Dansk 1

A/S Dansk Minox

Dr Ashish Varma
Ph.D, FICWA, PGDBM
Assistant Professor
Accounts and Finance
IMT, Raj Nagar
Ghaziabad.

Email: avarma@imt.edu, sir_ashish@rediffmail.com

 Dansk 2

Dansk Minox
The Setting
• A processed foods manufacturer in Denmark
• 30 products……Hmm…
• Solid market position
• Entering a higher growth phase:
• Late 60’s - Working mothers
- “Convenience” foods
- More disposable income
- More income spent on food
- Growth of “imaginative” food products
• One current product is vacuum-packed, cooked pork w/gravy
• A big Danish traditional meal is pork with red cabbage salad
• There are beginning to be packaged red cabbage salad products in
the stores
• Our idea—A “complete meal” package
• A pork package and cabbage package, together in one box, as our
first “complete meal”
 Dansk 3

1. Finance says price must be 8.20 to earn a fair profit (5.26

price for Dansk Minox).

2. Marketing says too high! Price should be 6.85 for good

penetration and good growth (4.40 price for DM).

3. Finance says we lose money at 6.85.

4. Introduce “CM” in 1966 at 8.20 with sales budget of 85,000

kg.

5. Sales are only 30,000 kg. Marketing says sales of 85,000 kg

are likely at 6.85.

6. What to do now?
 Dansk 4

Exhibit A
A/S Dansk Minox
Contribution Analysis
At a Retail Price of 8.20
Price to Dansk Minox D.Cr. 5.26
Incremental Cost 3.23
Less: Transportation, storage (.20)
Labor (.50) 2.53
Profit Contribution 2.73
Volume 30 tons (30,000 Kg)
Total Contribution ( 2.73 x 30,000) D.Cr. 81,900

At a Retail Price of 6.85

Price to Dansk Minox D.Cr. 4.40
Incremental Cost 3.23
Less: Transportation, storage (.20)
Labor (.50) 2.53
Profit Contribution 1.87
Volume 85 tons (85,000 Kg)
Total Contribution (1.87 x 85,000) D.Cr. 158,950

THE INCREMENTAL PROFIT IS HIGHER AT THE D. CR. 6.85 PRICE BY

77,050 (158,950 - 81,900).
 Dansk 5

The key idea embodied in Exhibit A is that, in the short run, the
impact on profits between the two prices is identical to the
change in contribution (158,950 - 81,900 = 77,050).

The lower price yields more profit contribution, given the

volume estimates.
 Dansk 6

Break-even Volume at 6.85 Price

÷ Contribution
Total Contribution
Margin per Unit
at 8.20 Price
at the 6.85 Price

81,900 ÷ 1.87

43,800 Kg

Thus, the low price yields more contribution as long as DM can sell
more than 44 tons, which is only 52% of projected sales of 85 tons.

Remembering that 30 tons were sold at the 8.20 price, it is quite

probable that at least 44 tons can be sold at D.Cr. 6.85.
 Dansk 7

The best case for the low price, high volume approach (D.Cr.
6.85 price), as proposed by the marketing department, can
be summarized as follows:
1. It produces good incremental contribution to profits. Since there is
excess capacity, we should take advantage of it.
The fixed costs are already being covered.

Is it possible / feasible to increase the prices soon after the product is

launched?
Will the customer realize that earlier they were billed on marginal cost
and now they are being billed on full cost.
 Dansk 8

2. The contribution is much better at D.Cr. 6.85 than at D.Cr.

8.20 because of the larger sales demand at the lower price.

The difference in consumer price between the standard and

the CM packs as proposed by the finance department implies
that the consumer would have to pay D.Cr. 3.35 (8.20 - 4.85)
for the red cabbage salad, since the sliced pork in gravy
content of the two packs is the same.

Similarly, at the D.Cr. 6.85 price, the consumer pays D.Cr.

2.00 (6.85 - 4.85) for the cabbage salad.

