Question

A Business Dilemma

Subway, the fast food restaurant franchise, announced in early 2018 it planned to bring back the “$5 Footlong” promotion. Hundreds of Subway franchise owners protested the promotion saying that they cannot afford to sell the footlong sub sandwiches for $5. You'll want to review the Subway webpage featured in the Chapter 8 module.

Assume that the costs related to a Subway footlong and a Subway franchise include the following

Cost Item	Details	Cost per sandwich
Meats, cheeses, toppings	Per footlong	$2.25
Sub roll bread	Per footlong	$.29
Labor cost per footlong	$15.00/hour wage rate and each worker can make 10 sandwiches per hour	$1.50
Credit card transaction fee	1.0% + $.10 per transaction	$0.15
Electricity	$360 per month dividend by 4,000 orders per month	$0.09
Rent	Rent $1,200 per month divided by 4,000 orders per month	$0.30
Franchise fee amortization	Franchise and startup fees $36,000 divided by 180 months (15 years) divided by 4,000 orders per month	$0.05
Royalty fee	8.0% of sales	$0.40
Advertising fee	4.5% of sales	$0.23
Equipment leasing cost	$600 per month divided by 4,000 orders	$0.15
Cost per footlong sandwich		$5.41

Question #1:  Bob owns a subway franchise and he is furious at the thought of offering $5.00 footlongs. His comment was “they cost us $5.41 each so we will be upside down on each sub sold. I’ll lose my shirt!”. Do you agree or disagree with Bob that this idea should be immediately rejected without any further analysis? If you don’t agree with Bob, why do you think further analysis is required?  

Question #2: What are the relevant and irrelevant costs in this pricing decision? (hint: there are 6 relevant costs)

Question #3: Can you think of any other reasons/factors besides the costs listed above that might be relevant to the pricing decision to offer the $5.00 footlongs? Use your imagination.

Answer 1

1. Relevant cost per footlong:

Meat, cheese, toppings	$2.25
Sub roll bread	$0.29
Credit card transaction fees	$0.15
Electricity	$0.09
Royalty fee	$0.40
Advertising fee	$0.23
Relevant cost per footlong	$3.41

Rent, franchise fees amortization, equipment leasing cost are fixed cost, there will be no change in amount incurred if the promotion is accepted or rejected.

Labour cost would also be incurred even if the promotion is accepted or rejected, since the franchise cannot run without labours, making it irrelevant for pricing decision.

The promotional offer is $5 for each footlong, and the profit based on the relevant costing of $3.41 is $1.59.

Therefore, i disagree with Bob that the promotional offer shall be rejected, the promotional offer should be accepted by Bob.

2. ‘Relevant costs’ can be defined as any cost relevant to a decision. A matter is relevant if there is a change in cash flow that is caused by the decision.

The change in cash flow can be:

• additional amounts that must be paid
• a decrease in amounts that must be paid
• additional revenue that will be earned
• a decrease in revenue that will be earned.

A change in the cash flow can be identified by asking if the amounts that would appear on the company’s bank statement are affected by the decision, whether increased or decreased.

Relevant costs for the above decision making are:

• Meat, cheese, toppings - Direct cost relating to the footlong preparation
• Sub roll bread - Direct cost relating to the footlong preparation
• Credit card transaction fees - Direct cost relating to each order of footlong based on the promotional offer price.
• Electricity - Direct cost relating to the footlong preparation, the additional electricity cost for each footlong
• Royalty fee - Additional royalty fee to be paid based on the sales price of the footlong
• Advertising fee - Additional royalty fee to be paid based on the sales price of the footlong

Irrelevant cost for the decision making are:

• Rent - Fixed cost, no change in outflow even if the promotion is accepted or rejected
• Franchise fees amortization - Fixed cost, no change in outflow even if the promotion is accepted or rejected
• Equipment leasing - Fixed cost, no change in outflow even if the promotion is accepted or rejected
• Labour Cost - No change in outflow even if the promotion is accepted or rejected

3. Sause packets to be provided with the footlong is also a relevant cost to be considered by the franchise holders.