Defining the problem
Countertop Appliances Division needs to reduce its overhead costs to help the division regain its initial profitability level. The main problem is identifying areas that need to be reduced and convincing the managers of the departments that it is the best option for the firm. Each department manager would like to retain the same level of resources because a cut in allocation will affect their department’s performance.
One of the best options that the division can select involves reducing expenditures in various departments to match their initial proportions. Other options for reduction may be considered after the first option has been implemented. Payroll will be the next level of consideration if reduction of costs to the initial percentages does not yield the required 20% cut.
Situation analysis
Internal Factors
The Countertop Appliances division has the coffee maker and the microwave oven as its two major product lines. The two product lines accounted for about 50% of sales and profits in the years before the decline in revenues. Other kitchen appliances include food processors, blenders, orange juice makers, and electric skillets. The decline of sales in its two major products has affected the profitability of the division.
The main target customers for the division are households. Corporate customers account for a smaller proportion of sales. The firm uses national and detached retail stores to reach customers. It offers the stores discounts to encourage them to shelve the products in their stores. The firm does not target segmented markets. It uses standardized products to target a single national market.
The existing corporate strategy is to use the Countertop Appliances Division to increase sales and profitability of the entire firm. It also includes using aggressive marketing to constantly keep the image of its products in the eyes of the customers. The division relies on marketing, its brand name, and quality products. The firm wants the division to be the largest manufacturer of countertop appliances by market share.
The firm focuses on all four components of the marketing mix. The firm has a reputation for quality products. Recently, the firm has delayed in modifying existing products and developing new products. The delays in its product design and development has caused a reduction in sales and profitability.
The firm has delayed in responding to competitive pricing. The firm shows weakness in engaging the product development department to develop products that can be sold at competitive prices. Customers are more sensitive to price than the brand name.
The firm has done well with advertising and promotions. The firm advertises on television stations with a national coverage. The marketing department also targets prime-time advertising, which increases effectiveness of marketing. The marketing department has a good performance at a high cost.
The firm uses multiple channels for distribution. The products reach customers through three groups of channels. They include national chains, smaller local departmental stores and discount houses, and the wholesalers. The larger chains obtain their stock directly from the firm. The smaller retail outlets obtain their stock from large national distributors. The firm uses discounts to increase sales through different channels. The large national retail stores obtain larger discounts than the small local stores. There are well-defined reliable distribution channels that ensure availability of products at the right place for customers.
The production capacity of the firm is sufficient to meet national demands. When the firm acquired Kitchen Help, it expanded its facilities to enable it to meet increasing demand for its products. In the current situation, the firm must be operating below full-capacity because of declining sales.
The firm has a product development department responsible for R&D. It develops new products and modifies existing products. It proposes changes to existing products to the top management. In the current situation, the department’s workforce is outstretched that some of the new products have to wait for the department to complete the modification of existing products. The department has been assigned the task of designing a competitively-priced coffee maker. The product development department is one of the critical areas for gaining competitive advantage, as an appliance maker. The manager of the department, Bob Erickson, feels that the firm’s focus on short-term goals affects long-term goals. Short-term goals are reactive development of products to match competitors’ new products. He wants the firm to focus more on new products with long-term goals.
The skills of the current management indicate that the division gets the best leadership. There is a focused direction. The managers in various departments have high credentials to hold their positions. They have a wide range of experience with the firm and externally to make informed decisions.
On the technological stage, the division uses the latest technology for its production facilities. The firm bought current technology for the division when it acquired Kitchen Help. The latest technology ensures that the firm production process is more efficient. It also ensures quality products by enhancing the ability to detect and eliminate defects.
The financial factors indicate that the firm’s performance increased in the first two years before it started to decline. The gross profit margin increased from 10% in Year 0 to 12% in Year 1. It started to decline in Year 3 before reaching 1.3% in Year 5. The decline in gross profit margin shows that the goods are increasingly being produced and marketed more inefficiently than in previous years. The net profit margin also started to decline in the third year. It moved from 6% in Year 2 to 0.7% in Year 5. It shows that the firm is approaching the break-even point.
Table 1
Table 2
Table 1 and Table 2 indicate the year over year growth in sales and profitability. Table 1 indicates that there has been growth in sales from Year 1 to Year 4. In Year 5, sales declined. In Table 2, profitability started to decline in Year 3 despite increase in sales in that year. It indicates that the division operates more inefficiently. The general manager is right to declare an urgent need to reduce costs.
External Factors
The competitors have been able to use competitive pricing to capture a larger market share from Countertop Appliances Division. The division’s strategy was to wait until the competitors review their prices upwards. It did not work as expected, which shows that competitors have made their processes more efficient. One of the major competitors has developed an improved coffee maker that increases flexibility in the number of cups that one intends to make. It has been able to cut into Countertop Appliances’ sales. Competitors have also successfully introduced a modified microwave oven, which has reduced Kitchen Help’s oven sales. Competitors are using innovation and competitive pricing to beat Countertop Appliances.
The current economic conditions are favorable with North America undergoing an economic recovery. The high level of optimism is likely to increase consumption of goods.
The firm has not segmented customers into demographics. One would expect the middle-aged group (30-45 years) to have the highest number of purchases. One of the reasons is that they have the purchasing power and they are settled in their homes. Studies indicate that more young people aged below 30 years are living with their parents. They also lack purchasing power. The aging population in North America may slow down sales because they are unlikely to make purchases of new products provided the old product is functional.
Legal issues may arise from faulty equipment and intellectual property rights. Electric kitchen appliances may be defective causing accidents and health concerns, which may cause the firm to be sued. However, instances of faulty appliances are rare. Legal concerns may arise from the issue of patents. Innovation is an important factor in the industry and firms would legally protect their products’ through patents. The firm may sue or be sued for violation of intellectual property rights.
