Pops, Incorporated Managerial Accounting as a Strategic Decision Tool BACKGROUND Paulo Pops Gigliotti emigrated from Italy and settled in Dayton, Ohio. In Italy, Mr. Gigliotti had earned both a bachelors and masters degree in food chemistry and worked for several food processing companies. Pops came to the United States when his cousin, Guiseppe Manganaro, offered him the position of senior food chemist at Manganaro Foods, a growing producer of Italian cuisine for the American market. Although he enjoyed working with family members, he did not feel challenged by his new job and therefore began tinkering with various experiments at home. Mr. Gigliotti was fascinated by the variety of carbonated beverages available in America. He enjoyed the refreshing sensation caused by carbonation, but felt all of the American soda pops were too sweet and none of them provided the depth of flavor to which he had been accustomed with non-carbonated beverages in Italy. After much experimentation, Mr. Gigliotti developed a formula for a semi-sweet, multiple-fruit-flavored carbonated beverage. After sampling his creation, friends and family alike responded in an overwhelmingly positive manner. Many of them encouraged him to bottle the beverage and sell it locally. Indeed, Mr. Manganaro was so excited about the beverage that he offered to provide the necessary production equipment, facilities, and capital. After much discussion, Mr. Gigliotti and Mr. Manganaro decided to call the beverage Pops Punch and began marketing it in the Dayton area. Consumer response was very strong. Within five years Pops Punch was selling well throughout the Midwest region. To keep up with demand, and to develop a more focused marketing strategy, the cousins detached the beverage operations from Manganaro Foods and established Pops, Incorporated. To compete more directly in the non-cola carbonated soft drink market; Mr. Gigliotti developed several individual fruit-flavored sodas, which were marketed under the Pops (Orange / Grape / Strawberry / Cherry) Soda brand name. This strategy proved to be highly successful and after five years, Pops, Inc. began selling its beverages on a nation-wide basis. Over the next 20 years, Pops, Inc. failed to introduce any new products, but experienced steady growth in both sales and profits from the base line-up. During this time period, the company achieved a respectable 4.7% share of the non-cola market and subsequently made its first public offering. After nearly 35 years in business Mr. Gigliotti and Mr. Manganaro both retired and sold all of their holdings. For the next eight years Mr. Gigliottis son, Paulo, Jr., served as chief executive officer, but was recently forced to resign after failing to achieve unit and dollar sales growth. Michael Newberg, formerly the firms chief financial officer, has been appointed CEO and charged with growing the company. CURRENT SITUATION Upon assuming his new responsibilities, Mr. Newberg and his management team performed a thorough S.W.O.T. analysis. The corporate history and culture had long emphasized slow gradual change. They concluded the company possessed neither the core competencies nor the capacity to change that would be necessary to diversify into an entirely new industry. Accordingly, Pops, Inc. would need to devise a new strategy by which to achieve growth within the soft drink industry. The team carefully considered several alternative ways of revamping its strategy within the non-cola market, but none of them seemed to have the potential for the magnitude of growth the team desired. The team then began to consider the unthinkable the possibility of entering the cola market. Although the risks were high, so were the possible rewards with each market share percentage point in the domestic soda market worth approximately $500 Million in annual retail sales. Under Mr. Newbergs leadership, Pops, Inc. began the process of developing a strategy with which to compete directly with the giants of the Cola industry. The research and development team created a formula for Pops Cola that performed very well against Pepsi and Coke in national blind taste tests. Ecstatic about these results, Mr. Newberg recently met with a group of venture capitalists in an effort to gain financing necessary to launch the new brand. The venture capitalists were intrigued by the idea, were impressed with the preliminary marketing research results, and believed Pops, Inc. possessed several requisite strengths. However, they highlighted the fact that entering the cola war was a very different battle-field than the non-cola market in terms of the (a) strength of the competition, (b) ferocity of the battles fought, and (c) resources required for successful marketing. In particular, the venture capitalist had several concerns regarding formula costs, economies of scale, and price points. In order to provide the necessary information in these areas, Mr. Newberg has assigned you to the project described below. COST ESTIMATION PROJECT Mr. Newberg has requested that you analyze the cost of making Pops Cola and then compare that cost to the current price points offered by Coke and Pepsi on both the 12 Pack of 355ml Cans and the 2 Liter Bottle. Your predecessor recently left the company, but has already pulled together the raw cost data you will need to complete the project. Sales Projections Over the past 12 months the corporation has been evaluating the product under the brand name Pops Cola in a Denver test market. Lacking any specific pricing expertise the company matched the on-shelf pricing of Coke and Pepsi, and determined the following sales estimates. Sales / Year Pops 12 pack (355ml/12 Cans) 100,000,000 Cases Pops 2 Liter 