04-29-2002, 02:41 AM
Uptown Computers Company
In May 2000, Jack Lopo, marketing vice president of Uptown Computers Company, was mulling over the discussion he had had the previous day with Jennifer Wu, a buyer from The Wiz Stores, Inc. The Wiz operated a chain of discount electronic stores in the New York Metro area. The Wiz’s sales volume had grown to the extent that it was beginning to add “house-brand” (also called “private-label”) merchandise to the product lines of several of its departments. Ms. Wu, The Wiz’s buyer for Electronic goods, had approached Mr. Lopo about the possibility of Uptown’s producing PCs for The Wiz. The PCs would bear the name “Speedy,” which The Wiz planned to use for all of its house-brand Electronic goods.
Uptown had been making PCs for almost 10 years. In 2000, the company’s line included 5 computer models. Sales were currently at an annual rate of about $130 million. The company’s 2000 financial statements appear in Exhibit I. Most of Uptown’s sales were through independently owned retailers (toy stores, department stores, electronic goods stores) and computer shops. Uptown had never before distributed its products through electronic store chains of any type. Mr. Lopo felt that Uptown Computers had the image of being above average in quality and price, but not a “top of the line” product.
The Wiz’s proposal to Uptown had features that made it quite different from Uptown’s normal way of doing business. First, it was very important to The Wiz to have ready access to a large inventory of PCs, because The Wiz had had great difficulty in predicting computer sales, both by store and by month. The Wiz wanted to carry these inventories in its regional warehouses, but did not want title on a computer to pass from Uptown to The Wiz until the computer was shipped from one of its regional warehouses to a specific The Wiz store. At that point, The Wiz would regard the computer as having been purchased from Uptown, and would pay for it within 30 days. However, The Wiz would agree to take title to any computer that had been in one of its warehouses for four months, again paying for it within 30 days. Ms. Wu estimated that on average, a computer would remain in a The Wiz regional warehouse for two months.
Second, The Wiz wanted to sell its Speedy PCs at lower prices than the name-brand PCs, like Dell and Compaq it carried, and yet still earn approximately the same dollar gross margin on each computer sold -- the rationale being that Speedy computer sales would take away from the sales of the name-brand computers. Thus, The Wiz wanted to purchase computers from Uptown at lower prices than the wholesale prices of comparable computers sold through Uptown’s usual channels.
Finally, The Wiz wanted the Speedy computer to be somewhat different in appearance from Uptown’s other computers. While the system board (mother board) and and monitor could be the same as used on current Uptown models, the monitor, system case, mouse and CDRom need to be somewhat different. Also, the PCs would have to be packed in boxes printed with the The Wiz and Speedy names. These requirements were expected by Mr. Lopo to increase Uptown’s purchasing, inventorying, and production costs over and above the added costs that would be incurred for a comparable increase in volume for Uptown’s regular products.
EXHIBIT 1
Financial Statements
(thousands of dollars)
Uptown Computers Company
The Balance Sheet
As of December 31, 2000
Assets Liabilities and Owners Equity
Cash $ 3,420 Accounts payable $ 5,120
Accounts receivable 13,590 Accrued expenses 3,400
Inventories 27,560 Short-term bank loans 26,260
Plant and equipment (net) 36,350 Long-term Note payable 15,120
Total liabilities 49,900
Owners’ equity 31,020
$ 80,920 $ 80,920
Income Statement
For the Year Ended December 31, 2000
Sales revenues $ 108,720
Cost of Goods Sold 80,450
Gross margin 28,270
Selling and Administrative expenses 23,540
Income before taxes 4,730
Income tax expense 2,180
Net income $2,550
On the positive side, Mr. Lopo was acutely aware that the “computer boom” had flattened out, and this plus a poor economy had caused Uptown’s sales volume to fall the past two years. As a result, Uptown currently was operating its plant at about 75 percent of one-shift capacity. Thus, the added volume from Wiz’s purchases could possibly be very attractive. If agreement could be reached on prices, The Wiz would sign a contract guaranteeing to Uptown that The Wiz would buy its house-brand PCs only from Uptown for a three-year period. The contract would then be automatically extended on a year-to-year basis, unless one party gave the other at least three-months’ notice that it did not wish to extend the contract.
Jack Lopo realized he needed to do some preliminary financial analysis of this proposal before having any further discussions with Jennifer Wu. He had written on a pad the information he had gathered to use in her initial analysis; this information is shown in Exhibit 2.
EXHIBIT 2
Data Pertinent To The Wiz Proposal
(Notes taken by Jack Lopo)
1. Estimated first-year costs of producing Speedy PCs (average unit costs, assuming a
constant mix of
models):
Materials $239.80*
Labor 39.60
Overhead (applied @ 125% of labor) 49.50
$328.90
* Includes items specific to models for The Wiz, not used in our standard models.
