Situation: Culinarian Cookware produces premium performance cookware. It occupied 6. 5% market share, which is the highest among the premium lines. There is a challenge between sales department and marketing department. The sales manger wants to implement the price promotion, because she believes that discount can increase commitment and brand awareness. However, the VP of marketing cannot accept price promotion. He worries that the discount will hurt brand image as premium products. Furthermore, marketing’s consultants also think that discount has a negative impact on company’s profit.
The argument between two departments focuses on the contribution margin. As a result, contribution margin is the key to solving the problem in this case. Approach: The consultant and sales manger use two ways to calculate the variable cost (VC). The consultant (Exhibit 1) added all the expense together, including direct labor cost; raw material cost; administrative cost; manufacturing overhead; advertising & promotion expense and selling expense. However, the sales manager’s variable cost (Exhibit 2) just kept the first two cost of consultant’s.
Obviously, the VC of sales manger is much lower than the consultant’s. Then they applied the formula “(actual units * actual contribution) – (forecast units * normal contribution) = incremental contribution impact”. According to this formula, consultant (Exhibit 3) concluded that the promotion in 2004 lost $ 469,489 in contribution, while the sales mangers boosted that there was an increase up to $ 2, 397,994 in contribution. Which calculation is correct? Neither is right. The key point is that neither of them uses the correct way to calculate the variable cost.
The wrong variable cost will lead to an overestimated or underestimated contribution. The Consultant’ VC included a lot of fixed cost, which should not be added in the VC. For example, advertising & promotion expense usually are seen as fixed cost. It shouldn’t be calculated in the VC. On the contrary, the sales manager VC didn’t account for overhead. Instead, she just added some of the variable costs. For instance, administrative cost; manufacturing overhead and selling expense included both fixed cost and variable cost. Both consultant and sales manager should separate the VC and fixed cost among these expenses.
There are several steps to get the correct contribution impact (Exhibit 4). First, Culinarian should figure out the sales averages from march to may in. In 2004 March to May, Culinarian did the price promotion, so the data has less credibility. However, 2002 & 2003’s date can be used because there are no promotions during these periods. So, average Sales from March to May in 2002 & 2003 is 91,247 + 78,778/2 = 85,012. Next step, Culinarian should calculate the forecast units. It can base on the historical growth. The historical growth rate is 21% here. According to this way, the forecast units should be 102,865.
Then, Culinarian can get the average variable costs according to consultant and sales manager’s assumption. The average variable cost is $45. This number is an estimate, based on the assumption that the consultant overestimated the cost while the sales manager underestimated the cost. Finally, Culinarian can use the formula and get its incremental contribution impact. From this method, Culinarian can have an increase by $432,169 in its contribution. Decision: Culinarian has several promotion choices to capture revenue growth and increase the margin. First, Culinarian can launch more promotions.
Promotion can help Culinarian to reach its goal in a short period. Second, Culinarian can increase more distributors or open its own stores. More distributors may increase the consumer base and sales. Third, Culinarian can keep the current situation. The new calculation shows that Culinarian had an increase by $432,169 in its contribution after promotion. Obviously, promotion proved to be useful. Culinarian should make a decision to do the promotions. Promotion can increase Culinarian’s consumer base and brand awareness. It also can contribute a lot to the revenue. Culinarian can compound gift and price promotion.
Culinarian can launch gift promotion in the peak month–June and December. People will buy cookware as the wedding or charismas gifts. If gift from Culinarian can “steal” consumers from its competitor. Culinarian also can have irregular price promotion. People will not keep waiting for sales, because they don’t know when Culinarian has the discount. As a result, this kind of promotion has less effect on future orders. Culinarian will not worry to overdraw the market consumption. Exhibit 1 Consultant [pic] Exhibit 2 Sales manager [pic] Exhibit 3 Promotion Evaluation Parameters [pic] Exhibit 3 IMC Promotion Evaluation Alternative [pic]