Freezing Out Profit

1.

ISSUES FACED BY COLD CUTS LTD (CC)

i.

Price reduction asked by major custo mer, Secconz

Secconz is CC’s biggest customer   in Singapore and Secconz also the only

local company in Singapore that they sold their major product called FFA (Fuzzy Frost Alpha System) apart from other part supply. Mr. Nelly from Secconz asked Mr. Dali, the Managing director of CC to reduce the selling price of CC’s products. If Mr. Dali did not fulfill Secconz demand to reduce the price, CC may lost their local business because Secconz was their main customer that had been contributed to the company profitability for the past two years as they did charged Secconz with high price on the product supply. Their other market is in Europe, however the price for exported product is much cheaper as compared to Secconz as they want to compete with international market. Obviously, they may loose their local market at any time, as their only customer is no longer doing business with them. It would be hassle to find new agreement with other customer as if Secconz decide to manufacture FFA in house, it will affect the CC’s business in long run and Secconz become their new competitor in the market. In the other hand, if they follow the Secconz demand to reduce the price, their profitability may decrease. Therefore, they have to plan new strategic planning to maintain the same profitability.

ii.

Anti-dum ping activity investigation towards their plant in China

The China’s authority   visited their plant in China in connection with Antidumping activities. This is due to the US International Trade Commission has begun investigation on their export from China to US in which they claimed that the pricing for CC’s product are much lower t han the fair value. Anti-dumping that investigated by the officer is intended to discourage importation and sale of foreign-made goods at prices substantially below domestic prices or is below its cost of production for the same items. If the government officer found their plant in China to be guilty, they will either have to ceased their operation or will be imposed to pay a huge anti-dumping tax on them. It will be the biggest impact for CC as their business may bankrupt because their plant was ceased to operate and unable to do the production process. In the other hand, if they are not asked to close down the operation, they have to pay a huge anti-dumping tax. Furthermore Mr. Rithisak wants to solve the problem by giving a bribe to the investigation officer.

2. POTENTIAL ISSUES i.

ACTIONS OR RECOMMENDATIONS TO SOLVE THE

Recomm endations to solve issues on price reduction asked by Secconz

Current action 

CC should agree to lower the price of product supply to Secconz. This may reduce CC profitability in a short run, however CC still can cover their production cost and get their desired profit in a long run. Therefore, to secure their future business relationship with Secconz, along with the price reduction, CC should make long-term agreement with Secconz to ensure CC profitability in long run and to mitigate their risk and exposure for future sustain in the business. Current selling price is $140; let say the selling price reduce to $135. The sales margin will be reducing by 0.7% and return on investment will be reducing by 1.5% only. It may reduce the expected annual sales by $125,000 only. This will be elaborate further in the feasibility analysis on cost versus profit under financial calculation on the next pages. Future action

Since Cold Cuts tend to sell the same product and reduce selling price, Cold Cuts must deduct the cost of the operation department such as reducing employees, specially the salaries of indirect employees such as plant managers, foremen, supervisors and quality control inspectors. Thus, they are still able to maintain their profitability, as lower costs would be reflected in a higher profit margin. If Cold Cuts could lower their cost, they have a strategic advantage in a competitive price war, they have the ability to undercut their competitors by cutting prices in order to gain market share. For example by reducing factory overhead by $4 per unit, the t otal cost will reduce to $54 per unit at the new selling price of $135. Cold Cuts can improve the sales margin from 48.06% to 49.3% percent, as the increasing total margin from $4,025,000 to $4,125,000. (The details will be elaborate further in the next pages). In short, by reducing selling price to RM135, it will help Cold Cuts to build good relationship with Secconz as both company will commit to more modest and flexible pricing models for long term contracts in order to mitigate their risk and exposure. Other financial analysis should be done on other cost that could be cut to maintain the same profit as if the price is not increased. For example lowering the transportation cost whereby CC may ask Secconz to provide their own transport to pick up the FFA system since Secconz is the only local customer that CC sold their FFA. Furthermore, to lower the administrative cost could also be done. CC needs to search for new local customers for FFA system; this is to safeguard the business by having other business relationship apart from Secconz.

ii.

