Case 17-2

Lipman Bottle Company^*

In November 1982 Robert Lipman, vice president of Lipman Bottle Company, was wondering what pricing strategy he should recommend to his father. Located in Albany, New York, Lipman Bottle began operations as a bottle distributor in 1909. Distributors maintain a close working relationship with several major bottle manufacturers (e.g., Owens-Illinois). In return for acting as a sales representative, distributors receive a discount of 5-8 percent off regular prices. This permits distributors to charge users of bottles the same price as if a purchase were made directly from the manufacturer.

Typically, distributors maintain a warehouse with an inventory of commonly used bottles and closures. For special or large orders, distributors arrange for an order to be shipped directly from the manufacturer to the distributor's customer. The manufacturer bills the distributor at factory price less 5-8 percent, and the distributor bills the user at factory price. The advantages for the manufacturer are that a smaller sales force is required and that the distributor will service accounts too small to be served by one manufacturer. The advantages to the user are that the distributor can provide immediate delivery of many items, can offer the advantage of greater buying power, and can serve as an expert who is familiar with bottles and closures from many manufacturers.

In the past 20 years the growing use of plastics had increased business for bottle distributors for at least two reasons. First, the choice of bottles had expanded greatly, making expert advice more valuable. The growing variety of caps, lids, and spray pumps handled by distributors had had a similar effect. A second reason was that distributors began specializing in printing labels directly onto plastic bottles. For many users it was convenient to have both purchasing and printing of plastic bottles handled by one vendor.

THE FIRM

In 1981 Lipman had total sales of $6.2 million, with $500,000 from printing operations. Although the printing operation was only marginally profitable, that service was considered essential for obtaining the more profitable bottle sales. While he realized that printing should not be viewed solely in terms of its profits, Mr. Lipman felt that the firm was offering a valuable service and should price that service to earn a reasonable return.

Last year printing sales were $500,000, and we made $30,000. This year, with the economy worse, we'll sell $450,000 and about break even (Exhibit 1). We have capacity for $1 million. I'm not sure what to do. We're the leading firm in Albany; there is another firm here, about half our size. There's also a new small firm causing trouble with price cutting. Our main competitor has begun to cut prices as well. I hate to, but I have to do the same thing. What worries me is that I don't really know what my prices should be, or which prices to cut. We can charge a little more than the large bottle manufacturers, but not much.

Albany is still a good market even with the competition. There is some price cutting, but I know we can keep our market share. The market here, though, is primarily to industrial users. The real market is New York-New Jersey. That's where the cosmetics and pharmaceutical manufacturers are located. If we could get a couple of shampoo bottles, we'd really grow.

PRICING

The bottle printing industry consists of two primary types of printers aside from distributors. Bottle manufacturers provide printing as a service to customers who purchase their plastic bottles. Price lists are published for printing, with the cost of scrap bottles included in the price. Discounts from list prices are unusual.

The second class of printers is custom decorating houses. Price lists are rarely published, although custom pricing is similar to price lists published by bottle manufacturers, adjusted for difficulty of design. Small discounts, however, are widespread. Since printing is normally done on bottles supplied by the customer, the printer is not responsible for scrap costs, but does not receive a commission on sale of bottles.

Lipman had far more printing capacity than needed to print bottles that the firm sold. Thus, Lipman both published a price list for simple designs and acted as a custom decorating house with special pricing. As shown in Exhibit 2, the price list of a major bottle manufacturer, prices are influenced by three factors: Bottle size (capacity in fluid ounces). Bottles are loaded onto a chuck, then rotated while a silk screen moves horizontally to print directly onto the plastic bottle. Since larger bottles take longer to print and require more warehouse space, prices increase as bottle size increases. Quantity. Each run requires setup time to load ink and a silk screen onto a machine and to set the machine to accept a bottle. In addition, there may be a slight learning effect with each bottle. Thus, cost per bottle decreases as quantity increases. Separations. "Separations" means the number of individual impressions required to print a single bottle. When round bottles are printed, they are rotated horizontally in place in the printing machine. A silk screen with the image to be printed is positioned above the bottle and slides horizontally, synchronized to move at the same speed as the surface of the bottle. Because it rotates 360, a round bottle can be printed front and back in a single machine cycle; i.e., this is a one-separation or single "pass" operation. However, two-sided bottles (commonly called ovals) cannot rotate and thus, generally, only one side can be printed per pass. Printing both front and back of an oval usually requires the entire lot of bottles to be loaded and unloaded twice?one pass per side, or a total of two separations. When decorating a bottle in multiple colors, the artwork must be separated into its color components and a separate screen prepared for each color. To decorate a round bottle in three colors, for example, requires three separate screens and three passes, whereas oval bottles require one screen and one pass per color, per side (a total of six separations, for a three-colored oval).

OPERATIONS The Lipman graphics department included a camera and a developing lab for producing silk screens for printing. Since customers were charged separately for these services, that department was close to a break-even operation. Production operations consisted of 10 printing machines and 8 drying ovens. Bottles were loaded onto a machine for printing, then placed on a conveyor that carried those bottles through a drying oven. Two extra printing machines were available so that they could be rolled to the setup area and prepared for a new job. This permitted greater utilization of costly ovens and the space they occupied. Eight of the machines were semiautomatic. Each bottle had to be loaded into the machine and unloaded onto the dryer belt by hand. Ovals, as described above, had to be printed on one side, allowed to dry, then reloaded for printing on the reverse side. However, one machine had an automatic feature for oval bottles. An operator still had to load and unload that machine manually, but ovals could be printed on both sides before being unloaded into the drying oven. The remaining machine was fully automatic. One operator loaded bottles into a feed hopper, while a second operator observed the printing operations for quality. Oval bottles could be printed on both sides in a single machine cycle and were automatically unloaded into the drying oven.