There is a big market for packaged cabbage salad at D.Cr. 2.00,

but there is a small market at D.Cr. 3.35. This makes sense
because the consumer is unlikely to pay more than the
market price for cabbage salad for the added convenience in
a CM pack.
 Dansk 9

3. New products such as the complete meal are the wave of the
future for the following reasons:
a. The convenience packs are rising in
popularity.
b. Packaged cabbage is already here.
c. CM fits the strategic thrust toward whole
meals vs. separate products.
d. Competitors will be here soon if we don't
move quickly (Maybe?).
 Dansk 10

4. It is inappropriate to charge cabbage the

same OH allocation as we charge pork.
Charging OH based on weight is incorrect.
5. The value price for the complete meal is D.Cr.
6.85 (based on the D.Cr. 2.00 value price for
the cabbage salad). That is the price at which
the market potential is large.
6. Any cannibalization of the standard pork pack
is irrelevant because our standard product is
vulnerable already from competitors
introducing the CM concept. It is better for us
to replace the standard pack than for a
competitor to do so.
 Dansk 11
Exhibit B
A/S Dansk Minox
Alternate Methods of Allocating Fixed Overhead

1. Current Method (Allocate Fixed OH on Kilograms)

Total Company Sales (kgs) = 1,260,000
Total Company Fixed OH = 1,510,000

OH/kg = 1,510,000 = 1.20/kg

1,260,000
A Complete Meal = 1 kg - 1.20 of OH

2. Alternate Method (Allocate Fixed OH on Labor Cost)

Company Labor Cost = 700,000
Total Company Fixed OH = 1,510,000

OH/Labor = 1,510,000 = 2.16

700,000
A Complete Meal = .50 Labor - 2.16 x .50 = 1.08 of OH

3. Alternate Method (Allocate Fixed OH on # of Packages)

Standard Pork Package = .450 kg. Assume this is average for the meat
products.
Company Sales in # of Packages = 1,260,000 ÷ .45 = 2,800,000 packages
Total Company Fixed OH = 1,510,000

OH/Package = 1,510,000 = .54

2,800,000
A Complete Meal = 2 packages - .54 x 2 = 1.08 of OH
 Dansk 12

The basic idea on allocating PFE to products is the “cost driver”

concept

ABC
1. What “activity” drives the PFE cost?
2. What share of that activity does “CM” consume?

NOTE:
If product moves through the factory in batches of a certain weight
(cooking, slicing, mixing, packing), then assigning PFE per Kg may
not be as silly as it at first appears!
 Dansk 13

Exhibit C
A/S Dansk Minox
Full Cost Analysis — The Complete Meal
Price to Dansk Minox D.Cr. 4.40
Variable Cost (3.23)
Production Fixed Expense (1.20 per Kg) (1.20)
Product Specific Fixed Cost (Advertising) ( .30)
Selling, and Administrative Expense ( .19)
Loss ( .52)

Since the Pork Pack alone shows .13 profit, the loss is .65 ie (0.52 +0.13) on the
Cabbage Salad Pack with .66 ie ( 1.2 – 0.54) PFE allocation.

Thus the Cabbage Salad can only support .01 of PFE!

 Dansk 14

The net conclusion of this analysis is that the choice of the best OH
allocation scheme is really moot.

Irrespective of the basis of OH allocation, the CM product is a

“loser” at the low price on a full cost basis.
 Dansk 15

Are fixed costs relevant for the decision?

1. Concerning the allocation of fixed overhead to the
complete meal, the following can be noted:
a. In the long run, the capacity really is not “free” in this market.
b. Normal growth of our standard pack and other products will soon
fill up the factory without the CM product. In growing markets,
capacity must be added ahead of sales. Excess capacity will thus
always exist, but it is not “free.”
.
 Dansk 16

c. Production fixed overhead at D.Cr. 1.51 million is large .

