FREEZING OUT PROFITS

INTRODUCTION

The Managing Director of Cold Cuts Ltd (CC), Mr Dali, had a meeting with Mr Nelly,
the Supply Manager from their biggest client, Secconz. Mr Nelly try to negotiate with CC to
lower the price because Secconz has been facing a lot of competition from China who has been
able to produce at a cheaper price. Secconz hopes that CC may consider their wishes to reduce
the price since they believes that CC has already gained their original investment. Cold Cuts Ltd
really need to think about this in order to keep its relationship with their biggest client.
Furthermore, their supply contract is almost over. Losing Secconz may bring a huge loss to CC.

There is also an ethical issue faced by Cold Cuts Ltd. CC need to decide whether CC
need to pay an anti-dumpling tax issued by United States International Trade or bribe them to
drop the case. This issue arises because United States International Trade Commission has begun
investigation on CC export from China to United States. They are saying that CC is pricing its
products much lower than the fair value even CC believes that they acted accordingly to the law.
The situation reach the climax because CC might be to shut down their company for a long time
even if they did not do anything wrong.

This report is prepared to analyse the issues faced by Cold Cuts Ltd and recommend the
potential solution to solve the issues. It provides information obtained through financial analysis
to help CC to decide on whether it wants to continue or stop the supply contract with Secconz. It
also help CC to evaluate the financial matters that will be affected by CC decision by using the
accounting standards. This report will comment on prospects of the company and make a
potential consequences of the various option open to the company. This observations do have a
limitation which will be noted.

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Question 1: Explain SIX (6) issues faced by Cold Cuts.

Cold Cuts Ltd was known as "CC" was a manufacturing concern in Singapore specializing in
refrigeration components. In order to maintain their business, there are several issues that Cold
Cuts need to be faced. The issues are:

i. Not able to keep its biggest client

Every large company has an obligation to remain their major customer in order to
continue survival in the market. As we can see from this case, Cold Cuts might lose their
biggest customer, Secconz. This is because Secconz asked to reduce the price since they
have a lot of competition from China who have been able to produce a product like them
at much cheaper price. Beside, CC’s product also high intensity of rivalry where there are
so many new entrance enter the market. Result from this, CC will incurred a huge losses
if they not be able to keep Secconz as the biggest client. Furthermore, sales volume to
Secconz was equals to one third of all FFA sales in Cold Cuts. They need to find a way to
solve this problem to make sure Secconz remain their major customer.

ii. Supply contract with Secconz near the end

Secconz is a long-time partner of Cold Cuts. Cold Cuts facing an issues when their
supply contract is near the end with the Secconz. CC need to reduce their price if they
want Secconz renew the new contract with them. Secconz believe that CC already cover
their orginal investment and the price set to the Secconz is a way over the material cost. If
they reduce the cost, Secconz will think about the vialibility of their parnetship in the
long term. As a price was so high, Secconz are thinking that maybe they need to
producing their own techonology in order to reduce their cost.

iii. Going Concern

The going concern principle is the assumption that an entity will remain in business for
the foreseeable future. As one of the issues from this case, if Secconz has stopped from
buying refrigerator component from CC due to high price, Cold Cuts may not be able to
sustain since Secconz is their major customer that contribute a higher profit to them. This
will lead their company may not be able to remain their business in future.

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iv. Having anti dumpling issues with International Trade

From this case, Cold Cuts is been investigating due to anti-dumping activities of their
exports FFA from China to the United States. United States International Trade
Commission saying that CC is pricing their products much lower than the fair value
(dumping). The option that CC have is either to seek for legal advices from the World
Trade Organization (WTO) or paying a huge anti-dumpling tax. Then, if authorities of
US find out that CC is guilty in pricing the components to European customers, they will
close CC’s business. If CC were not doing anything, they will get into trouble with their
customers.

v. Staff of United States International Trade want some bribes

Based on this case, Cold Cuts facing an issues because one of the US International Trade
Commission want some bribes to smoothen this things out. If CC do not want anything
charges to their company, they may need to sign some personal arrangements with US
International Trade to make this case go away. If Cold Cuts pay the bribes, they will
against the fundamental principle which is the integrity of their company. CC should
know that the bribe is only the empty threat by the authorities and it will give a bad image
towards the company if the case was spread to the public.

vi. Pricing strategies

This issue arise in this case when there are a different between the pricing in the local
market and international market. CC’s price for the FFA component is higher than its
competitor’s price at the local market but lower price at European country due to
competing with European technologies. As a result, Cold Cuts will lost its biggest client,
Secconz because they will get into trouble in maintaining its financial position. Then, CC
had decided to use a target costing method to overcome this problem where they focus on
company forecast for the price points, product costs, and margins that it wants to achieve.
Initially selling price to Secconz is $140, but European customers is $100. The selling
price is equal to manufacturing cost plus margin before machinery depreciation and
administration costs. Result from this, Secconz has contribute one third from the total
profit of the CC.

