Make your own free website on Tripod.com

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Safety Auto Accessories

 

___________________________________________

 

Submitted by: Anthony Amato, Deepti Golash, Zizi Zou

November 14, 2002

 

 

 

Executive Memo

 

 

 

TO:     Bob Wilson, President, Safety Auto Accessories

FM:     Sheila Wilson, Controller (was also present at Senior Management meeting)

Re:      Why did Safety Auto Accessories fail to meet expectations despite higher sales volume?

 

Analysis

The main cause for Safety Auto’s poor performance for the first half of the year was the reduction in price from $70 per unit to $65 per unit. Although the company sold 18,000 more units than planned and achieved efficiency in fixed manufacturing overhead, these additional revenues were offset by a corresponding rise in marketing costs; labor costs and lower gross profit margins, which dropped from $26 per unit to $22 per unit. See Appendix A.

 

Based on the original forecast prepared at the beginning of the year, we were expecting an operating profit of $1,258,800 at the end of six months assuming sales of 90,000 units. With an increase in sales volume to 108,000 units, this expectation logically grew to $1,852,800. However, due to the unfavorable variances mentioned earlier, the actual operating profit of $1,078,000 is disappointing as it falls $180,800 (or 14.4%) below budget and $774,800 (or 41.8%) below expectation.

 

While Sales may argue that they pursued an aggressive marketing campaign to achieve a 20% increase in sales volume, it is uncertain if this increase was due to greater advertising and promotion or reduced price. True to the old adage, we are not sure which component of the marketing campaign – promotion or price caused the sales volume to rise.

 

However, to aid the decision-making process for such situations in the future, I compared 3 scenarios based on past information. I assumed that production department would have been able to keep the overhead down to $1,026,000 in all scenarios as it actually did. I also assumed that sufficient demand exists for Safety Auto to sell 15,000 units per month with regular marketing programs and prices.

·        Scenario 1 – The firm pursues an aggressive marketing strategy and is able to increase sales to 108,000 units without compromising price per unit. The expected operating profit here is $15 per unit or a total of $1,618,000..

·        Scenario 2 – The firm pursues the original plan and sells 90,000 units at $70 per unit. This results in an operating profit of $14.6 per unit or a total of $1,314,000.

·        Scenario 3 – The firm performs the same marketing activities as planned/budgeted but reduces the price to $65 per unit, thus causing the sales to rise to 108,000 units. This leads to an operating profit of $12 per unit or $1,296,000.

See Appendix B for computations. While each scenario assumes that aggressive promotion and pricing are independent of each other, I believe that this is a reasonable assumption. Pricing is a major factor because:

At the same time, the effect of pricing can be downplayed by marketing campaigns as follows:

·        The safety of children is the primary concern of all parents

·         The product could be used over and over by first-time parents for their second or third child…

·        Emphasizing the quality of our product over the competition could easily lure customers in light of the previous two factors without having to reduce the price.

 

Recommendation

Based on the above analysis which isolates each marketing activity and gives us an opportunity to enhance profits compared to the original budget while tracking marketing effectiveness at the same time, I would like to recommend that Safety Auto implement Scenario 1 on a test basis for the next 6 months since it has the highest potential for return on sales. Subsequently should the strategy fail, we could always revert to budgeted sales of 90,000 at $70 per unit or reduce prices gradually to determine the optimum price customers are willing to pay for our product.

 

Alternative Action

To avoid such disappointment in the future, Safety Auto should implement a more rigorous control by holding performance reviews on a monthly basis. This would enable us to monitor performance ahead of time and make educated decisions using sensitivity analysis or take corrective steps rather than analyzing poor results afterwards.

 

 

 

Appendix A: Safety Auto Accessories

 

Variance Analysis

 

 

 

 

 

 

 

 

 

 

 

 

Master Budget

 

Flexible Budget

 

Actual

 

 

Per

Per

 

For Six

For Six

 

Actual

Per

 

 

Month

Unit

 

Months

 Months

 

 Units

Unit

 

 

           15,000

 

 

           90,000

         108,000

 

          108,000

 

 

 

 

 

 

 $70 per unit

 $70 per unit

 

$65 per unit

 

 

 

 

 

 

 

 

 

 

 

 

Sales

 

     70.0

 

       6,300,000

       7,560,000

 

       7,020,000

        65.0

 

 

 

 

 

 

 

 

 

 

 

Variable Materials

          300,000

     20.0

 

       1,800,000

       2,160,000

 

       2,160,000

        20.0

 

Variable Labor

          150,000

     10.0

 

         900,000

       1,080,000

 

       1,134,000

        10.5

 

Variable Overhead

           30,000

       2.0

 

         180,000

         216,000

 

          324,000

         3.0

 

Fixed Overhead

          180,200

     12.0

 

       1,081,200

       1,081,200

 