We are a high fixed cost operation. A good product must
be able to carry a fair share of that OH.
d. All allocation methods, as demonstrated in Exhibit B,
show a fixed overhead allocation to CM of about D.Cr.
1.00 per pack or more. Further, as noted on Slide 10,
allocating OH based on weight is defensible in this
situation
 Dansk 17

2. This product cannot really support any

manufacturing overhead at all. There is only
D.Cr. 0.01 of margin to cover fixed production
OH and a profit.
3. THUS, THE CABBAGE SALAD IS A “GOOD
CONTRIBUTION/NO PROFIT” PRODUCT.
 Dansk 18

4. DM's current market positioning is based on high value/high price

products, such as the standard pork package.

The complete meal does not fit that strategy. Our current products
tend toward higher value/lower bulk, but cabbage salad is lower
value/higher bulk:
a. Standard pack weighs .450 kg and sells for D.Cr. 3.11; but cabbage salad
weighs .550 kg and sells only for D.Cr. 1.29. The complete meal mixes a high
value/low bulk product (standard pork pack) and a low value/high bulk product
(cabbage salad) together as if both are appropriate for our factory.
 Dansk 19

b. In a factory configured for processing meats, processing vegetables

is very inefficient and expensive. Just because they are eaten
together does not mean they should be packaged together.

c. Cabbage salad takes just as much labor time (a rough proxy for
"value added") as pork—both require D.Cr. 0.25 of labor per unit.
However, cabbage salad sells for much less than pork.

One inference is that DM is using very expensive labor (whose skill

levels are needed to process meat products) to process cabbage. A
factory solely geared to packaging vegetable products would no
doubt employ much cheaper labor.

Thus, DM would be at a competitive disadvantage in their

manufacturing operations by processing meat products and
vegetable products in the same factory.
 Dansk 20

5. Cannibalization of standard pack sales by complete meal

sales would be much more likely at D.Cr. 6.85 price (D.Cr.
2.00 for cabbage) than at D.Cr. 8.20 price (D.Cr. 3.35 for
cabbage). At the D.Cr. 6.85 price, customers might well
prefer our CM pack versus our standard pork pack with a
competitor's packaged cabbage salad.

Thus our introduction of the complete meal at D.Cr. 6.85 will

directly erode sales of the standard pack, substituting a low
profit product for a higher profit one. Why cannibalize the
standard pork pack with our own loser? It makes more
sense to let someone else sell packaged cabbage to
promote sales of our standard pork package.
 Dansk 21

6. The complete meal concept is not really likely to be the wave

of the future.
a.) It seems like a bad use of our factory at the D.Cr. 6.85 price
(the value price); low value-added product not appropriate for
our high fixed cost factory.
b.) It is low volume and low growth idea at the D.Cr. 8.20 price
(full cost price).
c.) D.Cr. 8.20 is not even a high enough price because that
uses .30 for advertising which presumes 85 tons. At 30 tons,
advertising must be .85/kg, which implies a retail price of
D.Cr. 9.99. Cutting advertising probably would reduce sales.
Of course, at a 9.99 price, volume would fall still lower and we
would have to adjust price upward again, and so on.
d.) The vegetable packers selling the cabbage pack are not
likely to move into meat products (Different business for
them.).
e.) It appears that meat product firms cannot make a profit at
the value price of D.Cr. 6.85 (not enough value-added).
 Dansk 22

Recap of the Analysis

1. The marketing arguments for complete meal make sense only at the
D.Cr. 6.85 price.

2. The D.Cr. 6.85 price is in conflict with our manufacturing strategy of

low-bulk/high-value products.

3. Also, the D.Cr. 6.85 price is not financially attractive, given our factory
composition and overhead structure.

4. Complete meal should be priced at D.Cr. 6.85, but that price is

unprofitable for DM.

5. However, a price of D.Cr. 8.20, or even higher, would be unattractive to

the consumer.

