BEP :A REFRESHER AS EVERYONE SEES IT

Given overleaf is a recap note on Break Even Point analysis, as relevant to Service
Operations Management.
As I am sure, you would have already dealt with this topic as part of other subjects.
Hence go through this recap to avoid duplication prior to class.
We will discuss only specific issues of relevance to us service operations professionals.

GLIM

Page 1

Recap notes on break even point concept as relevant to Operations Management

Different ways of classifying cost:

Costs involved in the a manufacturing or service process can be classified invarious

ways: For example as:
o

Fixed costs and variable costs

Direct costs and indirect costs

Average costs and marginal costs

Standard costs

Fixed and Variable cost

Fixed costs do not change when production is higher or lower.

Examples of fixed costs:

Lighting, heating and power of factory

Wages and salaries of workers

Rent of building

Insurance on vehicles or fire insurance

Variable costs change in direct relation to the level of production.

Examples of variable costs:

More raw materials will be used when production levels increase.

You might need to employ more workers, and hence more wages when
production level is increased.

Increased production can also lead to workers having to work overtime.

Direct & Indirect Cost

Direct costs can be directly linked with the product that is produced. Example : The raw
material used for a product is a direct cost.

Indirect costs are not directly linked to the product or the production process. Example :
rent of the factory, administration cost of the business, the wages and salaries of the
administration staff.

Average Cost & Marginal Cost

GLIM

Page 2

Average cost of producing an article is found by dividing the total number of units
manufactured by total cost. If production levels increase, the unit cost of an article will
decrease. This is because the fixed cost stays the same although the variable costs
increase in direct relation to the increased production.

Marginal cost is the cost of making one product. It is calculated by looking at the
difference in total costs if one extra item is produced.
Example:
o

To produce 50 chairs costs $2000.

If 51 chairs are produced the total cost will increase to $2020.

Average Cost:
The average cost of one chair if 50 chairs are produced: $2000 / 50 =
$40.
The average cost of one chair if 51 chairs are made: $2020 / 51 = $39.6.

Note: Production costs can go down when more units are produced, because the
fixed costs stay the same only variable might be incurred.
Marginal Cost
The marginal cost to make an extra chair is $20.
The average cost of making 51 chairs is $39.6. The average cost per
chair decreases because the fixed costs stay the same.

Another Example

In a Photocopy shop

Output in

Fixed costs

Total Variable

Total cost

pages

in $ [ rental for

costs $ ( of

incurred $

photocopied

place and

manpower and

machine]

consumable)

1,500

1,500

1,000

1,500

500

2,000

2,000

1,500

1,000

2,500

When 1,000 units are produced the unit cost is $2 Total cost/number of units

When 2,000 units are produced the unit cost decreases to $1.25 2,500/2,000. From
the example you can see that when more units are produced the cost of producing one
unit decreases.

BEP AS WE KNOW
GLIM

Page 3

A business reaches the break-even point in production when the total sales value equals the total
cost incurred to produce the item. At this point no profit or loss is made
Example of working out the break-even point
Consider a haircutting saloon. The fixed cost of a business is $10,000 and the variable
cost of each persons hair cut unit is $8. The firm charges $12 per p
Calculate the break-even point:

Number of

Fixed

Variable

Total

Revenue @

Profit/

customers

costs $

costs $

costs $

$12 per unit

(Loss) $

10,000

10000

.0

(10,000)

1,000

10,000

8,000

18,000

12,000

(6,000)

2,000

10,000

16,000

26,000

24,000

(2,000)

2,500

10,000

20,000

30,000

30,000

Break even

3,000

10,000

24,000

34,000

36,000

2,000

Any unit produced over 2,500 will result in a profit

One formula to calculate the break-even point
Fixed cost
------------------------------------------------------selling price per unit less variable cost per unit
= 10,000 / (12 - 8) = 10,000 / 4 = 2,500 units

BEP CHART:
GLIM

Page 4

When we put this on a graph we need to look at:

Sales Revenue - this is plotted against units sold. [The higher the price the steeper the
gradient line. The lower the price the less steep is the gradient line.] This is the line marked
sales revenue in the diagram below.
Fixed Cost line - Before commencing production a firm must buy what are known as its
FIXED ASSETS. As such they have to be paid for regardless of output. Let's say that in our
example the fixed costs are $10,000 whether we fully produce or make a complete zero
amount of whatever it is we are producing. We can see in the diagram below that the fixed
costs line is horizontal.