       1,026,000

         9.5

 

Total Manufacturing Costs

          660,200

     44.0

 

       3,961,200

       4,537,200

 

       4,644,000

        43.0

 

Gross Margin

 

     26.0

 

     2,338,800

     3,022,800

 

      2,376,000

       22.0

 

Variable Nonmanufacturing costs

           75,000

       5.0

 

         450,000

         540,000

 

          648,000

         6.0

 

Fixed Nonmanufacturing costs

          105,000

       7.0

 

         630,000

         630,000

 

          650,000

         6.0

 

Total Nonmanufacturing costs

          180,000

     12.0

 

       1,080,000

       1,170,000

 

       1,298,000

        12.0

 

Total Costs

        840,200

     56.0

 

     5,041,200

     5,707,200

 

      5,942,000

       55.0

 

 

 

 

 

 

 

 

 

 

 

Operating Profit

 

   14.0

 

   1,258,800

   1,852,800

 

   1,078,000

      10.0

 

 

 

Variance

 Per Unit

 

 Total

 Type

 Function

 

 

 

 

 

 

 

 

 

 

 

Price Variance

      (5.0)

 

        (540,000)

 Unfavorable

 Sales

 

 

Labor Variance

      (0.5)

 

          (54,000)

 Unfavorable

 Production

 

 

Variable Manufacturing Overhead Variance

 

      (1.0)

 

        (108,000)

 Unfavorable

 Production

 

 

Fixed Manufacturing Overhead Variance

 

 

 

           55,200

 Favorable

 Production

 

 

Variable Nonmanufacturing costs Variance

 

      (1.0)

 

        (108,000)

 Unfavorable

 Sales

 

 

Fixed Nonmanufacturing costs Variance

 

 

 

          (20,000)

 Unfavorable

 Sales

 

 

 

 

 

 

 

 

 

 

Total Variance

 

 

 

        (774,800)

 Unfavorable

 

 

 

 

 

Appendix B:Safety Auto Accessories

 

 

Sensivity Analysis

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Scenario 1

 

Scenario 2 = Original Plan

 

Scenario 3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$70 Per Unit

Per

 

$70 Per Unit

Per

 

 $65 Per Unit

Per

 

 

 

          108,000

Unit

 

           90,000

Unit

 

          108,000

Unit

 

 

 

 

 

 

 

 

 

 

 

 

 

Sales

       7,560,000

     70.0

 

       6,300,000

               70.0

 

       7,020,000

        65.0

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable Materials

       2,160,000

     20.0

 

       1,800,000

               20.0

 

       2,160,000

        20.0

 

 

Variable Labor

       1,134,000

     10.5

 

         900,000

               10.0

 

       1,134,000

        10.5

 

 

Variable Overhead

          324,000

       3.0

 

         180,000

                2.0

 

          324,000

         3.0

 

 

Fixed Overhead

       1,026,000

       9.5

 

       1,026,000

               11.4

 

       1,026,000

         9.5

 

 

Total Manufacturing Costs

       4,644,000

     43.0

 

       3,906,000

               43.4

 

       4,644,000

        43.0

 

 

Gross Margin

     2,916,000

        27

 

     2,394,000

                 27

 

      2,376,000

          22

 

 

Variable Nonmanufacturing costs

          648,000

       6.0

 

         450,000

                5.0

 

          450,000

         4.2

 

 

Fixed Nonmanufacturing costs

          650,000

       6.0

 

         630,000

                7.0

 

          630,000

         5.8

 

 

Total Nonmanufacturing costs

       1,298,000

     12.0

 

       1,080,000

               12.0

 

       1,080,000

        10.0

 

 

Total Costs

     5,942,000

     55.0

 

     4,986,000

              55.4

 

      5,724,000

       53.0

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Profit

   1,618,000

   15.0

 

   1,314,000

             14.6

 

   1,296,000

      12.0

 

 

 

 

 

 

 

 

 

 

 

 

 

Assumptions:

 

 

 

 

 

 

 

 

 

 

Scenario 1 - Due to aggressive marketing, Safety Auto would have gained additional sale of 18,000 units without reducing the price to $65 per unit

 

 

Scenario 2 - Safety Auto would have produced and sold as planned, I.e. 90,000 units at $70 per unit

 

 

 

 

 

Scenario 3 - Safety Auto would not have pursued aggressive marketing but would have additional sales of 18,000 units due to reduced price of $65 per unit

 

 

 

 

 

 

 

 

 

 

 

 

 

Assuming that in all 3 scenarios, production would have achieved the efficiency that it actually achieved and thus would have a fixed overhead of 1,026,000

 

 

Assuming that a demand exists for 15,000 units without having to step up marketing or reducing price.

 

 

 

 

 

Assuming that price reduction and aggressive promotion are capable of producing results independent of each other.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 Appendix B