To: Herbert Waters, Paul Harvey
From: Charl Stander
Date: March 30, 2015
Subject: Cost Analysis and Recommendations
Retain product 103
If we look into the past financials of Superior, we see that product 103 have been operating at a loss in 2004 and 2005 does not look any better. With a loss of 2 million it is hard to keep the product line operating, but there is other factors that needs to be taken into consideration before illuminating a product line from the business.
By computing the contribution margin (Appendix 1) of product 103 we can better see the value of product 103, and the value it adds to the company as a whole. With a contribution margin of 13.92, or 51%, product 103 is not that far off comparing to product 101 that is the highest product contributor of 58% (Appendix 2). More importantly, product 103 should not be dropped because it will cause non variable, and fixed costs to increase. This will cause an increase in fixed costs such as rent for product 101 and 102, laying off workers since their services will not be necessary, and finally decrease profits for the entire company.
Keep up with market demands
Samras is the market leader in the space that Superior is competing in, and they recently announced a price reduction of product 101 from $24.50 to $22.50. This forces Superior to keep up with the industry price for product 101 if Superior do not wish to lose market share. Waters forecast that if Superior stay at $25.50, the unit sales will be 750,000 whereas the price of $22.50 will sell 1,000,000 units. The contribution margin per unit for $22.50 and $25.50 (Appendix 2) is $12.21, and $14.21, respectively. Taking the units into consideration the total contribution margin (Appendix 2) for $22.50 and $25.50 is $10.6 million and $12.2 million respectively.
Running a Sensitivity analysis (Appendix 3) with prices that range between $22.50-$25.50 while taking the unit count into consideration, the price of $22.50 that will have a demand of 1 million units will give superior the highest total contribution margin, and thus Superior should lower its prices for product 101.
Importance of cost systems and profitability
Waters changed the financial statements where it shows the cumulative costs, and the variances of the company actual costs. Why January – June of 2005 look more profitable is because Superior predicted unit prices, and did not adjust the prices to the current market environment. Rent, indirect labor, and depreciation expense were over predicted which was the main reason profitability increased.
Having an effective cost system is crucial for the day to day…