Case A: Revenue Recognition for Products

Smooth Blend, Inc., a calendar year company, produces several blends of whiskey. Maturing whiskey is stored for 3 years in a large, dark aromatic warehouse owned by Smooth Blend. Smooth Blend sells the whiskey to Distributor Company at the beginning of the aging process (January 1, 2011). Distributor Company will pick up the whiskey at the end of the aging process (December 31, 2013) and take it to its facilities for bottling. Distributor Company pays the full purchase price to Smooth Blend on January 1, 2011 to protect itself against price increases.

1. When should Smooth Blend recognize revenue? Why?
2. Would your answer change
   1. If the quality control manager of Distributor Company had the right to taste the whiskey on December 31, 2013 and receive a full refund if not satisfied with the quality of the liquor?
   2. If there was no right of return but Smooth Blend promised to help Distributor Company attract customers?
   3. If Smooth Blend acquired a fixed price option from Distributor Company to repurchase the whiskey in 6 months?
3. How would your answer change if Smooth Blend sold the whiskey to Friendly Bank, agrees to oversee the aging process on the bank’s behalf, and acquires a fixed price forward from Friendly Bank to repurchase the whiskey in 6 months?

Recall again that Rind & Bordia (1996) investigated whether or not drawing a happy face
on customers’ checks increased the amount of tips received by a waitress at an upscale
restaurant on a university campus. During the lunch hour a waitress drew a happy,
smiling face on the checks of a random half of her customers. The remaining half of the
customers received a check with no drawing (18 points).
The tip percentages for the control group (no happy face) are as follows:
45% 39% 36% 34% 34% 33% 31% 31% 30% 30% 28%
28% 28% 27% 27% 25% 23% 22% 21% 21% 20% 18%
8%
The tip percentages for the experimental group (happy face) are as follows:
72% 65% 47% 44% 41% 40% 34% 33% 33% 30% 29%
28% 27% 27% 25% 24% 24% 23% 22% 21% 21% 17%

This time, you are to perform a “hypothesis test” using the tip data, answering each of
the questions below. For short-answer questions, be brief. However, you must give
enough detail to justify your answers. Single-sentence responses will generally not
suffice, but do not exceed a paragraph for any given answer.

f. Recall that one of the assumptions of the independent t-test is homogeneity
of variance. If you had to explain this assumption to someone with little
statistical expertise, how would you explain it?

Recall again that Rind & Bordia (1996) investigated whether or not drawing a happy face
on customers’ checks increased the amount of tips received by a waitress at an upscale
restaurant on a university campus. During the lunch hour a waitress drew a happy,
smiling face on the checks of a random half of her customers. The remaining half of the
customers received a check with no drawing (18 points).
The tip percentages for the control group (no happy face) are as follows:
45% 39% 36% 34% 34% 33% 31% 31% 30% 30% 28%
28% 28% 27% 27% 25% 23% 22% 21% 21% 20% 18%
8%
The tip percentages for the experimental group (happy face) are as follows:
72% 65% 47% 44% 41% 40% 34% 33% 33% 30% 29%
28% 27% 27% 25% 24% 24% 23% 22% 21% 21% 17%

This time, you are to perform a “hypothesis test” using the tip data, answering each of
the questions below. For short-answer questions, be brief. However, you must give
enough detail to justify your answers. Single-sentence responses will generally not
suffice, but do not exceed a paragraph for any given answer.

o. Considering both the probability value and effect size measure, what
interpretations would you make about the findings? That is, what are your
conclusions about the effects of leaving happy faces on checks?