Recomm endations to solve Anti-dum ping activity investigation towards their plantation in China

Current action

Mr. Dali, along with the finance manager and the accountant should seat together to discuss on this matter. They should have proper plan on how to answer the officer queries in relation with anti-dumping activities to ensure that they are not guilty. They should explain to the officer on how they can come out with that pricing strategy for Europe market as on the group basis the machines have already been written down. If possible Mr. Dali should send their accountant to China to answer regarding this issues. In the other hand, Mr. Dali should advice Mr. Rithisak for not giving a bribe to the authority as giving a bribe is illegal and may create other dangerous impact to the company business and reputation, and it is unethical behavior. Mr. Dali should also prepare with the possibility of being imposed to pay a huge anti-dumping tax. By getting ready, they may saving money for this circumstances and they may ready to account for contingent liability in their financial statement in case, they are found guilty in anti-dumping activities. Furthermore, they should alert with worldwide current issues, as their market is international. They should alert with issued raised by European Union and World Trade Organization (WTO) in relation with anti dumping agreement to ensure the authority is conducting their inspection in relation with fair value comparison as stated by WTO rules on AntiDumping Agreement. Future action

Many developing countries nowadays are very strict with anti dumping activities as the dumped imports are causing injury to the their economic country. Therefore, to future sustain in the market, CC should increase the price for their international market, this is to avoid any legal action towards them in relation with anti dumping activities. They should make research on the international average fair value price in fixing the pricing strategy of their product. The price should be in the range of international average fair value of the same product and it should not too lower that can trigger the foreign authority to investigate their plant in China. By increasing the selling price, CC may increase their profitability, as the margin is increase. To attract potential buyer, they should produce a quality product that beyond the average standard. Enhancing after sales services and continuous improvement in their production could also be done to stay competitive in the market, as lower pricing strategy to enter the market is not relevant anymore in their product.

3(a)

FINANCIAL ANALYSIS

Situation 1: if Cold Cuts would like to keep Secconz as a client

If CC would like to keep Secconz as a client, therefore they need to reduce selling price. If the selling price reduces from RM 140 to RM135, the company profit will be as below: PRODUCT COSTING OF FUZZY FROST ALPHA SALE TO SECCONZ Selling Price from Cold Cuts to Secconz Direct Materials Direct Labour Direct Costs Factory overheads Manufacturing cost Margin before machinery deprecation and administration costs

Per unit (S)

Per unit (S)

135 40 10 50 8 58 77

Therefore changes in CC total sales and total profit are as below:  Annual Sales Secconz = 25,000 units X $135 = $3,375,000 European customer = 50,000 units X $100 = $5,000,000 TOTAL SALES

$8,375,000

Margin Secconz = 25,000 units X $77 = 1,925,000 European = 50,000 units X $42 =2,100,000 TOTAL MARGIN

$4,025,000

Situation 2: If Cold Cuts stop selling the FFA to Secconz

If Cold Cuts would like to stop selling the FFA to Secconz, the sales will only come from European customer. Therefore CC total annual sales and t otal annual profit would be as below: TOTAL SALES = 50,000 units X $100

$5,000,000

TOTAL MARGIN = 50,000 units X $42

$2,100,000

Based on situation above, the financial performance comparison shown as below: Situation Financial Performance Total Sales Total Margin Sales Margin = Total Margin /Sales Revenue Capital Turnover  = Sales Revenue/Invest ed Capital Return on Investment (ROI) = Profit/Invested Capital

Situation 1 Situation 2 Original Situation (Price @ $135) (Without Seconz) (Price @ $140) $8,500,000 $8,375,000 $5,000,000 $4,150,000 $4,025,000 $2,100,000 $4,150,000/$8,500,0 $4,025,000/$8,375,0 $2,100,000/$5,000,0 00 00 00 =48.8% =48.06% =42%

$8,500,000/ $8,300,000 =102

$8,375,000/ $8,300,000 =101

$5,000,000/ $8,300,000 = 60

4,150,000/ $8,300,000 =50%

$4,025,000/ $8,300,000 = 48.5%

$2,100,000/ $8,300,000 =25%

Conclusion and recommendations i.

