Swing v. Steady

Swing Manufacturing and Steady Manufacturing both operate in the widget industry, but with radically

different cost structures. Swing is a capital-intensive, automated manufacturer, while Steady is a laborintensive

"job-shop." Monthly operating data are as follows:

Swing Manufacturing Steady Manufacturing

Sales 5,000 units 5,000 units

Price $10.00 $10.00

Variable $2.50 $5.50

Fixed Cost $35,000/month $20,000/month

Full Cost $9.50 $9.50

Current Profit $2,500/month $2,500/month

Swing and Steady both currently have equal (50%) shares of the market. Each is evaluating

opportunities to enhance profits. One opportunity involves selling to a low-value, but potentially highvolume,

market segment not currently served by either company. The potential increase in sales for

either company entering that market alone would be at least 40% (2000 units). If they both entered, the

potential sales increase would be at least 20% for each of them. Unfortunately, reaching that market

would require pricing at $8.50, 15% below current levels.

(a) If either company could costlessly segment the market for pricing (that is, charge the 15% lower

price only to this new segment without undermining the prices charged to current customers), how

much additional profitability could each company earn by achieving a 20% and a 40% increase in

sales? Would you recommend that either or both companies pursue this opportunity?

(b) In fact, neither Swing nor Steady can effectively segment this market (each must charge one price to

everyone).

1. Calculate the break-even sales changes for this opportunity for each of them.

2. Calculate the changes in profit for a 40% increase in sales.

(c) Which competitor is better positioned to take advantage of this opportunity? Assuming that neither

company can segment the market, what advice would you give to Swing and to Steady regarding

this opportunity?

(d) Swing took the opportunity to enter the new market segment, cutting its prices 15% to do so. Consequently, Swing's unit sales are now 7,000 monthly at a price of $8.50. Steady, however, was belatedly forced to match Swing's price in order to retain its customers in this market. Steady's management believes that it would have lost at least 60% of its business had it failed to reduce its price. Unfortunately, Steady is now operating at a loss.

(d) Was Steady's decision to cut price financially justified? Assume that if Steady were to withdraw from this market, it could reduce its fixed costs by half (by giving up its lease on the rental property and eliminating other sundry costs). The other half of its fixed cost is debt service on assets with no resale value.

(e) Given the financial information that you have at this point, would Steady be better off to withdraw from this market altogether?

Fortunately, crisis has a way of focusing the mind. After reading Michael Porter's Competitive Advantage, Steady's management decided to analyze the entire value chain of which widgets are a part. Steady learned that at least 3500 units of current market demand comes from companies that must modify the commodity widget they buy to meet their specific needs.

This creates an opportunity for Steady to integrate forward, casting specialized widgets to meet the needs of each user. While Steady's costs of manufacturing will rise substantially, the increase will be less than what buyers currently spend to modify the generic widgets. To make specialized widgets, Steady would need to invest in additional fixed capital generating a fixed charge of $3,000 monthly and refocus its entire operation to produce specialized widgets exclusively. Steady's management believes that it could charge prices at least $6.00 higher than the going commodity price, but would incur additional variable cost of $3.00 more per unit. [Note: this decision would preclude Steady's continued production of generic widgets, unless of course Steady opted to buy all new buildings and equipment for the new operation, which would generate incremental fixed costs of $23,000 monthly rather than the $3,000 assumed above.]

(f) What is the minimum monthly unit sales that Steady would require to make it more profitable as a specialty widget manufacturer than it is currently as a commodity manufacturer?

(g) How much additional profit would Steady earn as a specialty widget, given its minimum case scenario of 3500 specialty units at a $6.00 price premium?

