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Business Proposal In Clear Hear Scenario - Essay Example

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The contribution margin from Beta is $18 and from Alpha is $12. The difference in the contribution margin is because of the higher selling price of Beta.
Kendra Sherman has procured an order from Big Box…
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Business Proposal In Clear Hear Scenario
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Business Proposal In Clear Hear Scenario Clear Hear operates two production lines in its factory- Alpha and Beta. The contribution margin from Beta is $18 and from Alpha is $12. The difference in the contribution margin is because of the higher selling price of Beta.
Figure 1. Contribution margin of Alpha and Beta.
1- Alpha
2- Beta
Kendra Sherman has procured an order from Big Box for manufacturing 100000 units at a price of $15 each, which are nearly identical to Alpha. However, Lisa Norman, the production manager informs that the excess capacity is only 70000 units. So, there are two options either 30000 units from Beta model, can be switched to Alpha or the Original Equipment Manufacturers (OEM) proposal to manufacture a prototype at a price of $14 per unit can be adopted. The decision will be based on the contribution earned or foregone by adopting an option. In the first option, the company looses a contribution of $11 and in the second option, the company can earn an additional contribution margin of $1 per unit. So, in order to maximize the revenue the company should accept OEMs offer to manufacture the remaining 30000 units. This will result in an additional revenue of $1500000.
Figure 2. Comparison of contribution margin.
Bar 1-If Beta is switched to Alpha
Bar 2- If the extra 30000 units are manufactured through OEM
From the above figure, it can be seen that the companys contribution becomes negative, if Beta model is switched to Alpha. So, it is advised that the company should adopt the second option. This will help the company to maximize its revenue. By doing so, the company will also be able to make use of its excess capacity. For this, the company will not have to incur any further fixed costs. As a result of this the existing fixed costs will get distributed over the excess units. The utilization of the excess capacity will also lower the Average Cost (AC) of each unit. This is because the Total Cost will now be allocated over a large number of units resulting in a reduced AC.
As the company does not have to incur any extra fixed cost for the excess 100000 units the profit will move up. For the additional units, the only cost that the company has to bear is the Variable Cost as the fixed costs remain fixed irrespective of the level of production.
In order to reduce the cost of production, the company can lower the material cost by setting up production centers near the sources of supply. This will reduce the distribution cost and will thus lower the purchase cost of the material (Kobayshi, 2003).
The company can also lower its overall costs by minimizing waste and ensuring efficient management of the available resources. By purchasing the goods in bulk quantity the company can avail the trade discounts which will reduce the cost of material.
Calculation of contribution per unit-
Production of excess 30000 units-
Production of 70000 units by using the existing capacity of Alpha
Kobayshi, T. (2003). How to reduce manufacturing and management costs of tractors and agricultural equipment. Retrieved October 28, 2009, from Read More
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