Variable Cost line: Next we need to look at our variable costs, which do vary with changes
in output. Therefore the line on the diagram is upward-sloping. At zero production we will not
incur any variable costs but as we expand production for each successive unit made we incur
additional cost of say 3$.
Total Cost line: When we add the fixed costs to the variable costs we get total costs line.
With fixed costs needing to be paid for regardless of sales, we can predict that in most
companies low levels of sales will not result in profits.
However, as sales increase so the fixed costs are being spread over a larger output and will
reduce per unit sold. To put this in more technical language the average fixed cost will start to
fall. So, if for example output is 100 units, fixed costs are $100 per unit produced, then if
output rises to 2000 units the average fixed cost will be $5 per unit produced.
The output required to break even is 2000 units (as marked break-even on the diagram
above), at which level the total sales revenue and costs equate at $16000.
It is always sensible to leave some room for change and so we introduce the concept of
margin of safety. This is the difference between the actual output and the break-even output.
So, if this company couldroduce 3000 items its margin of safety is 1000 units.
Mini caselet Dog Grooming & BEP: Linear

GLIM

Page 5

After working for ten years as a dog groomer, youre thinking of starting your own dog grooming
business. You found a place you could rent thats right next to a popular shopping center, and two
of your friends (who are also dog groomers) have agreed to work for you. The problem is that you
need to borrow money to start the business and your banker has asked for a breakeven analysis.
You have prepared the following cost estimates for your first year of operations:

Fixed Costs
Salaries

$105,000

Rent and utilities $36,000

Advertising

$2,000

Equipment

$3,000

Variable Cost per Dog

Shampoo

$2.00

Coat conditioner $1.50

Pet cologne

$0.75

Dog treats

$1.25

Hair ribbons

$0.50

You went online and researched grooming prices in your area. Based on your review, you
have decided to charge $32 for each grooming.

Q 1:
o Whats the breakeven point in unitshow many dogs will you need to groom in
the first year to break even?
o If you and your two employees groomed dogs five days a week, seven hours a
day, fifty weeks a year, how many dogs would each of you need to groom
each day? Is this realistic given that it takes one hour to groom a dog?
Q 2:
o If you raised your grooming fee to $38, how many dogs would you need to
groom to break even?
o At this new price, how many dogs will each of you have to groom each day
(assuming working as in Q1.)?
Q 3:
o

Would you start this business? What price would you charge to groom a dog?

How could you lower the breakeven point and make the business more
profitable?

BEP As an Operation manager see it

GLIM

Page 6

GLIM

Page 7

Example situation- Non Linear cost / price Jeanie In 2008

Brian plans to start a tailoring shop wherein he will stitch Denim Jeans to customers
measurement. The business model he plans to follow is:
-

The customers will bring their own cloth and Jeanie the Tailors will stitch custom fit
pants.

He understands that the demand for their product Designer Jeans is strongly influenced
by the price. To assess the price at which he can offer his stitching services, and hence
establish price to demand relationship Brian decides to conduct a Market Research . He
surveys among 1000 visitors to a shopping mall, by showing a sample stitched jeans, how
much they are willing to pay for the stitching alone.
The research shows the following estimate of sales at different prices.
STITCHING PRICE

ESTIMATED QTY

22.5-27.5

900

27.5-32.5

750

32.5-57.5

400

Brian has already fixed up a shop in Bugis.

He now estimates the costs he is likely to incur to include the following for the first few
months of operation:
a)

a fixed monthly rental of $ 4500

b)

a counter staff with a fixed salary of $ 1500

c)

Monthly electricity etc. will be approximately $ 500

d)

Part time tailors will be employed who will be paid $ 12 for every pant they

cut and stitch

e)

The consumables for the pant- viz. zip / button, thread etc. would cost

approximately $ 4 per pant.

