Question

Your firm has typically relied on its sales force, but with this new product, you will be going into new markets--your sales force has not been there before.  In addition, the product has a relatively low contribution margin ($40.00), making it difficult to justify making direct sales calls.  Assume that the only fixed costs you need to cover are your marketing expenses.  Consider the following communications methods for informing potential customers about your product:

1.   Direct mail

You could obtain mailing lists with 22,000 names of possible users for $1205.  You could produce and deliver a mailing which would include a letter, a sample of the product, a reply card and a brochure for $3.00 each.  You expect a 10% return of the reply cards.  You would have an outside telemarketing sales organization make the return calls--they would charge $12.00 per call.

2.   Advertising

You could use trade journals to reach your target audience (production and packaging engineers).  To advertise for one year in seven of these trade journals would cost $100,000.  You would encourage responses to the ads by including a reply coupon in the body of the advertisement of by including the product on the multicompany "Bingogram" information request cards.  You think you might be able to generate 10,000 inquiries.  Any inquiries would be followed up by the same telemarketing organization.

What is the break even sales volume you would need for each of these alternatives?

What assumptions are being made?  

One assumption that is being made is that there would be a return made through the use of mailing.

How sensitive are your results to these assumptions?

Does either alternative seem like a good option?

Answer 1

Sales

Less VC

-----------

Contributions

less OFC

-----------

EBIT

Less Interest

Less Tax

-----------

EAT/PAT/NI

-----------------------------------

Contribution of 40$

1. Direct email

-22000 users @ $1205

-$3 per user for complete communication. Cost = (22000*3).

-10% of 22000 coming back would cost additional $12 per unit. Cost = (2200*12).

2. Advertising

- $100,000 for 1 year

- convert 10,000 inquiries

- would cost additional $12 per unit. Cost = (10000*12).

operating break even = OFC / contribution). OFC- Operating Fixed Cost

for 1. OFC = 1250 + (22000*3) + (2200*12) = 1250 + 66000 + 26400 = $93,650 (for 2200 users). OFC for 1 user = $45.56.

for 2. OFC = 100000 + (10000 * 12) = 100000 + 12000 = $112000 (for 10000 users). OFC for 1 user = $11.20.

Break even for 1 = 93650/40 = 2341 users

Break even for 2 = 112000/40 = 2800 users

------------------------------------

Assumption for 1: No initial investment, would get you less users.

Assumption for 2: High initial investment, would get you more users with high probability of meeting target.

------------------------------------

Sensitivity and which option seems to be a good option?

- 1 is not a good option in case you plan to meet a huge target.

- 2 is not a good option in case you do not have high initial investment.

Option 2 would be a preferable option as it would increase the user base which would going ahead increase your profit. Focusing Demand and Supply in mind.

Hope this helps. In case you find it helpful then give a thumbs up.