Salem Telephone Company Case Study

Salem Telephone Company Case Study 1. Variable Expenses with respect to revenue hours: Power expense, hourly personnel salaries expense. Fixed expenses with respect to revenue hours: Rent, custodial services, computer leases, maintenance, depreciation of computer equipment and office equipment and fixtures, operations salaried staff, systems development and maintenance, administration, and sales, sales promotions, corporate services. 2. Units: dollars per hour January February March Power expense 4.7 4.7 4.7 personnel salaries expense 24 24 24 Total Variable cost per revenue hour 28.7 28.7 28.7 3. Income statement for Salem Data Services From the article, I know that intracompany work was billed at $400 per hour, and commercial sales were billed at $800 per hour. So, intracompany contribution margin: $400-$28.7= $371.3/hr Commercial contribution margin: $800-$28.7=$771.3/hr Sales revenue $192,400 Variable cost $9844.1 Contribution margin $182,555.9 Fixed cost $212,939 Net loss ($30,383.1) 4. Revenue = Variable Costs + Fixed Costs 205(400) + X (800) =(X+205) (28.7) +212,939 X= 177.39 commercial hours sold to break-even 5. Original March: P= Net Income= ($23,700) For option 1: P=205(400)+1000(96.6)-301.6(28.7) -212,939= -42,994.92 For option 2: P=205(400) +600(179.4)-384.4(28.7) -212,939= -34,331.28 For option 3: P=205(400) +800(179.4)-384.4(28.7) -212,939 = 1548.72 In conclusion, for option1 and 2, both will decrease in net income. For option3, net income will increase to a benefit amount. However, if the promotion expense is equal to or less than 1548.72, this option should be taken consideration. 6. Based on my analysis above, Salem Data Services is a problem to Salem Telephone Company.

Firstly, Flores should consider the promotion can be the turning point or not. Then decide if he will abort this service. For my consideration, I will recommend Flores to abort this unprofitable service.

Salem Telephone Company Case Study HBS case – Salem Telephone Company Opening In 2000 the Public Service Commission (PSC) was informed by the president of Salem Telephone Company (STC) that a profitable computer service subsidiary would reduce pressure for increases to telephone rates. With approval from the Public Service Commission, STC, a regulated public utility, established Salem Data Services (SDS) in 2001, an unregulated public utility to perform data processing for the telephone company and additionally to sell computer services to other companies and organizations in its’ immediate metropolitan region. After three years of operations SDS has yet to finalize a month in positive numbers and the president of STC is faced with the challenge of whether the subsidiary, SDS can be a profitable business. As Peter Flores, president of STC is preparing to meet with Cynthia Wu, manager of SDS, our group will review some common cost behaviors associated with distinguishing different types of costs; whether fixed or variable relevant to activity, construct a contribution margin income statement, review net income relative to reduction and increases to commercial price, and finally based on our financial analysis of SDS, make specific recommendations to the president of STC as to whether it is more or less profitable to keep the subsidiary SDS. With Incremental analysis we will be able to calculate the differences in revenue and costs between decision alternatives. Determining the actual fixed and variable costs will able our group to calculate the unit costs per commercial revenue hours. 1. When determining which expenses are considered to be fixed or variable for SDS you need to remember that expenses are based on revenue hours. The expenses that are affected by revenue hours will therefore be variable expenses and those that are not will be fixed expenses. The expenses affected by revenue hours are power and wages/salaries of hourly personnel. All remaining expenses are not affected by revenue hours. Variable are: • Equipment costs: power - variable cost due to the fact that there is a direct connection between computer utilization, which is increasing with the number of hours sold, and energy consumed. Wages and salaries: operations hourly personnel – salaries paid based on actual number of worked hours. Fixed are: • Space costs: 1. Rent – fixed cost because it is paid to STC independent of how many hours they are selling. 2. Custodial services - fixed cost because they depend on STC’s estimated annual cost per square foot and are paid independent of revenues. •

• Equipment costs: 1. Computer leases - fixed cost due to the fact that normally they were purchased before the business starts so they are independent from the revenue. 2. Maintenance - fixed cost because the inventory has to always to be controlled independent sell hours or revenue. 3. Depreciation fixed cost because the value of the asset is adjusted or reduced over a specified number of years that the equipment is being used or over the asset’s useful life. • Computer equipment – fixed cost as indicated Office equipment and fixtures – fixed cost as indicated Wages and salaries: 1. Operations salaried staff wages and salaries – salaried staff who run the center around the clock receive their salary based upon an agreed amount at time of hire and it is independent of revenues. 2. System development and maintenance – agreed upon amount to provide service to clients and maintain the systems and is paid independent of revenues. 3. Administration wages and salaries – administration salaries agreed upon at time of hire and are paid independent of revenues. 4. Sales – again this is an agreed upon amount at time of hire and is paid independent of revenues. Sales promotion – used for advertising and other promotional activities to persuade new customers to undertake in the service, total amount of promotions was agreed upon by management and paid independent of revenues. Corporate services – administrative functions paid to STC for payroll, billing and accounting services are paid independent of revenues. The analysis completed in questions 1 through 6 shed some light on the expenses that STC face. There is a considerable $85,644 in fixed cost. Large fixed costs like this make it very difficult to make profits. The question whether to close SDS or not can be answered by analyzing the numbers, see Table 1 below. Table 1: Fixed Expenses (numbers based on March): Rent Maintenance Power Salaried Staff Hourly Personnel $ 8,000 $ 5,400 $ 1,697 $ 21,600 $ 8,664 System Development Administration Sales Sales Promotion Total Save Expenses Outsourcing Costs (205 hours X $800) Extra cost if Salem Data Services closes $

12,000 $

9,000 $

11,200 $

8,083 $

85,644 $ 164,000 $ (78,356)

Table 1 offers a simple analysis of costs that are involved in closure. If STC closed SDS, it will realize a fixed expenses savings of $85,644. On the other hand, STC will still need the services that SDS provided and will have to purchase those services from another company at the going rate of $800. For 205 hours, that equals $164,000 of outsourcing costs. STC will be paying out an additional $78,356 because of the closure of SDS. If only this analysis is done, it proves that STC should keep SDS in business. STC will need to move taking SDS to break even to a higher priority position. Peter Flores made suggestions to increase promotion as well as reduce price but separately. STC should combine both of these ideas in order to take SDS to profitability more easily.