6. Hence, the CM concept of combining standard pork and cabbage salad

is a bad idea, at our current cost structure.
 Dansk 23

7. Therefore, unless someone can figure out how to

restructure the cost chain, the complete meal idea is
unlikely to create a big wave of anything!

8. Joint venture with a vegetable packing company?

∆ Shipping Cost & ∆ Convenience
Package Cost vs. to Customer

A Good “Value Proposition”?

 Dansk 24

Exhibit D—A/S Dansk Minox

Target Cost for Cabbage Pack
Retail Price 2.00
Tax (.22) (12.5%)
Net to Retailer 1.78
Retailer Gross Margin (.38) (21.5%)
Wholesale Price 1.40
Wholesale Gross Margin (.11) (8%)
Price to DM 1.29
Normal Profit Margin (.05) (4%) ($.13 on $3.11 for Pork)
Total Allowable Cost 1.24

Non-Mfg. Cost:
Advertising (.16)
Transport/Storage (.11)
G, S & A (4%) (.05)
TOTAL (.32)
Allowable Mfg. Cost .92

Current Mfg. Cost

Cabbage
Labor
Packaging
.50
.25
.15
*
Misc. .06
PFE .66 1.62

*Must cut Mfg. Cost by .70 on 1.62 = 43%

Gross Margin: Allowable .37/1.29 = 29%
Now Negative!
 Dansk 25

Exhibit E
A/S Dansk Minox
Perspective on Decision Making

Manufac-
Marketing Business Perspective
turing

Contribution Full Cost

Financial Metric
Margin Profit

Shorter Time Frame Longer

Yes
Decision to No
Introduce CM?

What Constitutes “Good Thinking” Here?

 Dansk 26

The Basic Thought

Our view of what seems smart and what seems

silly changes dramatically when we change the
“lens” through which we see the problem:

• A financial analysis “lens”

• A business analysis “lens”
 Dansk 27
Case Exhibit 1
Finance Department Proposal
Complete Pork Difference
Meal Pack (Cabbage Salad)
Consumer Price 8.20 4.85 3.35
Turnover Tax (12.5%) .91 .54 .37
Consumer Price Before Tax 7.29 4.31 2.98
Retailer’s Gross Margin (21.5%) 1.57 .93 .64
Wholesale Price 5.72 3.38 2.34
Wholesaler’s Gross Margin (8%) .46 .27 .19
Price to DM 5.26 3.11 2.15
Material: Pork 1.67 1.67
Labor: Pork .25 .25
Material: Cabbage .50 .50
Labor: Cabbage .25 .25
Packaging .26 .11 .15
Transportation and Storage .20 .09 .11
Sundry Variable Costs .10 .04 .06
Total Variable Costs 3.23 2.16 1.07
Production Fixed Expenses 1.20 .54 .66
Advertising Expense .30 .14 .16
Selling and Administrative Expense .23 .14 .09
Total Cost 4.96 2.98 1.98
Profit .30 .13 .17
 Dansk 28

Case Exhibit 2
Marketing Department Proposal
Complete Pork Difference
Meal Pack (Cabbage Salad)
Consumer Price 6.85 4.85 2.00
Turnover Tax (12.5%) .76 .54 .22
Consumer Price Before Tax 6.09 4.31 1.78
Retailer’s Gross Margin (21.5%) 1.31 .93 .38
Wholesale Price 4.78 3.38 1.40
Wholesaler’s Gross Margin (8%) .38 .27 .11
Price to DM 4.40 3.11 1.29
Material: Pork 1.67 1.67
Labor: Pork .25 .25
Material: Cabbage .50 .50
Labor: Cabbage .25 .25
Packaging .26 .11 .15
Transportation, Storage .20 .09 .11
Sundry Variable Costs .10 .04 .06
Total Variable Costs 3.23 2.16 1.07
Production Fixed Expenses .54 .54
Advertising Expense .30 .14 .16
Selling and Administrative Expense (4%) .19 .14 .05
Total Cost 4.26 2.98 1.28
Profit .14 .13 .01