Chapter 11 (B): Break-Even Analysis and Decision Making

When assessing potential marketing opportunities that may help strengthen or grow the business, Famoso must consider a variety of factors. These include how these opportunities fit with their overall marketing objectives and strategy, the situation (e.g. internal strengths and weaknesses plus factors arising from the industry and competitive environment, customer needs and wants, and relevant macro-environment factors (e.g. culture, demographics, etc.). Crucially, Famoso also must assess the potential financial implications of such opportunities. In this case, we consider three hypothetical marketing opportunities using concepts in the Break-Even Analysis and Decision-Making sections of Chapter 11.Note that all figures provided for this case are hypothetical. Further, while Famoso operates as a franchisor, and therefore does not recognize all revenues or costs, for simplicity, in this case we will examine Famoso as a wholly corporate-owned and operated restaurant chain. Using industry averages for fast casual / premium casual dining, assume that Famoso's overall base revenues this year across 25 locations will be $25 million, cost of goods sold (food and beverages) is 30% of revenue, variable labour costs (e.g. restaurant staff) are also 30% of revenue, marketing costs are $1 million, occupancy and equipment costs are $5 million, and home office administration costs are $2 million. Assume average revenue per transaction of $50.

Opportunity 1: Product improvement

Famoso would like to consider taking an even stronger product quality positioning by using organic food ingredients. This is expected to increase food and beverage costs as a percent of sales by 5%. They would make a one-time investment of $100,000 in marketing communications to promote this offering. They believe they could see a sales increase of 10% under this opportunity.

Opportunity 2: Sales promotion

Famoso wants your perspective on a free pizza promotion to generate trial and new customer acquisition. They would market the offer via direct email, using address lists likely to avoid current customers. The campaign would reach 300,000 people at a cost of $75,000. They expect that 1% of those who receive the direct mail/email would take advantage of the offer and spend $25 on their visit beyond the free pizza. For promotion cost purposes, assume that the average retail price of a Famoso pizza is $15. Famoso expects that half of those who participate in the promo would become a "regular" customer, going on to have two more transactions per year.

Opportunity 3: Third-party delivery service

Famoso has decided to consider a new distribution option: rolling out the use of a third-party service such as Just-eat.ca, Skipthedishes.com, or UberEATS for food deliveries. They have been conducting a market test of this service at one of their 25 locations. The test achieved 1,000 deliveries with an average purchase of $25. Famoso pays the third-party service $5 for each delivery and will spend $10,000 on in-store signage to promote the delivery option.

1.Given the hypothetical information provided, what is Famoso's overall break-even point in units? What is this as a percent of their current transaction volume? For this kind of business, units would be the number of tables served / transactions.

2.What is the break-even point in units for the product improvement idea (Opportunity 1)? What percentage sales increase is needed to achieve this break even?

3.What is the incremental transaction volume and variable cost of Opportunity 2?

4.What are the fixed costs of Opportunity 3? Is there a risk related to this investment?

5.Construct a basic income statement for Famoso's current business using the hypothetical information provided. A basic income statement would include line items such as revenue, variable costs, gross margin, fixed costs and net margin. It is useful to also note the average unit revenue and number of units (e.g. transactions) above the income statement to see "how" the revenue occurs.

a)How many transactions did Famoso have last year?

b)What is Famoso's current net margin in dollar and as a percent of sales?

6.Now create new columns next to your basic income statement for each of the three opportunities. In doing so, consider that each opportunity changes one or more of the following: the total number of transactions, the average transaction value, variable costs, fixed costs. The result of these changes will impact Famoso's overall revenues, margin dollars and percentage values.

a)Which of the opportunities are expected to result in the highest and lowest revenue gains? Be sure to discuss the revenue changes in percentage terms.

b)Which of the opportunities results in the worst net margin outcome?

c)Consider the three opportunities based not only on the quantitative analysis performed, but also on the qualitative considerations noted at the start of this caselet and long-term quantitative considerations. Given this more fulsome assessment, which opportunity would you recommend Famoso management prioritizes? Why?