200,000,000 Bottles Raw Material Costs POPS TOP - SECRET FORMULA Ingredient % in Formula Cost Per Liter of Ingredient* Carbonated Water 73.0% $0.08 High Fructose Corn Syrup 11.2% $0.49 Sugar 6.3% $0.37 Carmel Color 3.0% $1.40 Phosphoric Acid 2.7% $0.10 Caffeine 2.1% $0.12 Citric Acid 1.1% $0.15 Cola Flavor 0.6% $4.11 *Costs are delivered prices to the Plant Based on a conversation with the engineering staff the 355-ml cans need to be filled at 357 ml to avoid under-pack, while 2 Liter bottles need to be filled at 2.008 Liters per bottle. In addition to overfill, the manufacturing engineers expect to incur a 3% loss of raw materials during the making phase of production. Packing Material Costs 355 ml Can $ 25 / 1000 Cans 355 ml Lid/with opener $ 7 / 1000 Lids 12 Pack Carton $ 170 / 1000 Cartons 2 Liter Bottle $ 120 / 1000 Bottles 2 Liter Injected Molded Lid $ 25 / 1000 Lids Manufacturing engineers estimate that approximately 2% of all packing materials will be damaged/lost through production and warehousing. In addition to these costs, Pops will additionally need to purchase several new molds for 2-Liter Bottles and Lids at a total cost of $2,000,000. (Amortized Straight line over 3 Years.) The Company considers these expenses a part of Packing Materials and charges all bottle mold amortization to only the 2-Liter Bottles. Manufacturing Expense Pops fruit-flavored soda volume has maximized the capacity in the current production facilities. Pops, Inc. has decided to avoid the hassle associated with building a new plant and utilize a contract manufacturer to produce Pops Cola. After investigating several contract manufacturers, the purchasing department selected Shull Enterprises based on their ability to meet rigorous quality measures at a competitive price. Shull Enterprises will require a $1.5 Million Supplier Advance for new equipment (Pops, Inc. expects the equipment to last three years and recommends using straight-line amortization for all Supplier Advances.) In addition to these costs Shull will charge the following fees. Note that both products will be charged a fee for the making and packing process. Making Fee $ .035 / Liter Processing (Making Fee is applicable for both Can & 2 Liter Processing) Packing Fee $ .015 / Can Bottling $ .040 / 2 Liter Bottling Distribution Pops, Inc. has decided not to invest in the extensive sales/distribution system of its competitors. Instead Pops, Inc. will deliver its products in full truckloads directly to its customers distribution warehouses. Distribution costs should be allocated based on space utilization. The warehouse supervisor has pulled together the following assumptions: 80 of the 12 Pack Containers fit on a single Pallet 250 of the 2 Liter Bottles fit on a single Pallet 48 Pallets of either size fit on a normal truck The Distribution Coordinator estimates that the average cost for a trucking company to deliver a full truckload is $1,000/Truckload. Additionally, a one-time cost of $10 / Pallet will be charged for Storage and Handling at the warehouse. Other Fixed Costs Several departments will require additional resources on a long-term basis to appropriately staff the additional requirements of the new brand. Incremental Wages and benefits for incremental Purchasing/Planning Personnel amount to $300,000/Year. Additional non-manufacturing costs are expected to increase as follows: Research and Development $ Million / Year General Administrative $ 1 Million / Year Advertising and Promotional Spending $ 6 Million / Year Allocation Basis Unless otherwise indicated Pops, Incorporated allocates all fixed costs based on sales projections (in Liters) REQUIREMENTS 1. Calculate the Full Product Unit Cost of both the 12 pack and 2-Liter products. Make certain to round to four decimal places and include a detailed analysis by component (Raw Materials, Packing Materials, etc.) 12 Pack Unit Cost: 2-Liter Unit Costs: raw materials $0.4267, packing materials $0.145, Making Fee $0.035, packing fee $0.40, distribution $0.833 2. At what price would Pops, Inc. need to sell the 12 pack and 2-Liter products to the trade in order to provide a 25% profit mark-up for Pops, Inc. shareholders (Pre-Tax & Interest Expense)? 3. At what Price would the trade sell the 2 Liter and 12-pack on-shelf to the final consumer assuming that on average the trade requires a 30% mark-up? 4. (Optional) Visit at least three different channels (i.e. Grocery, Mass/Club Stores, Convenient Stores) that distribute Coke and Pepsi products. For each channel researched list the Store Name, Location, Date, and the promotional pricing currently offered for both the 2-Liter and 12 pack products. If you elect not to complete this requirement, please use the following competitive costs The following should be used with caution as actual pricing will fluctuate depending on the product's location, promotions, and type of channel researched. Channel Examples Average 2Liter Pricing Average 12-Pack Can Pricing Mass / Club Wal-Mart, Target, K-Mart, Sams Club, Costco 1.09 2.69 Grocery Kroger, Ralphs, Winn-Dixie, Super-Value, .99 2.59 Convenience Gas Stations, 7-Eleven 1.19 2.89 5. Based on a comparison between your cost analysis and competitive benchmarking would you recommend that Pops, Inc. enter the Cola Market and compete directly with Coke and Pepsi? Provide a strong justification for your conclusion and discuss what factors influence the difference in on-shelf pricing between Coke & Pepsi and Pops Cola. 6. Prepare an alternative strategy for gaining market share in the beverage industry. Determine whether Pops, Inc. should compete using a Low Cost or a Differentiation strategy, and provide specific examples of how you would implement your strategy.