Swing v. Steady1 Swing Manufacturing and Steady Manufacturing both operate in the widget industry, but with radically different cost structures. Swing is a capital-intensive, automated manufacturer, while Steady is a laborintensive "job-shop." Monthly operating data are as follows: Sales Price Variable Fixed Cost Full Cost Current Profit Swing Manufacturing 5,000 units $10.00 $2.50 $35,000/month $9.50 $2,500/month Steady Manufacturing 5,000 units $10.00 $5.50 $20,000/month $9.50 $2,500/month Please answer the following questions. DO NOT calculate the profitability of these changes by calculating profit levels before and after the changes, spreadsheet style. That approach would take four times longer and not show me that you understand the formulas. Use the simple concept of contribution to calculate just the change in profits due to the proposed price changes. Swing and Steady both currently have equal (50%) shares of the market. Each is evaluating opportunities to enhance profits. One opportunity involves selling to a low-value, but potentially highvolume, market segment not currently served by either company. The potential increase in sales for either company entering that market alone would be at least 40% (2000 units). If they both entered, the potential sales increase would be at least 20% for each of them. Unfortunately, reaching that market would require pricing at $8.50, 15% below current levels. (a) If either company could costlessly segment the market for pricing (that is, charge the 15% lower price only to this new segment without undermining the prices charged to current customers), how much additional profitability could each company earn by achieving a 20% and a 40% increase in sales? Would you recommend that either or both companies pursue this opportunity? (b) In fact, neither Swing nor Steady can effectively segment this market (each must charge one price to everyone). Calculate the break-even sales changes for this opportunity for each of them. Calculate the changes in profit for a 40% increase in sales. Briefly explain why this answer differs from your answer in part a. (c) Which competitor is better positioned to take advantage of this opportunity? Assuming that neither company can segment the market, what advice would you give to Swing and to Steady regarding this opportunity? Swing took the opportunity to enter the new market segment, cutting its prices 15% to do so. Consequently, Swing's unit sales are now 7,000 monthly at a price of $8.50. Steady, however, was belatedly forced to match Swing's price in order to retain its customers in this market. Steady's management believes that it would have lost at least 60% of its business had it failed to reduce its price. Unfortunately, Steady is now operating at a loss. (d) Was Steady's decision to cut price financially justified? Assume that if Steady were to withdraw from this market, it could reduce its fixed costs by half (by giving up its lease on the rental property and eliminating other sundry costs). The other half of its fixed cost is debt service on assets with no resale value. 1 Source: Nagle and Hogan, The Strategy and Tactics of Pricing Instructors Manual, 4th Edition (2006). (e) Given the financial information that you have at this point, would Steady be better off to withdraw from this market altogether? Fortunately, crisis has a way of focusing the mind. After reading Michael Porter's Competitive Advantage, Steady's management decided to analyze the entire value chain of which widgets are a part. Steady learned that at least 3500 units of current market demand comes from companies that must modify the commodity widget they buy to meet their specific needs. This creates an opportunity for Steady to integrate forward, casting specialized widgets to meet the needs of each user. While Steady's costs of manufacturing will rise substantially, the increase will be less than what buyers currently spend to modify the generic widgets. To make specialized widgets, Steady would need to invest in additional fixed capital generating a fixed charge of $3,000 monthly and refocus its entire operation to produce specialized widgets exclusively. Steady's management believes that it could charge prices at least $6.00 higher than the going commodity price, but would incur additional variable cost of $3.00 more per unit. [Note: this decision would preclude Steady's continued production of generic widgets, unless of course Steady opted to buy all new buildings and equipment for the new operation, which would generate incremental fixed costs of $23,000 monthly rather than the $3,000 assumed above.] (f) What is the minimum monthly unit sales that Steady would require to make it more profitable as a specialty widget manufacturer than it is currently as a commodity manufacturer? (g) How much additional profit would Steady earn as a specialty widget, given its minimum case scenario of 3500 specialty units at a $6.00 price premium? Hints: 1-Do this assignment in terms of changes in prices, volumes, etc., and not in terms of total costs and profits, etc. 2-Question A refers to new business that neither company has served before. 3-Question C: Think in terms of margins rather than costs. 4-Question D: The baseline for this calculation for Steady should be the same as its baseline in Question B. I'll let you figure out why that is. 5-Question E: Previous questions have dealt with doing business (price changes, etc.); this question deals with being in business. 6-Question F: Please assume that Steady is now operating at a baseline of $8.50 (which they decided to do in Question D), not the baseline of $10.00 assumed in Questions A and B earlier