Denzel Adams runs a carpet cleaning business in Tupelo, Mississippi. Denzel serves two major types of customers: motels and residential homes. Currently, Denzel spends three days each week cleaning the carpets and upholstery in six motels.
He devotes the remaining two days of each week to cleaning the carpets and upholstery of individual residences. Denzel has asked for your help in determining whether he should drop his motel customers and focus solely on residences. Although he likes the steady business the motels provide, he does not like the price—Mina Patel, the owner of the six motels, drives a hard bargain.
You gather the following additional information about Denzel and his business:
• Denzel works 50 weeks a year. He works 10 hours a day Monday through Wednesday, the days he cleans the motels. He works an average of 6 hours a day on Thursday and Friday, the days he cleans residential homes. Denzel does not work weekends. Denzel values his work time at $15 per hour.
• Denzel receives $150 in revenue for each motel he cleans and $80 (on average) in revenue for each house he cleans. Denzel cleans two motels per day on Monday through Wednesday and three houses per day on Thursday and Friday.
• Denzel uses a higher grade cleaner for residences than motels. Denzel figures that he spends $20 in supplies per residential customer and $30 in supplies per motel. Denzel leases his van and other equipment for $7,000 per year. Of this, $1,500 worth of equipment is used only for the motel cleaning jobs.
• Denzel takes out ads in the local newspapers and yellow pages to drum up residential business. (Denzel does not incur advertising costs related to the motels since he’s had the motel business for years.) He estimates this cost at $5,000 per year.
• Because he is under contract, Denzel needs to hire another company to clean the motels during the two weeks that he is on vacation (this company does not clean any residences for Denzel during these two weeks). While Denzel still receives the $ 150 fee per motel, he pays the other cleaning company a flat wage of $175 per motel (the other company uses its own supplies and employees to do all the work).
• Denzel works out of his home and uses his kitchen table as his office. He figures that he spends about $500 a year on supplies and $1,000 on telephone expenses. (These expenses cannot be directly traced to either motels or residences.)
Required:
a. Create an annual contribution margin statement by customer (motels and residences) for Denzel. (Be sure to include $15 per hour for Denzel’s time.)
b. Based on your analysis, should Denzel drop his motel clients? Assume that if he drops the motel business, Denzel can double his residential business if he also doubles his advertising budget. (Be sure to consider the value of any savings in Denzel’s time.)