Social issues cover the eating habits of people in North America that may affect the sale of products. The industry may be affected by the first food industry. It may result in an increase in the sale of kitchen appliances as takeaway sales in fast food shops increase. It may reduce sales if most of the people opt to eat their food in the fast food shops. A culture of working for long hours may also boost the sale of kitchen appliances, as people seek fast and effective kitchen appliances.
The global market offers opportunity for expansion of its newly-developed products. The division does not operate in the global market making its operation to be mainly determined by local factors. The global market offers an opportunity to compare production costs that may enable the firm to produce at the least-cost location.
The kitchen appliances sub-industry looks like the entire electronics industry where the most innovative firm prevails over competitors. A little difference occurs where customers are more sensitive to prices compared with other electronics. In other electronics market, brand loyalty may enable firms to charge a premium price. In this sub-industry, customers look at reliability and price. Reliability refers to the ability of the product to achieve what it was designed to do. The design may have an influence, but it is minimal. Design refers to features that add value to the functional value of the product. The firm has to be innovative and make products that can be sold at competitive prices for it to survive in the industry.
The main strength of the industry is that it rewards innovative firms with a rapid increase in sales within a short period of time. The main weakness is that competitive pricing causes low profit margins for firms that operate in the industry.
SWOT analysis
Strengths
- The division has highly skilled managers.
- It has a strong brand name and a skilled marketing team.
- It uses the latest level of technology in its production facilities.
- Its operations are diversified using different product lines.
- There is greater coordination between the sales and marketing departments.
Weaknesses
- There are delays in the product development department that affect sales.
- The product development department has an outstretched workforce.
- Sales and profitability are declining.
- There is reduced coordination between some departments.
Opportunities
- The firm may expand into the global market.
- The firm can target specific market segments using differentiated products.
- The new products that it plans to develop may create new markets.
- The economic climate favors expenditure on appliances.
- In North American, emerging eating habits may favor sales.
- Global markets may cause the discovery of a least-cost location.
Threats
- Intense rivalry among firms causes price wars, which reduces the profitability of firms.
- Global markets may bring in more competition.
- Competitors may launch new products that reduce sales for the firm.
Recommendation
Alternatives
Option 1
The division needs to reduce 20% of operational costs to enable the firm to operate profitably. An equal cut of 20% in all departments would have been easier to recommend as tabled in the case. However, the marketing and the production departments show that it is not viable if payroll is the target area. It would result in a complete closure of the two departments. One can notice that the marketing department incurs more costs in advertizing rather than personnel.
As a result of such a consideration, Option 1 will involve a 20% reduction in all departments. The only difference is that the department managers will decide the areas that they should reduce in their departments. Table 3, shown below, indicates that non-payroll expenditure is also significant. The total budget has been calculated from the 20% of the department’s budget. The departments have $29.7 million to reduce in the non – payroll budget. The non-payroll expenditure is obtained by subtracting payroll budget from the 100% budget.
Table 3
In Option 1, the firm should consider that it needs to strengthen the product development department because it is a critical area that has shown weakness. It can reduce other areas excluding the product development department. The firm requires a reduction of $ 9,140,800. It is possible to reduce costs from a combination of the payroll and non-payroll areas.
Option 2
Option 2 is based on the percentages found on the income statement. The income statement shows that sales and administration is one area that has increased disproportionately with increase in revenues. Sales and administration expenditure has increased from 12% in Year 0 to 20% in Year 5. Another area that has increased considerably is the proportion of discounts.
Discounts have moved from 3% to 6% of sales. In Year 5, 12% of sales and administration will amount to $ 12,508,800. Reducing sales and administration from 20% to 12% will save the division $ 8,339,200. Using mathematics, 3% of discounts will amount to $ 3,234,000. The division will save $ 3,234,000 through reducing discounts. In total, the division will save $ 11,573,200 by reducing sales and administration, and discounts to their initial levels. The reduction gives an extra $ 2,432,400 above the required reduction. It can be used to strengthen the product development department because it is the critical area of success.
Option 3
The third option involves a reduction of payroll by half in all departments. A reduction by a third would be the best option. However, it would not yield the required amount of reduction. The option combines the reduction in the discounts’ proportion to 3% and reduction of payroll by 50%. The option’s main weakness is that routine operations will be affected when half of the workforce is laid off. The division may need restructuring to prevent a personnel shortage within the firm.
Table 4
Table 4 shows that reducing the workforce by 50% results in saving $ 5,912,364 from payroll. An additional $ 3,234,000 is saved from reduction of discounts to 3%. In total, the option saves $ 9,146,364. It is adequate to cover the required reduction of $ 9,140,800.
Implementation
The firm division should select Option 2 because it causes the least disruption to operations. It may be against Central Foods’ philosophy of using aggressive marketing to drive sales, but it is the best option. The firm has maintained proportional increases in other operations. The proportion of the cost of goods sold has declined from 75% to 73%, which shows that other operations have become more efficient. The division’s cost of good sold proportion that was 67% of sales in Year 2. The firm should reduce the cost of goods sold to 67% and use the cuts to strengthen the product development department. Sales and administrative expenses are targeted because they have increased disproportionately with total sales and other operations. Discounts will also be restored to their initial proportion.
The division uses prime-time, advertizing, which is costlier than advertising during other times. One of the strategies is to let the prime-time advertizing contracts expire. The division should return to prime-time advertising only when it wants to market new products. In the current situation, there are no new products. The sales and administrative payroll should also be reduced by about 50%.