Effect on Profits of One-Price Approach to Selling Automobiles.

The Sunday New York Times Business Section (October 11, 1992) contained a story

("Moving Out the Cars With a “No-Dicker Sticker," p. 12) about one price auto dealers and the profit effect of using a one price approach. The following questions use material from that story.

Required:

a. Robert Fisher of Reading, Pennsylvania, lowered his average contribution margin on automobiles from $1,100 to $700. Assume he sells 120 cars per month; how much must he cut monthly fixed expenses to make up for the reduced margin?

Use the information from question a to answer the following. How many additional units must Robert Fisher sell to make the same profit he made before the price change assuming his monthly fixed expenses remain the same as they were before the price change?

How much will Robert's monthly profit increase if he increases monthly sales to 207 units with the new price while reducing monthly fixed costs by $8,000?

"Mark Eddins instituted no-haggle selling in March at his Chevrolet-Mazda and Oldsmobile-Cadillac-Jeep/Eagle showrooms in Texas. Sales are up 50 percent at all franchises, he said." If Mark was selling 2,000 units per month at an average contribution margin of $1,200 before he switched to the no-haggle pricing approach, how much margin must each vehicle produce under the new system if Mark wants to earn the same monthly profit he generated before adopting the new pricing policy. Assume his fixed costs are the same after the change in pricing policy as they were before the change and that the 50% sales increase refers to unit sales.

Compute the break-even point in units for a dealer who incurs $66,000 per month in fixed costs and sells cars for $500 above dealer cost. The manufacturer whose cars he sells pays him a "holdback" of 3% of the suggested list price of the automobile for each car the dealer sells. Assume the average car the dealer sells has a suggested list price of

$20,000.

Assume the dealer in question e currently has six salespersons working for him at an average annual compensation of $18,000 plus commissions of $500 per car sold. In addition each salesperson receives a benefit package that costs the dealer $2,400 per year.

The average automobile sold costs the dealer (net of all discounts and factory refunds, including holdbacks) $17,500 and sells for $19,000. Compute the monthly profit impact of changing to a no-haggle price that drops the average price of the car to § 18,400, that eliminates the entire sales force and replaces them with six customer service representatives who earn $15,000 per year plus annual benefits of $2,400, and that increases unit sales volume 30%. Before changing to the new system, the dealer sold 200 cars per month; under the new system the suggested list price remains at $20,000 per car.

Effects on Profits of Price Cuts.

Compaq announced a variety of price cuts on its machines in September of 1992, and the results were amazing. Sales soared, and the company could not produce products fast enough to meet customer demand. The following requirements are based on a story in the December 14, 1992 issue of Fortune that describes some of the events at Compaq.

Required:

a. Contribution margin before the price cuts was 34% of sales for a typical machine. How much will quarterly profit change if the company reduces prices by 20% and dollar sales double (assume quarterly sales before the price change were $500 million). Assume unit variable costs and company fixed costs remain constant as the price changes.

b. Assume that in addition to all the changes that occur in question

a, Compaq also makes cuts in unit variable costs of 30%. By how much will profits change?

c. Third quarter sales at Compaq increased 50% over sales of the previous quarter to a level of $1.1 billion, and earnings from operations quadrupled from the previous quarter to $72 million. The contribution margin percentage for the quarter was only 28% in contrast to that of 34% for previous quarters. Compute your estimate of quarterly fixed costs for Compaq.

d. By studying and analyzing actual failures, Compaq engineers were able to reduce the burn-in time for new machines from 96 hours to 2 hours. Assume that each computer in the burn-in process requires two square feet of floor space in a manufacturing facility.
How many square feet of manufacturing facility were made available by this change?
Assume the company produces 5,000 units per day.

e. Use your answer to question d to answer this question. Compaq has a backlog of demand for its machines, so production space is at a premium. How much was the change above worth to the company if each square foot of production space generates a quarterly contribution margin of $2,000?

f. "Compaq has totally revamped how it prices its products. In the past, product designers totaled up the cost of all the features they wanted on a machine, figured out which sole supplier would provide each part at what price, and added on a margin like 40%. The total was the price to dealers who typically added another 15% markup.
"Now the process is reversed. Managers first establish what they want the street price to be based on competitive factors. Then they assume a dealer markup, subtract a Compaq gross margin—about 30% today—and instruct the departments of materials, engineering, manufacturing and marketing to resolve among themselves how to allocate the remaining costs to make the product." David Kirkpatrick "The Revolution At Compaq Computer,"
Fortune (December, 14, 1992), p. 86.
Assume you have assembled the following information about a new machine Compag plans to introduce.
Components from Xeijang, Inc. .......... $ 200 Components from Okie Electronics ....... 150 Components from Compaq plant ......... 450 Compute the price Compaq would have charged to its dealers under its old pricing system.
Assume a customer will pay $1,200 for this machine and that dealers still add 15% to their cost to arrive at the retail price. Compute the allowable cost for the components from the Compaq plant if the other components stay at the same cost as that shown above. Hint: The markup on cost is not the same as the markup on sales, e.g., a 15% markup on cost for an item costing $100 represents only about a 13% margin on sales.
i 1.15 = .13