Question

Charlie’s Furniture Store has been in business for several years. The firm's owners have described the store as a "high-price, high-service" operation that provides lots of assistance to its customers. Margin has averaged a relatively high 34% per year for several years, but turnover has been a relatively low 0.4 based on average total assets of $800,000. A discount furniture Store is about to open in the area served by Charlie's, and management is considering lowering prices to compete effectively.

Required:

Calculate current sales and ROI for Charlie’s Furniture Store.

Assuming that the new strategy would reduce margin to 20%, and assuming that average total assets would stay the same, calculate the sales that would be required to have the same ROI as Charlie’s currently earns.

Suppose you presented the results of your analysis in parts a and b of this problem to Charlie, and he replied, “What are you telling me? If I reduce my prices as planned, then I have to increase my sales volume by 50% to earn the same return?” Given the results of your analysis, what is the actual amount of increase in sales required?

Now suppose Charlie says, “You know, I’m not convinced that lowering prices is my only option in staying competitive. What if I were to increase my marketing effort? I’m thinking about kicking off a new advertising campaign after conducting more extensive market research to better identify who my target customer groups are.” In general, explain to Charlie what the likely impact of a successful strategy of this nature would be on margin, turnover, and ROI.

What are the other alternative strategy that might help Charlie maintain the competitiveness of his business.

Answer 1

Current scenario:

Turnover = Sales / Average Total Assets = Sales / $ 800,000 = 0.4

Sales = $ 800,000 x 0.4 = $ 320,000.

Net income = $ 320,000 x 34 % = $ 108,800.

ROI = Net Income / Average Total Assets = $ 108,800 / $ 800,000 = 0.136 or 13.6 %

Margin reduces to 20 % :

Sales required to maintain the same ROI of 13.6 % = $ 108,800 / 0.20 = $ 544,000.

Effect of New advertising campaign :

Impact on sales volume : Increase

Impact of selling and administrative expenses : Increase ( because of higher spend on market research and advertising )

Impact on margin : Likely to increase, depending on the demand for the product.

Impact on turnover: Likely to improve.

Impact on ROI : Likely to increase.

Other alternative strategies:

• Reduce fixed operating costs
• Reduce variable cost per unit