Benson Appliance Corporation

Benson Appliance Corporation manufactures small appliances at its Michigan town, Indiana, plant. Both of the company's products, electric knives and electric can openers, are marketed exclusively through manufacturing representatives who service the retail appliance dealers. For this sales function, each representative is paid a salary plus a commission on each item sold.

During the past five years, Benson's sales have been growing at the rate of 10 percent per year, although its industry has recently experienced a decline in unit prices. The Companies 1999 income statement is shown in Exhibit -1.

Exhibit-1(Income Statement in $'000)
For the year 1999

Sales (400,000 knives and 400,000 openers)	$10,000
Manufacturing Costs	5,600
Gross Margin	4,600
Marketing Costs	2,700
General Admin Costs	500
Advertisising Costs	100
Profit Before Tax	1,300
Taxes(50%)	650
Profit After Tax	650

An analysis of Benson's cost structure is shown in Exhibit-2. This analysis reflects the low degree of capital intensity that characterises the small appliance industry. As a result Mr. Benson can expend production to any level needed. The variable marketing costs are primarily sales commissions and fright expenses. Labour cost constitute approximately 40% of the variable manufacturing cost while the reminder is made up of charges for component materials.

Exhibit-2 (Analysis of costs)

Variable Costs		Product Line($/unit)	Product Line($/unit)
Selling Price		$10	$15
Variable Manufacturing Cost
Volume <500,000		4	7
Volume > 500,000		5	8.75
Variable Marketing Cost		1	2
Fixed Costs
Manufacturing Costs	$1,000,000
Marketing Costs	$1,500,000
General Administrative	$300,000 (Plus 2% of total sales)
Budgeted Costs
Advertising	$100,000

Experience has shown that variable manufacturing costs for each product increases by 25 percent when total production volume for that product exceeds 500,000 units. For example, if knife production is 550,000 units 500,000 units are charged at $4 and 50,000 at $5 per unit.

Mr. Paul Benson, president and founder of Benson Appliance Corporation, is in the process of making up his 2000 budget and operating plan. In the past, this budgeting process amounted to a simple projection of the previous years operations while sale increased by 10 percent.

Mr. Benson however was not pleased with this process, particularly in view of price erosion that had taken place during the past few years. As a result, Mr. Benson asked his marketing manager, Fred Brinker, to prepare an analysis of price and advertising strategies open to the company.

In this analysis, Mr. Brinker emphasised that the product demand structure is extremely price sensitive. The tables given below describe these price - sales relationships for 2000. For knives the structure is not defined above a price of $12 per unit and below a $7 per unit price. For can openers these upper and lower limits are $17 and $13, respectively.

Mr. Brinker emphasised that prices must stay within these bounds. "Selling above these limits would lock us out of the market while a price under the established levels will be unreasonable from a profit standpoint" he warned.

In recent years the company had maintained an annual advertising budget of $100,000, split evenly between knives and can openers. In discussing the effect of changing the level of advertising expenditure, Mr. Brinker referred to the

Table -1 given below. "An increase in knife advertisement would result in an upward shift in our demand curve regardless of what price we charged as long as that price was within the stated limits. However advertisement is ineffective beyond a point. For instance, advertising more than $290,000 will not bring in any additional sales.

On the subject of can opener sales, Mr. Brinker indicated that the effect of increased advertising depended on the price charged :

Table - 2. An increase in advertisement will result additional sales. Advertising should not exceed $200,000. Furthermore, there will be no sales decrease if advertising is cut all the way to zero.

“Fred ,” Mr. Benson asked, “just what happens when we alter the distribution of advertising effort between knives and can openers?”.

Paul replied to Mr. Brinker that the two products carry different brand names. Therefore, he reasoned that they are independent where advertising effect is concerned and changes in one level of spending should not affect sales of the other product.

Mr. Benson was still concerned about the price erosion, which probably would continue in 2000. Although Mr. Brinker believed that the products quality images were strong enough to enable the company to obtain a price slightly higher than its competition, the effects of being a price taker in a declined market still disturbed Mr. Benson.

Mr. Brinker promised to develop a mechanism to assist Mr. Benson in arriving 2000 operating plans.