Recall again that Rind & Bordia (1996) investigated whether or not drawing a happy face
on customers’ checks increased the amount of tips received by a waitress at an upscale
restaurant on a university campus. During the lunch hour a waitress drew a happy,
smiling face on the checks of a random half of her customers. The remaining half of the
customers received a check with no drawing (18 points).
The tip percentages for the control group (no happy face) are as follows:
45% 39% 36% 34% 34% 33% 31% 31% 30% 30% 28%
28% 28% 27% 27% 25% 23% 22% 21% 21% 20% 18%
8%
The tip percentages for the experimental group (happy face) are as follows:
72% 65% 47% 44% 41% 40% 34% 33% 33% 30% 29%
28% 27% 27% 25% 24% 24% 23% 22% 21% 21% 17%

This time, you are to perform a “hypothesis test” using the tip data, answering each of
the questions below. For short-answer questions, be brief. However, you must give
enough detail to justify your answers. Single-sentence responses will generally not
suffice, but do not exceed a paragraph for any given answer.

h. Enter the data above into SPSS. You will enter in two variables for each
restaurant patron: 1) which experimental group they belonged to (1 = no
happy face, 2 = happy face) and 2) the tip percentage left.

Recall again that Rind & Bordia (1996) investigated whether or not drawing a happy face
on customers’ checks increased the amount of tips received by a waitress at an upscale
restaurant on a university campus. During the lunch hour a waitress drew a happy,
smiling face on the checks of a random half of her customers. The remaining half of the
customers received a check with no drawing (18 points).
The tip percentages for the control group (no happy face) are as follows:
45% 39% 36% 34% 34% 33% 31% 31% 30% 30% 28%
28% 28% 27% 27% 25% 23% 22% 21% 21% 20% 18%
8%
The tip percentages for the experimental group (happy face) are as follows:
72% 65% 47% 44% 41% 40% 34% 33% 33% 30% 29%
28% 27% 27% 25% 24% 24% 23% 22% 21% 21% 17%

This time, you are to perform a “hypothesis test” using the tip data, answering each of
the questions below. For short-answer questions, be brief. However, you must give
enough detail to justify your answers. Single-sentence responses will generally not
suffice, but do not exceed a paragraph for any given answer.

l. Using the formula discussed in class, calculate Cohen’s d effect size measure.
Provide a brief interpretation of the statistic. Note: simply saying that the
effect is “small”, “medium”, or “large” will not suffice.

Recall again that Rind & Bordia (1996) investigated whether or not drawing a happy face
on customers’ checks increased the amount of tips received by a waitress at an upscale
restaurant on a university campus. During the lunch hour a waitress drew a happy,
smiling face on the checks of a random half of her customers. The remaining half of the
customers received a check with no drawing (18 points).
The tip percentages for the control group (no happy face) are as follows:
45% 39% 36% 34% 34% 33% 31% 31% 30% 30% 28%
28% 28% 27% 27% 25% 23% 22% 21% 21% 20% 18%
8%
The tip percentages for the experimental group (happy face) are as follows:
72% 65% 47% 44% 41% 40% 34% 33% 33% 30% 29%
28% 27% 27% 25% 24% 24% 23% 22% 21% 21% 17%

This time, you are to perform a “hypothesis test” using the tip data, answering each of
the questions below. For short-answer questions, be brief. However, you must give
enough detail to justify your answers. Single-sentence responses will generally not
suffice, but do not exceed a paragraph for any given answer.

i. Obtain the appropriate test statistic. From the SPSS menus choose Analyze
and Compare Means, followed by the appropriate test.

Q 2?Rafique Inc. makes product A and sells at selling price of SAR 45 per unit. Badr Inc. wants to buy 5,000 units at SAR 27 per unit. Rafique Inc. has a normal capacity of 101,000 units and projected sales to regular customers this year is 92,000 units. Per unit costs traceable to the product (based on normal capacity of 92,000 units) are listed below?

Direct Materials??8.1

Direct Labour?`??6.0

Variable Mfg. Overhead?6.2

Fixed mfg. overhead??4.8

Fixed administrative costs?0.8

Fixed Selling Costs??0.4

Does the quantitative analysis suggest that the company should accept the special order?

k   Q 3 Discuss the qualitative factors in Keep or Drop Decision in details.