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Question 2: Based on the issues you have identified above in (i), recommend potential
actions that can be utilized to solve the issues identified in a proposal format.

i. Customer relation management

In order to Cold Cuts for keep their major client, Secconz, they need to build a good
customer relation management. The management need to have a good strategy on how to
convince its biggest client to accept the price had been charged. Besides, CC also must be
able to explain to the client that the price charged is equivalent with the quality provided
where their product is well produce and not be same with the competitors outside there.
The other competitor may be able to give a lowest price to Secconz but their quality may
be worse. Customer relation management of the Cold Cuts also must ensure that they
able to keep their major customer and sustain the customer relationship in the long term
for ensuring their business continue growth. Furthermore, a good relationship between
customer and supplier will benefit when they able to produce a good quality of product
that can boost in the market demand.

ii. Just In Time Manufacturing

Just in Time Manufacturing is the best solution to make sure Secconz renew their new
contract with CC. Just in time manufacturing is strategy used in the manufacturing
industry to reduce cost by reducing the in process inventory level. It is driven by a series
of signals that tell the production line to make a next piece for the product and when it is
needed in the manufacturing process. This strategy recorded levels for certain inventory
items set and new stock are ordered only when those levels are reached. There is no
overstocking of parts or items, which saves on the space in the warehouse. This
manufacturing strategy can lead to improvements in quality and efficiency where may
reduce a cost as Secconz want. It also can lead to higher profits and a larger return on the
CC investment even though the price is much cheaper than before and able to fulfill the
price as requested by Secconz.

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iii. Find more than one major customer

In order to Cold Cuts going concern, they need to find more than one of their major
customer. This is because, if one of their major customer want to leave, it will not affect
more on their business process and also their profitability. Furthermore, if they have more
than one major customer, they would be able to produce more component and it will lead
an increment of their sales of product. CC need to develop a good strategy on how to
attract more customer to buying their component by do a very good marketing plan. By
implementing this marketing plan, it will be able to gain more customer to purchase their
component and it will be a difficult to their competitor to compete with their company as
well.

iv. Seek for legal advices

We believe that Cold Cuts is not guilty for breaking the law. We recommend that CC to
seek for a legal advices and demand further explanation from the authorities about the
problem. CC deserves a clear basis on this problem. Below is the criteria that can be a
guideline for CC to defend itself from the accusation:
1. Consideration of volume effects of dumped imports
The agreement requires investigating authorities to consider whether there has
been a significant increase in the dumped import, either in absolute terms or
relative to production or consumption in the domestic industry.
2. Consideration of price effects of dumped imports
In addition, the agreement requires investigating authorities to consider whether
there has a significant price undercutting by the dumped imports as compared
with the price of a like product of importing Member. Investigating authorities are
also required to consider whether the effect of dumped imports is otherwise to
depress prices to a significant degree or to prevent price increases.
3. Examination of impact of dumped imports on the domestic industry
The agreement provides that in examining the impact of dumped imports on the
domestic industry, the authorities are to evaluate all relevant economic factors
bearing upon the state of the domestic industry. The agreement lists a number of
factors which must be considered including actual or potential effects on cash

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flow, inventories, employment wages, growth and ability to raise capital.

However, the list is not exhaustive and other factors may be deemed relevant.

v. Take action towards the person who proposed the bribe and ignore the bribe
In order to solve the fifth issues, it is recommend to bring this matter internally to their
top management of United States International Trade Commission or report to local
authorities so that the action can be taken towards the person who proposed the bribes. As
an example, Mr Rithisak may report to Suruhanjaya Pencegah Rasuah Malaysia (SPRM)
if its happened in Malaysia. However, since this is related to international stage, he can
refer INTERPOL, FBI or IAACA which is known as International Associate of Anti-
Corruption Authorities.
Other than that, Mr Rithisak may totally ignore the bribes from the United States
International Trade Commission’s staff and seek for any legal advices regarding this
matter. This will prevent CC’s staff too from any ethical issues. As for the company
itself, CC should implement a strategy for combating possible practices of bribery that
might happen in the future.

