the price and increasing sales volume will help it reflect the price competitiveness of the brand and help it increase recognition of the brand amongst customers. This could also positively affect its internet sales due to greater visibility.Reaction of URC and other retailers

Currently, URC earns a marginal revenue of $21, which is proposed to decrease to a marginal revenue $4.5. Therefore, to match current profits, sales would have to increase by 4.7 times. This will incentivize URC to provide prominent displays and promotions.

Other retailers may try and gain similar concessions which will reduce gross margin from wholesale sales by 29.01%. However, this concession need only be provided if they provide similar proposals to what URC offers, which leads to a further increase in return on investment to 11.01%. (See Exhibit 6)Reject the proposal Profitability and Liquidity Under status quo, the firm the firms profits would be expected to remain stable if there is no reaction to rejection from UCR. However, new entrants are actively seeking to gain WLs retail accounts, and UCR has the knowledge to effectively replicate the signature line. Thus, WL could lose UCRs account which accounts for 59.2% of its overall profits.

Alignment with Brand ImageUnder status quo, the growth rate would remain at 1.8%, which would be well under the stated aim of 10-15%. Also with a market share of only 1.24%, the recognition of the firm would remain low.If the firm does lose the URC account, then the loss of the signature line will negatively impact its brand image and could also have an effect on overall sales due to brand dilution.Reaction of URC and other retailers

UCR has detailed knowledge of the production process and facilities in China. It could replace the signature product on its shelves with a private label with similar design or with a competitor who is willing to follow the model proposed.

Other retailers could view the loss of an account and decrease in sales as a negative, given the emphasis placed in the industry on product sales. WL could try to market its signature line through another retailer. However, given its urgency, any such transaction would revert it to status quo at best or grant the retailer a greater margin.

RecommendationWL should accept UCRs proposal and reduce the price of its signature product from $69.99 to $ 29.99.Action Plan Negotiate with UCR to gain concessions on prominent shelf spaces and other promotions

Negotiate with the Chinese manufacturer for discounts on signature line production

Bargain for a discount on all its products due to increase in volume

Obtain a line of credit for $114,286 to meet cash requirement for inventory

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Exhibits

EXHIBIT 1: Calculation of Return on Investment

EXHIBIT 2: Segmented Contributions to Earnings and Margin Ratios

* The various items have been split between sectors as per instructions in the case. Where no instructions were provided, they have been segmented proportional to sales.** Operating Margin (%) = Operating Income / SalesEXHIBIT 3: Calculation of Revenue Given Retailer Margins

EXHIBIT 4: Analysis and Comparison of Proposal* For 2006, all Signature items are taken as 1/3 of Wholesale items* For 2007, Signature Sales = (5*2006 Signature Sales*New Per Unit Revenue)/2006 per Unit Revenue

*For 2007, COGS = (5 * 2006 Signature COGS * $ 20)/$30

* For 2007, SGA = 2006 SGA * 1.2

* For 2007 SW = 2006 SW *2.5 EXHIBIT 5: Calculation of Inventory and Loan Amount

EXHIBIT 6: Analysis of the Scenario Where All Retailers Give Similar Proposals

* All Figures calculated as in Exhibit 4, only using Wholesale items as base

References

Census of Canada 2006. (2006). Population gain fastest among the oldest. Retrieved on July 31, 2008, from Statistics Canada online via access:http://www12.statcan.ca/english/census01/Products/Analytic/companion/age/canada.cfmPAGE 1