10-52 Budgeting for Marketing Expenses; Strategy You have been recruited by a former classmate, Susanna Wu, to join the finance team of a company that she founded recently. The company produces a unique product line of hypoallergenic cosmetics and relies for its success on an aggressive marketing program. The company is in a start-up phase and therefore has no significant history of expenses and revenues upon which to rely for budgeting and planning purposes. Given the restriction on available funds (most of the available capital has been used for newproduct development and to recruit a management team), the control of costs, including marketing costs, is thought by the management team to be essential for the short-term viability of the company.
You have held a number of intensive discussions with Susanna and John Thompson, director of marketing for the firm. They have asked you to prepare an estimated budget for marketing expenses for a month of operations.
You are provided with the following data, which represent average actual monthly costs over the past three months:
Sales commissions $120,000
Sales staff salaries 40,000
Telephone and mailing 38,000
Rental—office building 25,000
Gas (utilities) 12,000
Delivery charges 70,000
Depreciation—office furniture 8,000
Marketing consultants 25,000
Your discussions with John and Susanna indicate the following assumptions and anticipated changes regarding monthly marketing expenses for the coming year.
• Sales volume, because of aggressive marketing, should increase on a monthly basis by 10 percent.
• Sales prices are expected to decrease, to meet competitive pressures, by 5 percent.
• Sales commissions are based on a percentage of sales revenue.
• Sales staff salaries, because of a new hire, will increase by 10 percent per month, regardless of sales volume.
• Because of recent industrywide factors, rates for telephone and mailing costs, as well as delivery charges, are expected to increase by 6 percent. However, both of these categories of costs are variable with sales volume.
• Rent on the office building is based on a two-year lease, with 18 months remaining on the original lease.
• Gas utility costs are largely independent of changes in sales volume. However, because of industrywide disruptions in supply, these costs are expected to increase by 15 percent per month, regardless of changes in sales volume.
• Depreciation on the office furniture used by members of the sales staff should increase because of new equipment that will be acquired. The planned cost for this equipment is $30,000, which will be depreciated using the straight-line (SL)
• method, with no salvage value, over a five-year useful life.
• Because of competitive pressure, the company plans to increase the cost of marketing consultants by $5,000 per month.
1. Use the preceding information to develop an Excel spreadsheet that can be used to generate a monthly budget for marketing expenses. (Use the built-in function “SLN” to calculate monthly depreciation charges for the new equipment to be purchased.) What is the percentage change, by line item and in total, for items in your budget?
2. The management team is worried about the short-term financial position of the new company. Given the strain on available cash, the president has expressed a desire to keep marketing expenses over the next few months to a maximum of $350,000. Discussions with the marketing department indicate that telephone and mailing costs are the only category, in the short run, that can reasonably bear the planned- for reduction in marketing costs. The budget you have prepared includes an assumed 6 percent increase in telephone and mailing costs. What must this percentage change (positive or negative) be in order to achieve targeted monthly marketing costs? (Hint: Use the Goal-Seek function in Excel, which is found under Data Tools, then What-If Analysis.)
3. Comment on the use of the budget in this situation for cost-control purposes.
11-54 Make or Buy GianAuto Corporation manufactures parts and components for manufacturers and suppliers of parts for automobiles, vans, and trucks. Sales have increased each year based in part on the company’s excellent record of customer service and reliability. The industry as a whole has also grown as auto manufacturers continue to outsource more of their production, especially to costefficient manufacturers such as GianAuto. To take advantage of lower wage rates and favorable business environments around the world, Gian has located its plants in six different countries.
Among the various GianAuto plants is the Denver Cover Plant, one of Gian Auto’s earliest plants. The Denver Cover Plant prepares and sews coverings made primarily of leather and upholstery fabric and ships them to other GianAuto plants where they are used to cover seats, headboards, door panels, and other GianAuto products.
Ted Vosilo is the plant manager for the Denver Cover Plant, which was the first GianAuto plant in the region. As other area plants were opened, Ted was given the responsibility for managing them in recognition of his management ability. He functions as a regional manager although the budget for him and his staff is charged to the Denver Cover Plant.
Ted has just received a report indicating that GianAuto could purchase the entire annual output of Denver Cover from suppliers in other countries for $60 million. He was astonished at the low out- side price because the budget for Denver Cover Plant’s operating costs for the coming year was set at $82 million. He believes that GianAuto will have to close operations at Denver Cover to realize the $22 million in annual cost savings.
Denver Cover’s budget for operating costs for the coming year follows:
DENVER COVER PLANT Budget for Operating Costs
For the Year Ending December 31, 2010 (000s omitted)$
Indirect plant 4000
Pension expense 4000
Plant manager and staff 2000
Corporate allocation 6000
Total budgeted costs $820,000
Additional facts regarding the plant’s operations are as follows:
• Due to Denver Cover’s commitment to use high-quality fabrics in all its products, the purchasing department placed blanket purchase orders with major suppliers to ensure the receipt of sufficient materials for the coming year. If these orders are canceled as a result of the plant closing, termination charges would amount to 15 percent of the cost of direct materials.
• Approximately 400 plant employees will lose their jobs if the plant is closed. This includes all direct laborers and supervisors as well as the plumbers, electricians, and other skilled workers classified as indirect plant workers. Some would be able to find new jobs, but many would have difficulty doing so. All employees would have difficulty matching Denver Cover’s base pay of $14.40 per hour, the highest in the area. A clause in Denver Cover’s contract with the union could help some employees; the company must provide employment assistance to its former employees for 12 months after a plantclosing. The estimated cost to administer this service is $1 million for the year.
• Some employees would probably elect early retirement because GianAuto has an excellent plan. In fact, $3 million of the 2010 pension expense would continue whether Denver Cover is open or not.
• Ted and his staff would not be affected by closing Denver Cover. They would still be responsible for managing three other area plants.
• Denver Cover considers equipment depreciation to be a variable cost and uses the units-of-production method to depreciate its equipment and the customary straight-line method to depreciate its building.
1. Explain GianAuto’s competitive strategy and how this strategy should be considered with regard to the Denver Plant decision. Identify the key strategic factors that should be considered in the decision.
2. GianAuto Corporation plans to prepare a strategic analysis to use in deciding whether to close the Denver Cover Plant. In your analysis, use the above information, and include consideration of global competition and GianAuto’s competitive strategy.
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