Monica’s Designer Handbags: Creative Marketing
Decision-Making
Based on Financial Analysis—A Case Study
Michael T. Manion
University of Wisconsin – Parkside
Karen Crooker
University of Wisconsin – Parkside
Peter Knight
University of Wisconsin – Parkside
Monica learned much about the designer apparel trade as an intern
with a major retailer, and started a designer handbag business,
selling through independent retailers. She practiced making sound
marketing decisions using financial analysis techniques learned in
college. These techniques proved useful when a regional discount
chain offered a deal to sell her handbags through their stores on a
trial basis. She was faced with a tough decision to accept the
deal, reject it, or renegotiate it on mutually acceptable terms.
Students are asked to analyze case data and to advise Monica on how
to proceed with the prospective deal.
INTRODUCTION
Monica, after completing an internship with a national apparel
company, decided that she wanted to exercise her creative design
talents and her strong entrepreneurial spirit by starting her own
fashion design business. She conducted fundamental market research,
as she had learned in college, and determined that there was an
unfulfilled market need for her designs in the moderately priced
fashion handbags at the $100 retail price point. She also learned
that the independent women’s apparel stores she was targeting
require a 50% retail margin, which retailers variously refer to as
a “100% markup,” or “keystoning,” to cover their own display and
selling costs. Monica approached a number of independent local
stores that liked her handbag design prototypes and her retail
price point and would consider carrying her handbag line, but she
was told consistently that area retailers purchased such
moderately-priced fashion designer products through a particular
apparel distributor. She, in turn, met with the well-established
distributor, showed her designs, and discussed his operations. The
regional distributor was interested in representing her line to his
independent retailers, but indicated that he required a “20%
wholesale margin,” that is, a 20% discount off the price to the
retailers. Monica realized that to be successful in her new
business she would have to manage her costs and contribution
margins carefully and negotiate the distribution channels and
retailer relationships wisely.
Monica’s Contribution Margins
Monica learned during her retail management course in college and
her internship with a national retailer that she would have to
generate sufficient contribution margins on her products to recover
her fixed sales, general, and administrative costs of doing
business, her overhead. Monica had obtained an authoritative
Harvard Business School (1983) reference from her father Bill who
had earned his MBA at Harvard a generation ago. In addition to this
Note on Marketing Arithmetic and Related Marketing Terms, she used
her college managerial accounting text (Whitecotton, Libby, and
Phillips, 2013), as a more recent, second source. She determined
that the contribution margin on each unit of product sold can be
established by setting a reasonable price to the distributor and
subtracting all variable, or direct, costs to provide each unit.
Monica realized that the retail handbag market had pre-determined
price points to the end consumer, e.g., $100. Her price to the
distributor would be the retail price net of both the retailers’
and distributor’s margins, which motivated these partners to handle
her product through their channel. Her price to the distributor had
to be at least sufficient to cover the product’s variable costs,
including direct manufacturing and shipping costs, and thus produce
a positive contribution to overhead.
Determination of Monica’s Price to the Distributor
So, Monica sat with her tablet at her drafting board and did the
necessary financial analysis.
She assumed that her $100 retail price point to the end consumer
was realistic, given the confirmations she received from several
independent retailers and the regional distributor. Monica also
assumed that the independent retailers would require a 50% margin,
and thus would markup the distributor’s price to them by 100%. So,
her concern was what price she should set for the distributor. She
calculated the retail unit price, the retailers’ unit margin, the
distributor’s price to the retailers, the distributor’s unit
margin, and an acceptable price to the distributor. She drew out on
her drafting board the transaction prices and margins in a diagram,
showing the relationships between all the parties in this
channel.
Variable, or Direct, Unit Costs
Monica had negotiated for the production of her designer handbags
with a contract manufacturer, based in Vietnam, that she had come
to know through her internship. She had also arranged monthly LTL
(less than truckload) shipments of each season’s new handbags
directly from the factory to the distributor who, in turn, ensured
that retailers’ shelves were stocked with Monica’s designs. At the
volumes she projected each season, the manufacturing costs averaged
$10 per handbag. Her shipping costs, at current volumes, averaged
$5 per handbag. She extended her diagram to show these two direct
costs and the relationship of the manufacturer and the shipper in
the transaction flow. Monica could now determine her contribution
margin per handbag.
