The Plan of The Shoe Shop in Opening a Retail Outlet - Case Study Example

Running Head: THE SHOE SHOP: A PRELIMINARY REPORT The Shoe Shop: A Preliminary Report in Harvard Format by Course Name University I. Executive Summary In relation to the plan of The Shoe Shop in opening a retail outlet, this report presents an analysis of the costs and the projected income of the company in the medium term. Based on the analysis, The Shoe Shop will be a profitable venture with a relatively low break-even point and very high margin of safety. At the end, the paper recommends stimulating overall demand in order to enhance the utilization of resources. II. Introduction With the ever increasing disposable income in the London area, the proliferation of shoe manufacturers which compete with the more established players is warranted by the huge profit opportunities (BFA 2007). The shoe industry, together with the apparel and accessories sectors posts increases in total turnover in the past year which shows the increasing demand and market for these products. The creation and operation of The Shoe Shop which will commence on January 2008 is another quest to provide products for this profitable market. The price of shoes in London is highly dependent on the strategies employed by the different industry players (BFA 2007). Business organizations which employ differentiation and niche strategies enhance the image of their brands by putting a high margin in their shoe products. A good example of this is Russell and Bromley where a pair of women's shoes can cost up to '200.00 (Russell and Bromley 2007). On the other hand mid-priced companies charge from '40 to '90 for a pair of shoes. Shoe manufacturers who are utilizing cost leadership strategies can price more competitively at less than '30. Ben Sherman can price as low as '15 for a pair of women's shoes. These pricing strategies of the competitors in the market together with the survey conducted to determine the target consumers' preferences become the primary bases of The Shoe Shop's proposed pricing strategies. Proposed Pricing Strategy The pricing strategy of a business organization is one of the key elements to its success and even mere survival in the industry where it operates (Kotler 2005). In this consideration, The Shoe Shop formulates its pricing strategy as a way to efficiently generate the maximum profit available. The main aim of the pricing strategy is to cover all the company's efforts in production and other activities, provide ample margin for profits, build the hip image that the company desires, and generate enough demand by pricing competitively and at par with other industry players. In order to determine the pricing strategy, the market research department of the shoe shop conducted a survey which is geared in appropriate rice for a pair of shoes. Considering the target market of The Shoe Shop, the survey was participated by both men and women whose age ranges from 18-35 years old. The market research department concluded that within this age range, consumers are very much concerned about their image and prefer products which express what is hip and trendy. They are willing to pay more for image but most will not spend more than '92.00 for a pair of shoes. Thus, with this consideration, The Shoe Shop will price a pair of shoes in its product line for '70.00. III. Per Unit Cost Statement The costs associated with the production and marketing of the company's shoes generally has a variable and fixed component. The variable costs are direct materials and direct labor both of which can be directly traced to the individual shoes being manufactured. Even though the sizes and design of the shoes vary, the company's direct material cost '27.25 for each pair. Direct labour is 1.25 hours and employees are paid '15.00 per hour of labor. In terms of indirect costs, The Shoe Shop pays a monthly overhead of '7,500. The manufacturing department together with other functional areas, is serviced by the administrative and marketing department. The Shoe Shop allocates a monthly overhead of '3,000 for the manufacturing and '2,500 for the manufacturing department. Thus, shoe production has a total fixed cost of '13, 500. The current resources and facility of The Shoe Shop has a maximum production capacity of 1,500 pair of shoes per month. Thus, each pair of shoes is allocated a total overhead of '9. Table 1 below shows the company's per unit cost statement concluding that with the present capacity, a pair of shoes will utilize '55.00 to manufacture. Table 1. Per Unit Cost Statement Cost Amount Direct Material '27.25 Direct Labor '18.75 Indirect Costs '5.00 Manufacturing Overhead '4.00 Per Unit Cost '55.00 IV. Annual Statement under Marginal Costing This portion shows the company's income statement for the first three years of operation through the use of marginal costing. Marginal costing assumes that the company's level of indirect costs will remain the same for the entire period (Osborne 2007). This is true if The Shoe Shop operates within its current maximum capacity of 1,500. For most business organizations, the first year of operation presents the most challenging period because the product is relatively new in the market. The volume of sales during the first year is expected to be at minimum. However, The Shoe Shop expects that during the second and the third years, total demand will eventually increase. The three year sales are as follows: 10,000 units; 12,000 units; and 15,000 units. Table 2. Annual Income Statement for Years 2008-2010 V. Break-even Analysis and Margin of Safety The Shoe Shop's profitability in its operation is highly dependent on its volume of sales. Break-even analysis will show the total unit sales that the company needs in order to have zero profits. Thus, The Shoe Shop needs to sell shoes which is more than or equal to its break-even point. In order to get the break-even in units, The Shoe Shop will divide its total fixed cost with it per unit contribution margin. The computation is as follows: Contribution Margin = Fixed Cost / Contribution Margin per Unit = '13,500 / '24 = 563 units The business organization is required to sell 563 units per month or 7,656 units annually to break even. Margin of safety is defined as the difference between a business organization's expected sales volume to its break-even point. The margin of safety represents the level of insulation from losses. This measure indicates the potential financial health of a business organization. If the margin of safety is positive, the company reaps profits. However, when it is negative, the firm incurs losses. The Shoe Shop's margin of safety is computed from its presented financial statements and calculated break-even point. Since, the concern of the company is its financial health for the next three years; margins of safety are computed for the fiscal years 2008, 2009, and 2010. Table 3. Margins of Safety from 2008-2010 (in units) 2008 2009 2010 Expected 10,000 12,000 15,000 Break-Even 7, 656 7, 656 7, 656 Margin of Safety 2,344 4,344 7,344 VI. Conclusion and Recommendation Based on the calculations and financial analysis presented in the report, the launching of The Shoe Shop opens the company into profitable opportunities. If everything goes as expected, the business organization will be posting huge profits because of its high margin of safety. The company's break-even point is only half its maximum capacity. It is therefore recommended that The Shoe Shop stimulate demand through marketing aggressively. It should be noted that operating far below the maximum manufacturing capacity will result in having a large portion of idle resources and underutilization. References British Footwear Association 2007, Retrieved 5 August 2007, from http://www.britfoot.com/ Kotler, P. 2005, Marketing Management, New Jersey: Prentice-Hall Marginal Costing 2007, Osborne Books, Retrieved 5 August 2007, from http://www.osbornebooks.co.uk/pdf/active_accounting_22.pdf Russell and Bromley 2007, Retrieved 5 August 2007, from http://www.russellandbromley.co.uk/page.pl'id=1 Read More