Brian wonders what price he should charge, how much orders he should get per month
to break even and how much for a profit which he can take home of $ 2000 at least

Price

Mid value qty

22.5-27.5

25

900

27.5-32.5

30

750

32.5-57.5

45

400

1000
900
800
700
y = -24.615x + 1503.8
R = 0.9971

600
500
400
300
200
100
0
0

10

20

30

40

50

Price
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
11.0
12.0
13.0
14.0
15.0
16.0
17.0
18.0
19.0
20.0
21.0
22.0
23.0
24.0
25.0
26.0
27.0
28.0
29.0
30.0
31.0
32.0
33.0
34.0
35.0
36.0
37.0
38.0
39.0
40.0
41.0
42.0
43.0
44.0
45.0
46.0
47.0
48.0
49.0
50.0

sales qty sale Rev fixed cost var cost TC

profit
1475
1475
6500
23600
30100
-28625
1450
2900
6500
23200
29700
-26800
1426
4278
6500
22816
29316
-25038
1401
5604
6500
22416
28916
-23312
1377
6885
6500
22032
28532
-21647
1352
8112
6500
21632
28132
-20020
1327
9289
6500
21232
27732
-18443
1303
10424
6500
20848
27348
-16924
1278
11502
6500
20448
26948
-15446
1254
12540
6500
20064
26564
-14024
1229
13519
6500
19664
26164
-12645
1204
14448
6500
19264
25764
-11316
1180
15340
6500
18880
25380
-10040
1155
16170
6500
18480
24980
-8810
1131
16965
6500
18096
24596
-7631
1106
17696
6500
17696
24196
-6500
1081
18377
6500
17296
23796
-5419
1057
19026
6500
16912
23412
-4386
1032
19608
6500
16512
23012
-3404
1008
20160
6500
16128
22628
-2468
983
20643
6500
15728
22228
-1585
958
21076
6500
15328
21828
-752
934
21482
6500
14944
21444
38
909
21816
6500
14544
21044
772
885
22125
6500
14160
20660
1465
860
22360
6500
13760
20260
2100
835
22545
6500
13360
19860
2685
811
22708
6500
12976
19476
3232
786
22794
6500
12576
19076
3718
762
22860
6500
12192
18692
4168
737
22847
6500
11792
18292
4555
712
22784
6500
11392
17892
4892
688
22704
6500
11008
17508
5196
663
22542
6500
10608
17108
5434
639
22365
6500
10224
16724
5641
614
22104
6500
9824
16324
5780
589
21793
6500
9424
15924
5869
565
21470
6500
9040
15540
5930
540
21060
6500
8640
15140
5920
516
20640
6500
8256
14756
5884
491
20131
6500
7856
14356
5775
466
19572
6500
7456
13956
5616
442
19006
6500
7072
13572
5434
417
18348
6500
6672
13172
5176
393
17685
6500
6288
12788
4897
368
16928
6500
5888
12388
4540
343
16121
6500
5488
11988
4133
319
15312
6500
5104
11604
3708
294
14406
6500
4704
11204
3202
270
13500
6500
4320
10820
2680

10000
5000
0
-5000 0.0
-10000
-15000
-20000
-25000
-30000
-35000

10.0

20.0

30.0

40.0

50.0

60.0

40000

30000

20000

10000

sale Rev
fixed cost

var cost
0

-10000

-20000

-30000

-40000

200

400

600

800

1000

1200

1400

1600

TC
profit

The Learning and Experience Curve

The Learning Curve that was discovered and published by T. P. Wright in 1936. The
Learning Curve, developed in the aircraft industry, was based on the observation that
unit direct labor usage, expressed in total man-months, declined with increasing
experience.
The experience curve was popularized in the 1960's by Bruce Henderson, founder of
The Boston Consulting Group. Henderson promoted, under a new name, Henderson
noted that the same was true for unit cost. Based on this observation, he went on to
develop a strategy model with the experience curve at its foundation.
The experience curve is based on the premise that the more you do something, the
easier and better you do it. In other words, the more experience you have making a
product, the faster and cheaper it is to make.