To reduce selling price to $135

Secconz is a major customer of Cold Cuts, losing of Secconz will give a big impact to the financial of the company especially in their revenue. By looking at the above comparison, the revenue will drop about one third in which $3,500,000 (25,000 units@$140) of the existing revenue stream and it will affect the company profit margin. The sales margin is greater if Cold Cuts going to reduce the price lower to Secconz rather than they stop supply FFA to Secconz. It only reduces by 0.7% as compared to 6.8% reduction in sales margin if they stop business with Secconz. A low sales margin means that the business generates a low level of revenue to pay for operating expenses and net profit. The Capital Turnover measure of how well a company uses its equity to generate revenue. The higher the ratio it is, the more efficiently a company is using its capital. Capital turnover drop from 102 to 60 if Cold Cuts stop selling to Secconz, it show that Cold Cuts not utilizing its working capital to support a given level of sales. The ROI of 48.5% is almost reached ROI 50% from original selling price, $140. It would tell us that for each dollar invested on the average, the segment is generating about 48.5 cents of profit that increased the value of the whole company. If an investment has a positive ROI and there are no other opportunities with a higher ROI, then the investment should be undertaken. Hence, Cold Cuts should continue

keep Secconz as client so that they need to fulfill Secconz order to reduce the selling price as they are CC’s main client.

ii.

To reduce the cost of production

Since Cold Cuts tend to sell the same product and reduce selling price, other alternative that should be undertaken by Cold Cuts is to deduct the cost of production. For example to deduct the cost of operation department such as by reducing employees, especially the salaries of indirect employees such as plant managers, foremen, supervisors and quality control inspectors. Thus, they are still able to maintain their profitability, as lower costs would be reflected in a higher profit margin. Lower cost firms also have a strategic advantage in a competitive price war, they have the ability to undercut their competitors by cutting prices in order to gain market share. For example, Cold Cuts can improve the sales margin from 48.06% to 49.3% by reducing the factory overhead of $4 per unit, whereby the total cost will be reduce to $54 per unit at the reduce selling price of $135. The total margin will be increase from $4,025,000 to $4,125,000, and the revised ROI will be:

Return on Investment (ROI)

= sales margin × capital turnover = 49.3% x 101 = 49.7% ≈ 50%

In short, by reducing selling price to RM135, it will help Cold Cuts to build good relationship with Secconz for future business sustainability, as both company will commit to more modest and flexible pricing models for long term contracts in order to mitigate their risk and exposure.

3(b)

QUALITATIVE ANALYSIS

i.

SWOT Analysis

SWOT is a basic and straightforward model that assesses what an organization can and cannot do as well as its potential opportunities and threats. The method of SWOT analysis is to take the information from an environmental analysis and separate it into internal (strengths and weaknesses) and external issues (opportunities and threats). Once this is completed, SWOT analysis determines what may assist the firm in accomplishing its objectives, and what obstacles must be overcome or minimized to achieve desired results. In this case, the strengths and weaknesses of Cold Cuts Ltd. (CC) can be summarized as follow: a. Strength

Specializing in refrigeration components. The company developed its own brand of refrigeration process technology known as Fuzzy Frost  Alpha system (FFA) Their FFA product has a good quality as compared to other plant produce in China   Their products were exported worldwide c. Opportunity 

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The continuous business relationship with Secconz will give another profitable year for CC since Secconz is their main customer.   CC will able to upgrade FFA technology and consider investing new advanced technology to capture a new market as well as meeting the expectations of Secconz. 