Fixed Sales, General, and Administrative Costs
Monica had hired one salaried marketing person to assist her with
all sales and promotions activities, including maintaining the
website, entering order transactions, and running reports on a
basic enterprise system. She had also retained an advertising
agency, an attorney, an accountant, and a banker to facilitate all
of her other general and administrative matters as needed. She
rented a small office space near her residence for her design work,
system and marketing operations, and business meetings. Monica
estimated the total of all these fixed overhead expenses at $25,000
per month. She felt that these were all necessary business expenses
and that she could grow her volume substantially with this support
base in place.
Breakeven Volume and Market Share
Monica next determined the minimum volume of handbags that she
would have to sell in order to cover her overhead expenses, which
her seasoned accountant referred to as her “nut.” She divided her
monthly overhead expense by the contribution margin per handbag,
which she had calculated earlier, to determine her breakeven volume
in units. She next extended this breakeven volume by her wholesale
price to determine her breakeven sales volume, measured in
dollars.
However, Monica also wanted some confirmation about the
reasonableness of her breakeven volume expectations, and therefore
sought to estimate what share of the retail market she would have
to achieve in order to breakeven. Her earlier research found that
the total U. S. retail market for moderately priced (that is, about
$100 at retail) fashion handbags was $120,000,000 per year. Based
on her findings, she calculated the total number of such bags sold
at retail in the U. S. in an average month. Monica then divided her
monthly breakeven volume by one-twelfth of the total annual U. S.
retail market, to determine her minimum market share to
breakeven.
Profit Impact
Monica, however, would not be satisfied by achieving only a
financial breakeven for her enterprise. She had not taken a salary
from the business so far and had invested her own capital to get
the business started. She reasoned that her time was worth money
and the alternative of returning to her previous employer would
involve the advantages of a stable healthy income and benefits, and
considerably less risk. Monica wanted her business to generate a
sustainable profit, so that she could reinvest in growing her
enterprise and take a steady income. She set an ambitious, initial
goal of earning a profit of $50,000 per month and sought to
determine what volume she would need to sell in order to reach that
bottom line target. If selling the breakeven number of units per
month covered the $25,000 monthly overhead expense, Monica
considered how many handbags she would have to sell to generate a
$50,000 monthly profit impact, beyond the breakeven.
Trade Discounts and Terms of Sales
Monica had negotiated with the distributor for a 2% discount for
payment at end of month, with net amount due in 90 days. The
distributor generally did not take the offered discount, but rather
paid at the end of each season, as was typical in the seasonal
apparel trade.
Profit Margin
Monica was soon able to achieve her goal of an average profit
impact of $50,000 per month on sales to the distributor of
$1,440,000 per year. She also was interested to know what the
average profit margin, expressed as a percentage, of her expanded
business might be, for comparison purposes.
A Grand New Opportunity
Monica next set an ambitious goal to grow her business into a $2
million company in annual sales to distributors. Soon, her sales
assistant approached her while she was seated at her drafting board
with some good news! A buyer for Grand*Mart, a very large regional
discount retail chain, who had seen Monica’s handbag designs on her
website, e-mailed an invitation to propose a contract. The
Grand*Mart buyer, however, was specific about several conditions
for Monica’s proposal. Monica was excited about this prospective
new customer, which in addition to her independent retailer
business would help achieve her new total sales goal.
Sales and Profit Impact of the New Deal
Grand*Mart would initially receive 2,000 handbags per month for
three months of seasonal designs similar to Monica’s most popular
handbags and stock them in 20 test stores outside Monica’s
traditional territory, handling all of the transportation from the
overseas factory and all of the distribution to their stores in the
U. S. Grand*Mart indicated that they would pay within 90 days, as
the handbags sold through their stores. They also would
substantially increase their order to a minimum of 10,000 handbags
per month during the second quarter, based on the success of the
initial trial, and would consider carrying an “exclusive” line of
Monica handbags in Grand*Mart’s entire chain, including all 100
stores. They proposed that a wholesale price of $20 per handbag
would be acceptable to them under the terms and conditions,
beginning with the first quarter. Grand*Mart extended an invitation
to Monica to call on their Mobile, Alabama headquarters during the
next week and to propose her “best and final offer” to their
buyers.