In the 1960's, management consultants at The Boston Consulting Group observed a

consistent relationship between the cost of production and the cumulative production
quantity (total quantity produced from the first unit to the last). Data revealed that the real
value-added production cost declined by 20 to 30 percent for each doubling of
cumulative production quantity:
Experience Curve

The vertical axis of this logarithmic graph is the real unit cost of adding value, adjusted
for inflation. It includes the cost that the firm incurs to add value to the starting materials,
but excludes the cost of those materials themselves, which are subject the experience
curves of their suppliers.
Note that the experience curve differs from the learning curve. The learning curve
describes the observed reduction in the number of required direct labor hours as
workers learn their jobs. The experience curve by contrast applies not only to labor
intensive situations, but also to process oriented ones.

The experience curve, like the half-life, is also an empirical observation. It states that for
each doubling of cumulative experience (total units produced from the very beginning,
not just this year), real unit cost drops by a constant percent, for example 20%. If your
first million units cost $10 each, then your next million units should cost $8 each, the
next two million units, $6.40, the next four million units, $5.12, etc. Because cost is
driven by cumulative units produced (1+1+2+4 million in our example), the rate of
decline of cost drops over time unless unit volume grows at a sufficiently high
exponential rate.
Research has shown that as the cumulative number of units of a product rises
(cumulative means the total number of units produced since the business was formed,)
the cost of producing a unit drops at a predictable rate. For example, as shown in Figure
1, every time production doubles (from 1X to 2X and from 2X to 4X), the cost of making
a unit drops by 40 percent (C1 to C2 and from C2 to C4).

Figure 1: 40 Percent Experience Curve

To provide a numeric example, with a 40 percent experience curve the cost per unit
declines from $20.00 per unit at 10,000 units of cumulative production to $12.00 ($20 x
40% = $8, $20 - $8 = $12) at a cumulative production of 20,000 units (2 x 10,000 units.)

As can be observed, the experience curve concept is more applicable to some products
than to others, and the rate of reduction varies greatly depending on the product and the
business.

The experience curve concept is not the same as Economies of Size. Economies of
size involve spreading a fixed amount of cost (e.g. facility cost, administration cost, etc.)
over an increasing number of units of production. Conversely, the experience curve
involves improving skills expertise, and finding new ways of doing things. Also, the
experience curve analysis is based on the number of units produced since the business
was started. Economies of size is based on the number of units produced during a
production period such as a calendar year.

The experience curve relationship holds over a wide range industries. In fact, its
absence would be considered by some to be a sign of possible mismanagement. Cases
in which the experience curve is not observed sometimes involve the withholding of
capital investment, for example, to increase short-term ROI. The experience curve can
be explained by a combination of learning (the learning curve), specialization, scale, and
investment.
Implications for Strategy
The experience curve has important strategic implications. If a firm is able to gain market
share over its competitors, it can develop a cost advantage. Penetration pricing
strategies and a significant investment in advertising, sales personnel, production
capacity, etc. can be justified to increase market share and gain a competitive
advantage.
When evaluating strategies based on the experience curve, a firm must consider the
reaction of competitors who also understand the concept. Some potential pitfalls include:

The fallacy of composition holds: if all other firms equally pursue the strategy,
then none will increase market share and will suffer losses from over-capacity
and low prices. The more competitors that pursue the strategy, the higher the
cost of gaining a given market share and the lower the return on investment.

Competing firms may be able to discover the leading firm's proprietary methods
and replicate the cost reductions without having made the large investment to
gain experience.

New technologies may create a new experience curve. Entrants building new
plants may be able to take advantage of the latest technologies that offer a cost
advantage over the older plants of the leading firm.