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b. Weaknesses

  The price of the component offered by CC to Secconz is quite high 

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CC doesn’t have a proper pricing

strategy   The cost of manufacturing is higher  The technology of FFA is getting obsoleted 

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d. Threat

  The competitor produce same product with a cheaper price in China. Any improvements became subject to easy copying Secconz might produce a similar technology in-house in the future 

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Recommendations

It is obvious from this analysis that the main weaknesses of CC is in term of the price that they charged to Secconz. Since CC wants to retain Secconz as their main customer, they should consider offering the product in a lower price to Secconz by reducing the cost of factory overhead to maintain their profitability. This is also to avoid Secconz from producing their own similar technology in house where they

might end up being the competitor to CC in the future. In addition, the strength of CC is that they are having the FFA technology that makes them outstanding from other competitor. ii.

Balance Scorecard

The balanced scorecard is a tool that translates an organization’s   mission, objectives and strategies into performance measures that focused around a number of different perspectives. It includes financial, customer, internal business and learning and growth perspective. It is also performance metric used in strategic management to identify and improve various internal functions and their resulting external outcomes. Below are the areas of concern in Balance Scorecard for CC in order to measure their performance: Generic Measurements Sales growth, increased market share and ROE, Economic Value Added, Cash flow.

Initiatives Cutting overhead cost in manufacturing and revise the pricing strategy. It means that CC have to increase the price in the Europe Market to avoid antidumping tax levy and at the same decrease the price in local market for continuous sales growth.

ii.

Customer Customer satisfaction perspective measure, number of What do our regular customers retained customer requires from us and how are we doing according to these requirements?

In order to maintain their largest customer (Secconz), CC should reduce the price that they currently offered to Secconz and at the same time maintain the quality of the product. This is to ensure that Secconz is satisfied with the service offered by CC and not considering producing similar technology in-house. CC should always seek for a satisfactory arrangement in order to meet Secconz requirement in the future to maintain a good relationship between them.

iii.

Internal Business perspective To satisfy our stakeholders, what must be our levels of

The (Fuzzy Frost Alpha) FFA technology that is developed by CC facing a rapid obsolescence. There is not much alteration since its invention and any

i.

Objectives Financial perspective What must CC do to create sustainable economic value?

Includes measurements for innovation, operations. (Utilize innovation to advance and improve internal processes to keep

 productivity, efficiency quality?

iv.

business moving forward)

improvements became subject to easy copying. To overcome this problem, CC should consider investing in R&D programs in order to enhance their technology and come out with latest innovation to compete with European technologies.

Include measurement for:  –  People employee retention, training, skills, morale

 Apart from pricing strategies issue, CC also facing the problem of anti-dumping activities. CC should consider to send their employee for a course on: a) Anti-dumping issue  APEC (example: Training Courses ). This is to ensure that the employee updated with the current issue relating  Anti-dumping.

and

Learning & growth How does our employee  performance management system, including feedback to employees, support high performance?

Recommendations

By using Balance Scorecard (BS), it provides a clear prescription as to what CC should measure in order to 'balance' the financial perspective and how to maintain a longer relationship with Secconz. One of it is to reduce the selling price of the product as requested by Secconz. Furthermore, BS enables the executives in CC to truly execute their strategies by identifying what should be done and measured not only in financial perspective of CC but also focus on the customer perspective, especially Secconz and internal business growth.

References 

Management Accounting 6th Edition. Langfield et al. McGraw Hill (2012) http://www.shell-livewire.org/swot-analysis/ http://smallbusiness.chron.com/advantages-balanced-scorecard-59821.html http://thebalancedscorecard.com/benefits_bsc.htm http://www.scribd.com/doc/128342447/Dumping http://www.studymode.com/essays/a-Case-Study-On-Cost-Estimation-1090770.html http://www.inpaspages.com/anti-dumping-law-affect-steel-industry-business/