Accountant says about 40 percent of total production overhead cost is variable.
2. One-time added costs of preparing drawings and arranging sources for system boards, monitors, keyboards, and shipping boxes that differ from those used in our standard models: approximately $15,000.
3. Unit price and annual volume: The Wiz estimates it will need 50,000 computers a year and proposes to pay us (based on the assumed mix of models) an average of $361.79 per computer for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflation-caused increases in costs shown in item I, above; thus, the $361.79 and $328.90 figures are, in effect, “constant-dollar” amounts. Wu intimated that there was very little, if any, negotiating leeway in the $361.79 proposed initial price.
4. Asset-related costs (annual variable costs, as percent of dollar value of assets):
Pretax cost of funds (to finance receivables or inventories) 15.0%
Record keeping costs (for receivables or inventories) 1.0
Inventory insurance 0.3
State property tax on inventory 0.95
Inventory-handling labor and equipment 3.0
Pilferage, obsolescence, breakage, etc 0.5
5. Assumptions for Speedy-related added inventories (average over the year):
Materials: two months’ supply.
Work in process: 2,000 computers, half completed (but all materials for them issued).
Finished goods: 1,000 computers (awaiting next carload lot shipment to a The Wiz warehouse).
6. Impact on our regular sales: Some customers comparison shop for computers, and many of them are likely to recognize a Speedy computer as a good value when compared with a similar computer (either ours or a competitor’s) at a higher price in a non-chain toy or computer store. In 2000, we sold 196,000 computers. My best guess is that our sales over the next three years will be about 200,000 computers a year if we forego the The Wiz deal. If we accept it, I think we’ll lose about 6,000 units of our regular sales volume a year, since our retail distribution is quite strong in Wiz’s market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we’re making computers for The Wiz.
REQUIRED [Your Report should be no more than 5 typewritten pages]:
1. What is the outlay cost of manufacturing a Speedy computer?
2. What is the relevant cost (on a per computer basis) of carrying the working capital investment involved in The Wiz deal?
3. Should The Wiz deal be charged for the opportunity cost of lost sales of computers through the regular distribution channel? If so, what is the opportunity cost?
4. Assuming no inflation, should Jack Lopo accept The Wiz’s offer of 50,000 computers a year at $361.79 per computer? Discuss in detail, all relevant issues that should be considered in arriving at this decision including an analysis of all relevant costs.
Thoughts?
In May 2000, Jack Lopo, marketing vice president of Uptown Computers Company, was mulling over the discussion he had had the previous day with Jennifer Wu, a buyer from The Wiz Stores, Inc. The Wiz operated a chain of discount electronic stores in the New York Metro area. The Wiz’s sales volume had grown to the extent that it was beginning to add “house-brand” (also called “private-label”) merchandise to the product lines of several of its departments. Ms. Wu, The Wiz’s buyer for Electronic goods, had approached Mr. Lopo about the possibility of Uptown’s producing PCs for The Wiz. The PCs would bear the name “Speedy,” which The Wiz planned to use for all of its house-brand Electronic goods.
Uptown had been making PCs for almost 10 years. In 2000, the company’s line included 5 computer models. Sales were currently at an annual rate of about $130 million. The company’s 2000 financial statements appear in Exhibit I. Most of Uptown’s sales were through independently owned retailers (toy stores, department stores, electronic goods stores) and computer shops. Uptown had never before distributed its products through electronic store chains of any type. Mr. Lopo felt that Uptown Computers had the image of being above average in quality and price, but not a “top of the line” product.
The Wiz’s proposal to Uptown had features that made it quite different from Uptown’s normal way of doing business. First, it was very important to The Wiz to have ready access to a large inventory of PCs, because The Wiz had had great difficulty in predicting computer sales, both by store and by month. The Wiz wanted to carry these inventories in its regional warehouses, but did not want title on a computer to pass from Uptown to The Wiz until the computer was shipped from one of its regional warehouses to a specific The Wiz store. At that point, The Wiz would regard the computer as having been purchased from Uptown, and would pay for it within 30 days. However, The Wiz would agree to take title to any computer that had been in one of its warehouses for four months, again paying for it within 30 days. Ms. Wu estimated that on average, a computer would remain in a The Wiz regional warehouse for two months.
Second, The Wiz wanted to sell its Speedy PCs at lower prices than the name-brand PCs, like Dell and Compaq it carried, and yet still earn approximately the same dollar gross margin on each computer sold -- the rationale being that Speedy computer sales would take away from the sales of the name-brand computers. Thus, The Wiz wanted to purchase computers from Uptown at lower prices than the wholesale prices of comparable computers sold through Uptown’s usual channels.