Monica realized that this one initial deal would achieve larger
scale and her set goal of becoming a $2 million revenue business!
However, she was concerned that Grand*Mart’s suggested wholesale
price was low relative to the wholesale price she received in the
independent retailer channel. Monica calculated that the proposed
price would cover her present direct manufacturing cost and
eliminate her direct shipping costs. However, she estimated that
she would have to double her existing $25,000 per month overhead
expenses just to meet the initial required level of customer
service that Grand*Mart specified for first quarter store
advertising, customer support, and returns handling. She drew out
Grand*Mart’s suggested transactions and relationships between
parties in another diagram. Again, she sought to determine the unit
contribution margin and the profit impact that the initial 2,000
bag per month deal, as proposed, would bring to pay the incremental
overhead and drop to her bottom line each month.
Monica, who was an optimist at heart, also was tempted by the
prospective Grand*Mart order increase for the second quarter, if
the initial trial quarter was successful. She envisioned the
advantages of selling 10,000 handbags per month exclusively to
Grand*Mart. She estimated that her overhead expenses, attributable
to Grand*Mart, would grow substantially to $75,000, or three times
the amount required for the initial 2,000 handbag deal. But she
also wondered if she could then achieve the same profit impact just
from exclusively supplying Grand*Mart, while dropping the
independent retailer channel.
A Time for Serious Reflection
Monica looked at the existing and new diagrams and realized that
she had some key decisions to make. She needed to decide if a) She
should propose the initial 2,000 bag per month Grand*Mart deal, on
the terms that they suggested, including their wholesale price; b)
She should take a pass on the Grand*Mart deal, and stay exclusively
with the independent retailers’ channel in which she has had
success; c) She should go to Mobile and renegotiate the initial
2,000 bag per month deal, offering a “best and final” price that
could be acceptable to both parties; or d) She should propose the
exclusive deal to Grand*Mart, based on a successful trial and a
minimum order volume of 10,000 handbags per month, beginning in the
second quarter. And, importantly, she wondered what other financial
and non-financial considerations (such as, cannibalization, or even
loss, of her independent retailer channel by the exclusive
Grand*Mart deal) she should contemplate before getting on a flight
to Alabama.
Monica’s Further Research on Grand*Mart
Monica promptly went to three local Grand*Mart stores, thoroughly
inspected the handbag sections, and recorded the prices of similar
merchandise on the shelves. She also sent e-mail inquiries to
several of her industry colleagues who knew the discount chain and
the discount fashion trade well. From her field research, she
garnered that Grand*Mart probably would price her handbags at $45
each, and that they would require at least a 33-1/3% contribution
margin on their retail price (which also could be expressed as a
50% markup on their wholesale costs). With this intelligence,
Monica was able to estimate the maximum wholesale price, after
incurred costs, that Grand*Mart might be willing to pay for each
handbag. With both her minimum breakeven price and their maximum
wholesale price in mind, Monica was in a better position to make a
decision about her “best and final price” offer alternatives. She
could also estimate the incremental profit impact of her possible
deals with Grand*Mart.
QUESTIONS
1. What is the incremental profit impact (in dollars per month) of
the suggested initial Grand*Mart 2,000 bag deal to Monica, after
the increased overhead expense of $25,000? What is the incremental
profit impact of the prospective 10,000 bag order, after increased
overhead expense of $75,000?
2. What are Monica’s other key financial and non-financial
considerations (such as, cannibalization of the independent
retailer channel) for the suggested Grand*Mart deal?
3. Should Monica propose the Grand*Mart deal as suggested? Or
should she take a pass and stay exclusively with the independent
retailer channel? Or should she renegotiate the initial 2,000 bag
deal for the first quarter? Should she offer Grand*Mart an
exclusive 10,000 deal for the second quarter?
4. What is the maximum wholesale price that Grand*Mart could be
willing to pay Monica, given their probable retail price and
typical margin requirements? If Monica decides to renegotiate the
initial Grand*Mart deal as of the first quarter with volumes of
2,000 bags per month and incremental overhead of $25,000 per month,
what “best and final” price should she propose that would be
acceptable to both parties? What is the revised incremental profit
impact?