Based on the principle:

More we do a job quicker we do it

Noticed in 1930-40s during World War

Shortage of manufacturing capacity
Record of manufacturing time showed interesting
trend

Same concept honed later on by BCG in

1960s as Experience Curve.

At the start of production runs:

Workers are unfamiliar with their tasks
Time it takes to produce the first few units is high

As the workers learn their tasks:

Their output per day increases up to a point
Then their output levels off to a rather constant
rate

As the quantity doubled the

time required for the piece was
impacted by the learning rate
factor

Most aircraft manufacturing tasks experience an

80% learning rate.
If the production quantity doubles , labor-hours
required to assemble an aircraft is 0.8 times original
time.
If 1st aircraft assembled requires 10000 labor-hours
2nd aircraft would require 8000 labor-hours
4th aircraft would require 6400 labor-hours
8th aircraft would require 5120 labor-hours
and so on

Labor-Hours for nth

120 Unit
100
80
60

Aircraft Assembly
80% Learning
Curve

40
20

10 20 30 40 50 60 70 80 90 100 110 120 130

Unit Number (n)

By analyzing workers learning situations, we

are able to estimate:
The exact labor-hours required to produce the
nth unit of a production run
The total labor-hours required to produce N
units in a production run
The average labor-hours required per unit for N
units in a production run

Learning Curve Estimating learning rate

EZ Machine Shop has a contract to manufacture 100 turbines.
The first 20 turbines have been completed. The labor-hours
required for a portion of the completed turbines are listed below.
Use this data to estimate the shops learning rate in manufacturing
the turbines.
Unit No. Labor-Hours
Unit No. Labor-Hours
1
140
5
95
2

118

10

81

109

15

75

102

20

68

Learning Curve - Arithmetic Analysis

Compute the learning rate for each of the doubles.
Units 1 and 2
Units 2 and 4
Units 5 and 10
Units 10 and 20

118/140 = .8429
102/118 = .8644
81/95 = .8526
68/81 = .8395

(.8429 + .8644 + .8526 + .8395)/4 = .8499

The approximate learning rate is 85%.

Three approaches to learning-curve problems

are:
Arithmetic analysis
Logarithmic analysis
Learning curve tables
Excel calculations

Arithmetic Analysis
The simplest approach to learning-curve
problems
If we wish to find the labor-hours required to
produce nth unit, and n just happens to be a
number that is one of the doubled values,
then this approach works.
For example if 20th unit takes 68 hours , 40th
unit will take .85 x 68 hours.

A table of learning curve coefficients allows us

to compute:
The labor-hours for the nth unit in a
production run
The total labor-hours for the entire
production run, where the nth unit is the last
unit in the run

The manager of EZ Machine Shop wants a good

estimate of the total labor-hours required to
manufacture the entire 100 turbines.
Also, he is curious about how many labor-hours
will be needed for the last (100th) unit.
Use the observed 85% learning rate and 140
labor-hours required for the first turbine to
compute your estimates.

Total time for 100 units:

Total Labor-Hours Required for 100 Units
= (Hours for 1st unit)(Table total time @ 85% in 100th unit)
In Table locate the line for the 100th unit and read across to
the Total Time column under the 85% learning rate. The
value is 43.75.
Total Labor-Hours Required for 100 Units
= 140(43.75) = 6,125 labor-hours

Labour required for 100th unit:

Labor Hours Required for the 100th Unit
= (Hours for 1st unit)(Table unit time: 85%, 100th unit)
In Table locate the line for the 100th unit and read across to
the Unit Time column under the 85% learning rate. The
value is .340.
100th unit will require 34% of the time 1st unit required
Hence 100th unit requires 140(.340) = 47.6 labor-hours

Logarithmic Analysis
The following relationship allows us to compute Tn, the
labor-hours required to produce the nth unit:
Tn = T1(nb) and b = log r/log 2
where:

T1 = labor-hours to produce the first unit

b = slope of the learning curve
r = learning rate percentage

Logarithmic Analysis
Compute, using logarithmic analysis, the labor-hours
required for the 50th turbine (assuming an 85% learning rate
and 140 labor-hours required for the 1st unit).
b = log (.85)/log (2) = - 0.234465253
T50 = 140(50-0.234465253)
= .399623 or .400*140
= 56