THE PROBLEM Mr. Lipman asked Thomas Shull, a consultant, to review the firm's pricing policy: We publish a price list for simple jobs printed on our bottles. Since we earn a commission on the bottles, prices aren't all that important for printing. However, I'm not sure that the industry pricing is correct. Prices decrease with order size and increase with bottle size. I think that the decrease in price with order size is reasonable, since we don't have to search for more business to keep our shop full if we have large orders. Bottle size pricing doesn't seem quite right, however. It does take longer to print a large bottle than a small one, but the difference isn't all that great. Maybe the price differential shouldn't be as large as it is. A second factor is the new automatic machines that print both sides of an oval without reloading. Most of our competitors use semiautomatic machines. Maybe we shouldn't be charging as much for ovals with the new machines. The final problem is our custom decorating. We are trying to expand in the New York-New Jersey area, and almost all of the business we might get would be custom decorating. We would have no commissions on bottles, so our profit would be entirely from printing. We would also have to pay freight.

I would like to see our published price list revised to reflect our costs. However, I don't want it to vary greatly from the ones published by major manufacturers.

I would also like to know variable cost for bidding on custom decorating. That won't be published, since I have to adjust each price for difficulty of the order; but I'll use the cost list as a guide. Finally, I'd like costs adjusted for transportation to New York-New Jersey. My goal is to earn 30 percent on sales before tax when we're at capacity. Before preparing price lists, Mr. Shull, Mr. Lipman, and the operations manager agreed that the scrap and shipping costs in Exhibit 3, and the operating information in Exhibit 4, would be used in pricing calculations.

Modified Case 17.2 Questions:

• Calculate the variable costs per thousand bottles for one-separation rounds, two-separation rounds, and two-separation ovals, assuming that all ovals are printed on the machine with the automatic feature for ovals.
• Do one set of calculations for the Albany area (scrap included) and another for New York-New Jersey (freight included, but not scrap).
• Only do one bottle size (the smallest) and assume the average order size is 10,000 bottles.
• Prepare a suggested price list for the Albany area; when completing this section, consider only one-separation rounds and two-separation rounds or ovals, for only the smallest size bottle.
• How did Mr. Lipman's goal of a 30 percent margin (at capacity) affect your price recommendations?

Which products should the company attempt to sell in New York-New Jersey? Explain.

Lipman Bottle Company Income Statement - Printing Operations 10 Months Ended October 31, 1982 Variable w/ machine hours Sales Revenue Expenses: Payroll Supplies Factory Expense Machine Parts Depreciation Rent Heat, Light and power Health Insurance Misc. Insurance Payroll tax Advertising Total Expenses Profit (loss) Total Machine-hours (including setup) Variable cost per machine-hour Total Passes Cost per thousanc passes Variable w/ no. of passes 379,880 216,258 12,458 20,389 4,457 22,505 23,770 20,897 19,176 7,933 14,541 17,793 1,664 381,841* $ $ (1,961) $ 161,258 12,458 5,000 4,457 10,389 17,505 18,897 14,000 7,933 10,000 13,000 234,085 $ 40,812 16,000 14.63 $ 15,500,000 2.63 * scrap costs are not included in the printing dept. expenses Price per Thousand (M) Bottles at Various Order Quantities Bottle Size (oz.) One Separation 0-4.9 5-9.9 10-14.9 15-23.9 24-32.9 Two Separations 0-4.9 5-9.9 10-14.9 Under 10M Order Quantity 25M 50M 10M 40.45 47.00 59.00 68.80 72.40 31.80 36.60 46.00 53.20 56.80 24.40 27.90 35.30 41.00 43.10 21.20 24.10 30.80 35.60 37.90 94.00 106.00 132.00 72.10 82.60 103.00 55.70 63.40 78.90 48.60 55.40 69.00 15-23.9 24-32.9 158.60 162.20 122.80 125.60 94.60 96.10 82.80 84.10 Cost of Scrap One Separation Size (oz.) 0-1 1 1/4 - 4 5-6 7-10 11-12 13-16 17-32 Cost of 1,000 bottles 70 84 94 116 125 130 145 Two Separations Cost of 2% Lost Bottles (scrap) 1.4 1.68 1.88 2.32 2.5 2.6 2.9 Cost of 4 % Lost Bottles (scrap) 2.8 3.36 3.76 4.64 5 5.2 5.8 Cost of Shipping to New York - New Jersey Area Size (oz.) 0-1 1 1/4 - 4 5-6 7-10 11-12 13-16 17-32 Bottles per Cost per 1,000 Truckload Bottles 1040000 1.06 280000 3.93 190000 5.79 145000 7.59 120000 9.17 86000 12.79 42000 26.19 Loss of 2% of Printing 0.5 0.5 0.5 0.5 0.5 0.5 0.5 any Operations 31, 1982 Fixed $ 55,000 5,000 5,000 23,770 2,000 5,176 4,541 4,793 1,664 106,944 100M 250M 20.25 23.40 29.00 34.10 36.10 18.20 20.80 263.10 30.50 32.20 46.50 52.50 66.10 42.40 47.30 59.15 79.00 80.40 Separations Total Cost of Scrap 3.3 3.86 4.26 5.14 5.5 5.7 6.3 70.50 71.40