5. If Monica decides to offer Grand*Mart an exclusive deal as of
the second quarter at minimum volumes of 10,000 bags per month with
overhead expenses of $75,000 per month, what “best and final” price
should she propose that would be acceptable to both parties? What
is the profit impact of this exclusive deal?
Hi,
There are 3 cases against which Monica has to take a call on her decisions. To put in table below we are estimating the profit in each case:
Case I : Her initial study as how can she arrive at the break even volume of sale & the growth she wants i.e. $50000 profit from independent retailers
Case II : Additional initial offer from Grand Mart for 2000 pcs/month with the current business of independent retailer.
Case III: Go with proposed offer of Grand Mart only.
Amt in $ | Case I | Case II | Case III | |||
Initial / month | Growth Avg. per month | Independent retailer | Addl. Grand Mart proposal | Total | Proposed by Grand Mart | |
Retail price / unit | 100 | 100 | 100 | 45 | 75 | 45 |
Sales Units | 714 | 2400 | 2400 | 2000 | 4400 | 10000 |
Sale price / unit to distributor | 50 | 50 | 50 | 20 | 36 | 20 |
$ sales value | 35710 | 120000 | 120000 | 40000 | 160000 | 200000 |
Manuf. Cost | 7140 | 24000 | 24000 | 20000 | 44000 | 100000 |
Shipping costs | 3570 | 12000 | 12000 | 0 | 12000 | 0 |
Total Mnf costs | 10710 | 36000 | 36000 | 20000 | 56000 | 100000 |
Gross Margin / Contr. Margin | 25000 | 84000 | 84000 | 20000 | 104000 | 100000 |
Fixed SGA costs | 25000 | 25000 | 25000 | 25000 | 50000 | 75000 |
Net Margin / Profit | 0 | 59000 | 59000 | -5000 | 54000 | 25000 |
Clearly in 1st case the break even qty / month comes to $714 (SGA costs / GM per unit) = $25000 /(50-10-5) = $714.
Her 2nd objective was to achieve $50000 per month avg. profit which she did by $144,0000 sales
The 2nd case includes her analysis including her current business with independent retailer & additional proposal of 2000 handbags / month from Grand mart. In this case she can earn a net margin of $54000 as Grand Mart is giving negative returns. so after a quarter sales she would have reduced $5000 * 3 = $15000 from her profits.
In 3rd case the analysis is her move to go ahead only with Grand Mart. Here again the profit / month is still reducing.
So with current Grand Mart deal she would reduce her profits & her financial goals would not be met. So for this now we should work out the best possible price that she can offer in the given conditions:
$30 / handbag should be the best price that she can propose to Grand Mart on which they can put 50% mark up & earn
33 1/3 % contribution margin (GM). So this is the max. wholesale price that it would be willing to pay her.
So when we go back to Case II on accepting addln 2000 handbags from Grand Mart would give her profit of $74000 which is 48% higher than her current avg. output of $50000 profit / month.
And when she later on goes with same price of $30 for 10000 handbags / month then her profit would be 1,25000 which is 150% higher than her current avg. of $50000 profit / month.
Case II | Case III | |||
Amount in $ | Independent retailer | Addl. Grand Mart proposal | Total | Best offer to Grand Mart |
Retail price / unit | 100 | 45 | 75 | 45 |
Sales Units | 2400 | 2000 | 4400 | 10000 |
Sale price / unit to distributor | 50 | 30 | 41 | 30 |
$ sales value | 120000 | 60000 | 180000 | 300000 |
Manuf. Cost | 24000 | 20000 | 44000 | 100000 |
Shipping costs | 12000 | 0 | 12000 | 0 |
Total Mnf costs | 36000 | 20000 | 56000 | 100000 |
Gross Margin / Contr. Margin | 84000 | 40000 | 124000 | 200000 |
Fixed SGA costs | 25000 | 25000 | 50000 | 75000 |
Net Margin / Profit | 59000 | 15000 | 74000 | 125000 |
Monica’s Designer Handbags: Creative Marketing Decision-Making Based on Financial Analysis—A Case Study Michael T. Manion University...
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