Microsoft in 2005

As their 2005 fiscal year came to a close, Bill Gates and Steve Ballmer could reflect on the last year as well as the previous five years—with mixed emotions. Microsoft had slowed down after two decades of spectacular growth in revenues, profits, and stock price (see Exhibits 1, 2, and 3). Although Microsoft remained one of the most valuable and profitable companies in the world, its two core products, Windows and Office, had been experiencing anemic growth in revenues and profits. Moreover, competing software, such as the Linux operating system, and the rising popularity of search engines like Google, were posing new threats to Microsoft’s franchise.

On the positive side, Microsoft had the strongest balance sheet of any company in the world. Management was committed to aggressive reinforcement of its core businesses, including significant investments in new operating systems and Web services, as well as ongoing investments in new businesses, ranging from Xbox to Business Solutions. Perhaps most importantly, Microsoft had settled many of its public and private lawsuits on reasonably favorable terms by 2005 (see Exhibit 4).

One of the most daunting challenges was how to reposition Microsoft for modern times. When Gates started the company in 1975, he proclaimed that the mission of Microsoft was “to place a PC running Microsoft software on every desk and in every home.” When Gates reflected on Microsoft strategy with the casewriters in the mid-1990s, he further articulated this view:

We look for opportunities with network externalities—where there are advantages to the vast majority of consumers to share a common standard. We look for businesses where we can garner large market shares, not just 30%–35%. But at the same time, we are not a software conglomerate. The key to our business is building annuities, by tapping into the broad revenue streams that will rely on our software expertise.1[A1]

In 2005, 30 years after Microsoft was founded, the company had a new vision statement: to be “the worldwide leader in software, services and solutions that help people and businesses realize their full potential.” Gates remained the company visionary as well as its chairman and chief software architect. However, it was CEO Ballmer, Gates’s friend from his freshman days at Harvard, who was now leading the charge. While Ballmer was forcefully driving the company forward, the big question remained: Would these efforts allow Microsoft to repeat its previous spectacular successes, or would the future belong to a new generation of leaders?[A2]

The Early Microsoft Years (1975–1990)

Gates and his high school friend, Paul Allen, founded Microsoft in 1975, and the company’s first product was a condensed version of the BASIC programming language for the first personal computer (PC). Over the next few years, Microsoft developed numerous versions of other programming languages, becoming the leading distributor of software development tools. But Microsoft’s big break came in 1980, when IBM asked Gates to provide the operating system (OS) for its new PC. Rather than develop an OS from scratch, Gates bought an existing OS from a local programmer for $50,000 and tailored his new product, called MS-DOS, to work exclusively with Intel microprocessors—the “brains” of the IBM PC. By 1984, MS-DOS had achieved an 85% market share, pushing Microsoft sales over $100 million. When Gates took the company public in 1986, the stock price tripled within a year, making Gates a billionaire at the age of 31.

During the 1980s, Microsoft was already trying to expand beyond MS-DOS. As early as 1981, Microsoft began work on a graphical user interface (GUI) called Windows, shipping version 1.0 in 1985. At the same time, Microsoft worked with IBM to develop a totally new OS called OS/2. The first “killer apps” in the software industry—applications that everyone wanted—came from two of the larger independent software vendors (ISVs), Lotus and WordPerfect. Microsoft was originally seen as an imitator with second-rate products. Early releases were especially derided. Industry pundits joked about never buying a Microsoft product called “1.0.”

Ironically, Microsoft’s greatest success in the 1980s outside of its OS came from recognizing the potential of the Apple Macintosh and choosing to write applications for the Apple OS. While major ISVs largely ignored the Mac, Microsoft became the dominant supplier of Macintosh word processing and spreadsheet software. Microsoft’s familiarity with developing applications for the Macintosh helped it develop Windows, which used a Mac-like GUI that took the market by storm.

