Question

Consider the following scenario:

The privately owned Baker Company was founded in 1960. The company manufactures kitchen cabinets and has been very successful, expanding from one facility to twelve facilities in the same and other states. All facilities but the original are located near interstate highways. The original facility, which is no longer the headquarters, is in a downtown area of a major city (which grew up around it) with relatively high real-estate taxes. It has had a negative contribution margin and a net loss for the last five years. The founder is retired and three of his children want to close the facility. The fourth does not, because it "was Dad's first place and I went there every day after school." She believes they can bring the facility back to profitability if the city's downtown revitalization project succeeds and they dedicate the first floor of the facility to retail.

Consider:

• Your definition for "negative contribution margin."
• Whether the fact that the facility is not near an interstate makes a difference in the decision.
• Would it make a difference if the company were publicly traded?
• Might there be additional costs, in addition to revenues, to convert the first floor of the facility to retail?
• What risks may be associated with leasing to retail stores?
• What is your recommendation? Close and sell the facility or modify the first floor to be able to lease to retail stores.

Answer 1

• Your definition for "negative contribution margin."

Contribution means the Sales minus the Variable Cost . It includes Fixed Cost + Profit.

Negative Contribution Margin means that your variable cost and expenses are more than the Sales . It means that even after the sale quantities are good , it is not resulting into Profit as the variable cost itself and the expenses are so high that the sale price is unable to cover the same . Negative Contribution margin is an indicator that the Company should look into the pricing factor , urgently and make it viable.

• Whether the fact that the facility is not near an interstate makes a difference in the decision.

Yes, the Location plays vital role in the setting up and growth of the business. The First facility is located at the Downtown of a major city , while the other facilities are at Interstate highways. Generally, the customer for Kitchen Equipments would like to explore the main market of the city and normally , doesn’t expect it on Interstate highways . The Location of the first facility at Downtown gives an edge the facility over the other facilities and certainly make a difference .

• Would it make a difference if the company were publicly traded?

We don’t think that being Public or Private makes a difference here. It is all about the business that matters most , may it be Public or Private. It requires a proper place of business and the handling of customers .

• Might there be additional costs, in addition to revenues, to convert the first floor of the facility to retail?

There shall be certainly additional costs in building first floor as Retail office but it would give an advantage for the Company where the Manufacturing facility as well as the Retail facility so that the customer can be convinced with manufacturing facility as well as the various options available under Retail section on first floor.

• What risks may be associated with leasing to retail stores?

When a property is leased out , the user may not treat the property as owners do maintain. Moreover, when the property location is hot and having good price , the leased retail business might not generate the expected returns on business . The retail business must earn good return so as to pay off the lease rent as well as the margins to the leased person.

• What is your recommendation? Close and sell the facility or modify the first floor to be able to lease to retail stores.

We would recommend for modifying the first floor to retail stores as it would earn good rental income as we know that the area is now having a high cost real estate place and the company should capitalize by using the facility for leasing to retails.

Closing the facility also is not so easy and it has a cost too. Whenever we go to market for selling the property , it is very much possible that the price is not so good. Moreover, the place is a high cost real estate area which can have good price in future so better keep the place and go for leasing.