Finally, The Wiz wanted the Speedy computer to be somewhat different in appearance from Uptown’s other computers. While the system board (mother board) and and monitor could be the same as used on current Uptown models, the monitor, system case, mouse and CDRom need to be somewhat different. Also, the PCs would have to be packed in boxes printed with the The Wiz and Speedy names. These requirements were expected by Mr. Lopo to increase Uptown’s purchasing, inventorying, and production costs over and above the added costs that would be incurred for a comparable increase in volume for Uptown’s regular products.
EXHIBIT 1
Financial Statements
(thousands of dollars)
Uptown Computers Company
The Balance Sheet
As of December 31, 2000
Assets Liabilities and Owners Equity
Cash $ 3,420 Accounts payable $ 5,120
Accounts receivable 13,590 Accrued expenses 3,400
Inventories 27,560 Short-term bank loans 26,260
Plant and equipment (net) 36,350 Long-term Note payable 15,120
Total liabilities 49,900
Owners’ equity 31,020
$ 80,920 $ 80,920
Income Statement
For the Year Ended December 31, 2000
Sales revenues $ 108,720
Cost of Goods Sold 80,450
Gross margin 28,270
Selling and Administrative expenses 23,540
Income before taxes 4,730
Income tax expense 2,180
Net income $2,550
On the positive side, Mr. Lopo was acutely aware that the “computer boom” had flattened out, and this plus a poor economy had caused Uptown’s sales volume to fall the past two years. As a result, Uptown currently was operating its plant at about 75 percent of one-shift capacity. Thus, the added volume from Wiz’s purchases could possibly be very attractive. If agreement could be reached on prices, The Wiz would sign a contract guaranteeing to Uptown that The Wiz would buy its house-brand PCs only from Uptown for a three-year period. The contract would then be automatically extended on a year-to-year basis, unless one party gave the other at least three-months’ notice that it did not wish to extend the contract.
Jack Lopo realized he needed to do some preliminary financial analysis of this proposal before having any further discussions with Jennifer Wu. He had written on a pad the information he had gathered to use in her initial analysis; this information is shown in Exhibit 2.
EXHIBIT 2
Data Pertinent To The Wiz Proposal
(Notes taken by Jack Lopo)
1. Estimated first-year costs of producing Speedy PCs (average unit costs, assuming a
constant mix of
models):
Materials $239.80*
Labor 39.60
Overhead (applied @ 125% of labor) 49.50
$328.90
* Includes items specific to models for The Wiz, not used in our standard models.
Accountant says about 40 percent of total production overhead cost is variable.
2. One-time added costs of preparing drawings and arranging sources for system boards, monitors, keyboards, and shipping boxes that differ from those used in our standard models: approximately $15,000.
3. Unit price and annual volume: The Wiz estimates it will need 50,000 computers a year and proposes to pay us (based on the assumed mix of models) an average of $361.79 per computer for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflation-caused increases in costs shown in item I, above; thus, the $361.79 and $328.90 figures are, in effect, “constant-dollar” amounts. Wu intimated that there was very little, if any, negotiating leeway in the $361.79 proposed initial price.
4. Asset-related costs (annual variable costs, as percent of dollar value of assets):
Pretax cost of funds (to finance receivables or inventories) 15.0%
Record keeping costs (for receivables or inventories) 1.0
Inventory insurance 0.3
State property tax on inventory 0.95
Inventory-handling labor and equipment 3.0
Pilferage, obsolescence, breakage, etc 0.5
5. Assumptions for Speedy-related added inventories (average over the year):
Materials: two months’ supply.
Work in process: 2,000 computers, half completed (but all materials for them issued).
Finished goods: 1,000 computers (awaiting next carload lot shipment to a The Wiz warehouse).
6. Impact on our regular sales: Some customers comparison shop for computers, and many of them are likely to recognize a Speedy computer as a good value when compared with a similar computer (either ours or a competitor’s) at a higher price in a non-chain toy or computer store. In 2000, we sold 196,000 computers. My best guess is that our sales over the next three years will be about 200,000 computers a year if we forego the The Wiz deal. If we accept it, I think we’ll lose about 6,000 units of our regular sales volume a year, since our retail distribution is quite strong in Wiz’s market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we’re making computers for The Wiz.
REQUIRED [Your Report should be no more than 5 typewritten pages]:
1. What is the outlay cost of manufacturing a Speedy computer?
2. What is the relevant cost (on a per computer basis) of carrying the working capital investment involved in The Wiz deal?
3. Should The Wiz deal be charged for the opportunity cost of lost sales of computers through the regular distribution channel? If so, what is the opportunity cost?
4. Assuming no inflation, should Jack Lopo accept The Wiz’s offer of 50,000 computers a year at $361.79 per computer? Discuss in detail, all relevant issues that should be considered in arriving at this decision including an analysis of all relevant costs.
Thoughts?
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