Pittman Company is a small but growing manufacturer of telecommunications equipment. The company has no sales force of its own; rather, it relies on independent sales agents to market its products. These agents are paid a sales commission of 15% for all items sold.

Barbara Cheney, Pittmans controller, just prepared the companys budgeted income statement for next year as follows:

Pittman CompanyBudgeted Income StatementFor the Year Ended December 31Sales$ 22,000,000Manufacturing expenses:Variable$ 9,900,000Fixed overhead3,080,00012,980,000Gross margin9,020,000Selling and administrative expenses:Commissions to agents3,300,000Fixed marketing expenses154,000*Fixed administrative expenses2,040,0005,494,000Net operating income3,526,000Fixed interest expenses770,000Income before income taxes2,756,000Income taxes (30%)826,800Net income$ 1,929,200

*Primarily depreciation on storage facilities.

As Barbara handed the statement to Karl Vecci, Pittmans president, she commented, I went ahead and used the agents 15% commission rate in completing these statements, but weve just learned they refuse to handle our products next year unless we increase the commission rate to 20%.

Thats the last straw, Karl replied angrily. Those agents have been demanding more and more, and this time theyve gone too far. How can they possibly defend a 20% commission rate?

They claim after paying for advertising, travel, and the other costs of promotion, theres nothing left over for profit, replied Barbara.

Thats ridiculous, retorted Karl. And I also say its time we dumped those guys and got our own sales force. Can you get your people to work up some cost figures for us to look at?

Weve already worked them up, said Barbara. Several companies we know of pay a 7.5% commission to their own salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed expenses would increase by $3,300,000 per year, but that would be more than offset by the $4,400,000 (20% $22,000,000) we would avoid on agents commissions.

The breakdown of the $3,300,000 cost follows:

Salaries:Sales manager$ 137,500Salespersons825,000Travel and entertainment550,000Advertising1,787,500Total$ 3,300,000

Super, replied Karl. And I noticed the $3,300,000 equals what were paying the agents under the old 15% commission rate.

Its even better than that, explained Barbara. We can actually save $101,200 a year because thats what were paying our auditors to check out the agents reports. So our overall administrative expenses would be less.

Pull all of these numbers together and well show them to the executive committee tomorrow, said Karl. With the approval of the committee, we can move on the matter immediately.