Telephone Computer Corporation (TCC)
Telephone Computer Corporation (TCC) manufactures and sells two computerized directory assistance computers to telephone companies. The firm has its own sales force that sells directly to the phone companies. TCC currently sells two computer systems: the Alpha and the Beta. TCC has 90 percent of the high-end market (Beta) and 50 percent of the low-end market (Alpha). The Alpha sells for $100,000. The Beta sells for $200,000 but has three times the capacity of the Alpha.
TCC has developed a new high-volume machine, Zeta, that has four times the capacity of the Beta and lower operating costs, but a price of $300,000. The unit manufacturing cost is $170,000. Users can connect the Zeta directly to mainframe computers for customer billing as well as to future expected telecommunications advancements. If the Zeta is introduced, management expects that its closest competition will be from the Beta, so most initial sales of the Zeta will come at the expense of Beta sales.
Senior management has invested considerable resources in Zeta. It believes that the future of the company is tied closely to the success of this project. Next year’s operations of TCC (if the Zeta is not introduced) are:
Next Year’s Projected Profits by Product without Zeta
| Alpha | Beta | Total |
Sales in units | 100 | 50 |
|
Selling price | $ 100,000 | $ 200,000 |
|
Revenue | $10,000,000 | $10,000,000 | $20,000,000 |
Cost per unit | 50,000 | 80,000 |
|
Cost of units sold | 5,000,000 | 4,000,000 | 9,000,000 |
Sales force salaries* | 2,000,000 | 2,000,000 | 4,000,000 |
Commissions (10% of revenue) | 1,000,000 | 1,000,000 | 2,000,000 |
Product-line profits | $ 2,000,000 | $ 3,000,000 | $ 5,000,000 |
*Assigned based on commissions.
The existing sales force will sell all three types of machines. Salespeople are paid a salary plus 10 percent of sales. To sell the Zeta, salespeople with more knowledge of telecommunications and computer systems will be hired. The additional salary cost of these new employees will be $500,000. The existing sales force will still sell the Zeta but will call in these system experts to assist with the sale. The Zeta system experts are paid a flat salary, and the existing sales force’s 10 percent commission incentive will not change with the introduction of the Zeta.
If the Zeta is not introduced, Alpha unit sales are projected to grow at 5 percent per year and Beta unit sales are projected to grow at 10 percent per year. Selling prices will remain constant in real terms. (Prices and salaries will grow at the inflation rate. To keep the analysis simple, all numbers should be projected in real, not nominal, terms. That is, do not adjust the numbers for inflation.)
If the Zeta is introduced, Alpha unit sales will not be affected. But Beta unit sales will be affected: All the Zeta sales will come from the Beta sales in the first year and then Beta unit sales will grow only 2 percent per year. Zeta sales will grow at 9 percent per year from an initial base of 25 machines.
Required:
Management wants to see how the preceding table on product-line profitability will appear when the Zeta model is added. In particular, management asks you to project profits for the Alpha, Beta, and Zeta for the next five years and to make a recommendation on this project. Discuss how the five-year product-line profitability projections should be presented to senior management.
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