Selecting a learning rate

Industry journals
Historical experience

Uses and limitations

Products and services tend to be custom designed
Batches tend to be small
Product/services tend to be complex.... learning
occurs quickly

Learning curve: 80%

60.000

50.000

CAT

40.000

30.000

20.000

10.000

0.000
0

100

200

300

400

500

600

Batch Number

10

Learning curve: 90%

60.000

50.000

CAT

40.000

30.000

20.000

10.000

0.000
0

100

200

300

400

500

600

400

500

600

Batch Number

Learning curve: 60%

60.000

50.000

CAT

40.000

30.000

20.000

10.000

0.000
0

100

200

300

Batch Number

11

80% Learning Rate

Batches
Total Time
1
50.00
2
80.00
4
128.00
8
204.80

128
1,342.18

CAT
50.00
40.00
32.00
25.60

10.49

12

Batches
1
2
4
8

128

No Learning
Total Time
50.00
100.00
200.00
400.00

6,400.00

CAT
50.00
50.00
50.00
50.00

50.00

Implications of learning taking place as opposed

to no learning taking place if the cost is $ 1 per
hour and each batch has 5 pieces.

13

Units
5
10
20
40

640

Average Cost/unit
80% Learning No Learning
10.00
10.00
16.00
20.00
25.60
40.00
40.96
80.00
268.44
1,280.00

80% Learning Rate

Batches
Total Time
Average
time
1
50.00
50.00
2
80.00
40.00
4
128.00
32.00
8
204.80
25.60

128
1,342.18
10.49

14

Batches

No Learning
Total Time

1
2
4
8

128

50.00
100.00
200.00
400.00

6,400.00

Average
time
50.00
50.00
50.00
50.00

50.00

industry averages:

Aerospace

85%

Shipbuilding

80 85%

Raw materials

93 96%

Purchased parts

85 88%

15

Problems & caselets on Learning curve

1. An assembly line for making trays of cup cakes has a 90% learning curve. The line has
begun to work on the first tray and it takes 28 minutes for the first piece. Estimate:

The time needed for the first 5 trays

The time taken for the 20th to 25th tray

2. Filling up of a form is supposed to have a learning rate of 82%. Time for the first 4 units
are 30.5, 28.4, 27.2 and 27.0 Does the assumption look realistic?

3. The company wants to identify which of the following trainees will reach the set target
of reaching 6 hours or less by the time they manufacture the 6th piece.

Arun took 10 hours and 9 hours for the first and second piece.

Baskar took 10 hours and 8 hours for the first and second piece.

Charles took 12 hours and 9 hours for the first and second piece.

Which trainee / trainees will make the standard? Explain your reasoning.
4. URA has received a pilot order for setting 20 ATM Machines Based on their experience
of setting up the first two ATMs they will be quoting for additional 18 such ATMs. The
contract envisages that they will be paid separately for Labour and material costs at the
rate of cost + 10%. They are negotiating a learning rate with the material supplier as well
The first ATM took 40 hours to complete and cost $ 300 in materials and equipment
usage. The second took 32 hours and $ 210 in material. Labour cost is charged at $ 18
per hour.
a) Estimate the total manhours required for total of 20 ATMs.
b) What will be the average total cost for the 20 ATMs in the contract.
c) Work out the financial advantage to the customer by not estimating based on 1st
ATM alone and basing cost based on experience curve principle.

5. A customer has offered you the contract for cutting and packing vegetables for salad and
supply to STAS. The raw material will be supplied by the customer. As per the customer
each packet of cut vegetable should be ready in an average time of 1.5 minutes and
they are willing to reimburse your cost at the rate of $0.50 per minute for the labour.
The contract is for 1000 sets. Your first test took 4 minutes and the second 3.6 minutes.
Would you take the contract?