Application Software

Application software had a very different business model from that of OSes. While OSes were sold mainly through hardware OEMs, applications were sold through a myriad of channels, including computer companies, corporate site licenses, various retail channels, and after the mid- 1990s the Internet. The key for successful OS vendors was to build close relationships with ISVs to produce as many applications as possible on their OS. Though ISVs did not have access to the proprietary source code for the Microsoft OS, they did have access to “hooks,” called application program interfaces (APIs), by which they could take advantage of various OS features. Successful ISVs, in turn, competed on software features, customer service, shelf space/availability, and price. Since 1990, most PC application programs, which previously sold for hundreds of dollars, had by 2005 dropped to an average of less than $40.

Until the advent of Windows, customers would typically choose a software application and then stick with it. Training workers to use a new spreadsheet or word processor once cost up to five times as much as the program itself. For productivity application vendors, such as Lotus and WordPerfect, their large customer base and high switching costs led to very profitable operations. Over the 1990s, however, Lotus, WordPerfect, Borland, and others found their businesses under pressure. First, the cost of producing a major software program grew from a few hundred thousand dollars to more than

$10 million. Second, by providing standard interfaces and file formats, Windows reduced customers’ switching costs from five times to roughly twice the cost of the application. And third, after Windows took off, Microsoft itself became the world’s largest PC application vendor.

Microsoft’s success in PC applications began in the late 1980s when it pursued a new paradigm. To induce customers to switch from their favorite applications, such as WordPerfect and Lotus 1-2-3, Microsoft was the first to offer a bundle, or suite, of applications at a discounted price. Microsoft also began offering “competitive upgrades,” a sales program whereby Lotus 1-2-3 or WordPerfect customers could switch to Microsoft for a significantly discounted price.7 Part of Microsoft’s success with Windows applications was the result of competitors’ mistakes. While Lotus and WordPerfect matched Microsoft’s competitive upgrade pricing, they were initially reluctant to write for Windows and even slower to create their own bundles. As a result, Word and Excel were the best products on the Windows platform, and by the mid-1990s, Excel was outselling Lotus by 2 to 1 and Word soon dominated WordPerfect.8 Furthermore, as competitors played catch-up by increasing their Windows development efforts, they furthered the success of Microsoft’s Windows operating system. By 1995, many ISVs, except for Microsoft, had completely abandoned Macintosh development.

Microsoft’s stand-alone products ranged from Money (financial management) and Project (project management) to Flight Simulator (a popular computer game). However, specialized ISVs were able to dominate most of the niche application markets. For example, Intuit was the dominant provider of financial management and tax software, Adobe’s PageMaker was preeminent in desktop publishing, and Autodesk’s AutoCAD was the lead vendor in computer-aided design (CAD).

Applications software accounted for about one-third of Microsoft’s total sales in 2005, after peaking at around 60% in the mid-1990s. Microsoft had captured 90% of the market for productivity software applications in 1995. Its market share then rose to around 95% by 1998, with Corel’s WordPerfect Suite and IBM’s Lotus Suite carving up the remaining scraps. Yet despite Microsoft’s great success, application revenues were under pressure. Revenue from stand-alone versions of Word, Excel, and PowerPoint had been in a steady decline since around 1995 as the Office Suite gradually absorbed each of these individual markets. Microsoft acknowledged that this trend exerted a steady downward pressure on prices because Office sold for less than the sum of the individual programs. Second, upgrades (rather than new sales) were taking a larger share of revenue, and upgrades had lower margins than new products.9 Moreover, industry wisdom held that 80% of customers used less than 20% of the features.

USE THE ABOVE SCENARIO TO ANSWER THE FOLLOWING QUESTIONS

How did Microsoft use bundling to price discriminate? Use specific cited examples. How did Microsoft build revenues so fast? Be specific in your details. What are three big threats to Microsoft's success? Be specific and explain the details and impacts of each threat.