Mini Caselets
6. What should Bus Chair do?
Bus Chair has developed a new chair. On their first prototype chair they had incurred a
cost of: 500 $. The GM proposed a selling price of $ 700 to the Furniture Mega Mart.
The marketing department shows the chair to the Furniture Mega Mart and their
observation is that the price has to be halved if they have to make any impact on the
market. If halved they can sell at least 300 chairs in next 6 months and if the price is
$150 they can promise a sale of minimum 1000 pieces. Bus chair then decides to make a
few more chairs and record the costs which reads as follows:
2nd Chair : 415 $ 3rd Chair : 360 $

4th Chair : 310 $

5TH Chair : 290 $ 6th Chair : 285 $

7th Chair : 235 $

8th Chair : 205 $

What should be their strategy for manufacturing?

7. The product recall :
An automobile manufacturer is carrying out a product recall after it was discovered that
there was a possible defect in the steering system. The company sent out letters to car
owners promising to repair the defect at no cost with their nearest dealer.
The company prior to recall carried out a series of tests. The repair work was basically
manual refitting of the steering parts. They decided that a reimbursement rate of $88
per repair would be appropriate based on an hourly manpower rate of $22.
Shortly thereafter, dealers began repairs. The company received complaints that rate of
$88 was too low and dealers threatened to stop repairs. They found the $22 per hour
rate acceptable, but not the four hour estimate. You have requested information from
the dealers. One of the dealers also sent the following data on job times. He informed
the automobile manufacturer that he has tested with his mechanics. Each completed
two repairs. Their average time for the first unit was 9.6 hours and for the second unit
7.2 hours. The dealers suggested a rate of $ 110 per repair. You have been asked to
investigate the situation and submit a report based on the analysis of the data.

Supply of Coffee Vending Consumables

Messrs Cofco , is in the business of supplying coffee vending machine consumables. On

1st September 2008, as the new CEO who has taken charge, Mr. Symonds has asked for a
briefing on the companys operations as well as an opportunity to take stock of their
operations. The companys business is to supply kits comprising of all the relevant
consumables like milk powder, coffee powder and sugar as required to be put in the
coffee making machines. They procure these raw materials in bulk, re pack and deliver
as kit set for the coffee vending machine.
Marketing Brief:
In the meeting, Mr. Mark the Marketing chief has informed the CEO that:

Their analysis shows they cater to 2 distinctly clear markets :

a) Restaurants
b) Corporate offices

Their last year sales were 300,000 kits, 90% being sold to restaurants.

The company markets the kit at a differential pricing to the two markets i.e. at
$ 36 for the restaurants at $ 43 for the offices.

Obviously the office kit is packaged nicer and delivered in smaller lots for easy
usage by individuals. The delivery to offices is aimed at ensuring delivery within
one hour of receiving the call in at least 90% cases.

The restaurants have a regular delivery schedule. They are supplied weekly and
on designated days. the van from the company visits the outlets and delivers the
goods. They stock typically 2 weeks requirement

The Marketing manager also expresses his concern about the Restaurant business
wherein he is experiencing stiff competition from a new entrant. As a result he feels

they should reduce their sales price to restaurants by at least $1 per kit. He feels
otherwise he might lose his market share to the competitively priced new entrant.
The Accounts head Ms. Maria brief:

The basic cost of material in each kit is $ 10 per pack.

The labour content involved in packing is $ 5 per pack.

The companys annual costs comprise of:

o Sales commission paid at

$ 3 per kit.

o Delivery related cost

$ 2.7 million

o Marketing and advertising costs

$ 1.5 million

o Product management teams cost

$ 0.4 million

o Administration

$ 0.5 million

The company the overheads & not directly allotted costs given above based on the
kits sold to each market segment.

Data Analysis:
Mr Symond the CEO carries out basic cost calculations in the meeting to determine:
a) Margin for both market segments
b) the net profit for each product segment.
c) What is the assessment of the business? What should he do?

What happens next?

d) At this juncture, you as the operations head who is responsible for the re-packing
and organizing all deliveries intervene. How can the operations professional
interfere in this situation?