vi. Set a standard selling price for both customers or reduce the selling price for Secconz and
increase the price for European customer
There are two option that CC can use to solve their last issues. As a first solution is, CC
need to standardized the selling price for both client which is local and international
clients. As an example, CC target to achieve $62 margin for all customers. Calculation as
per below:
Manufacturing Costs $ 58
(+) margin before machinery depreciation
and administration cost $ 62
Total cost $120

In a conclusion, CC will sell at $120 for FFA component for both customer where they
still be able to achieve their targeted profit margin.

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The second option can be taken is by reduce the selling price for Secconz and increase
the price for European customer. CC target to achieve $52 and $72 margin for Secconz
and European customers respectively. Calculation as per below:
FOR SECCONZ:
Manufacturing Costs $ 58
(+) margin before machinery depreciation
and administration cost $ 62
Total cost $120
FOR EUROPEAN CUSTOMERS:
Manufacturing Costs $ 58
(+) margin before machinery depreciation
and administration cost $ 72
Total cost $130

In a conclusion, CC may reduce the price for Secconz from $140 to $110 and increase the
price for European customer from $100 to $130. From this, CC still be able to gain their
targeted margin and maintain their sales.

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Question 3: Assume that Cold Cuts Ltd wishes to keep Secconz as a client. Using Cost
Volume Profit (CVP) analysis, provide THREE (3) options you would like to offer to
Secconz.

Cost Volume Profit analysis is to estimate how much changes in a company cost, both fixed and
variable, sales volume and price will affect a company’s profit. Cost Volume Profit requires all
the company cost including manufacturing, selling and administrative cost to be identified as
variable or fixed cost. Below is the three options that CC would like to offer to Secconz:

i. Break – Even Analysis

X = Break-even point in unit

140(25000) +100x = 58(25000 + x) + 4,150,000

3,500,000 + 100x =5,600,000 + 58x

42x = 2,100,000

X= 50,000 units

Break-even point in Dollar = sales price per unit x Break-even point in unit

= $140 x 2222 units

= $ 311,080

One of the options that CC would like to offer to Secconz is by using break –even analysis. Break
even analysis is the relationship between cost and profit at various levels of activity. This point
is where the business receives either a profit or loss when total money received from sales is equal
to total money spent to produce the item for sale. CC has to determine in what units the company
can met the breakeven units to prevent any loss or to identify the level of the units sold in order to
make a profit. Based above calculation, the breakeven units are 50,000 units as the Secconz’s
annual requirement was signed on a contract for 25,000 units per year for FFA. It will help CC
to understand the viability of a business proposition and avoid produce the over product. This
option will attract Secconz to continue as their major client of CC and CC will supply more unit
as estimated and will give benefit to the both of them.

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ii. Contribution Margin method

Key calculations when using CVP analysis are the contribution margin which is the
amount of sales dollars available to cover (or contribute to) fixed costs. Once fixed
costs are covered, the next dollar of sales results in the company will be as a
revenue.

Secconz
Before After

Price per unit 140 100

Cost per unit 58 58

Sales unit (‘000) 25 25

Contribution margin per unit 82 42

Total contribution margin (‘000) 2050 1050

Contribution margin ratio 58.57% 42%

Result can be seen in the table above, the changes in price can affect the contribution
margin sold per unit. The breakeven point for the product sold by CC was achieved at
selling price per unit which is equal to RM58. Therefore, CC can reduce the price for
their product not less than RM58 in order to achieve their profit. This shows that CC
is able to fulfil the request made by Secconz which is to reduce the price and renew
the new supply contract with them.

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iii. Target Costing

Last option that CC would like to offer to Secconz is by using the target costing
method. This option is use the anticipated selling price to deduct the desired profit
that CC want to get. The anticipated selling price is RM 140 and selling to Secconz,
then the desired profit CC can get is RM40. Therefore, CC will get a target cost of
RM100. Target costing method is the cost of a product which is determined in the design
stage. Once the product has been designed and develop, it is a bit difficult to reduce
its cost. The only way to reduce the cost is by designing the product that easy to make, uses
inexpensive parts and use a reliable raw materials. CC may not be able to reduce the cost
of the product, if they have a little control over the cost especially when the product has
been develop. Then, CC need to have a suitable way on how to make sure this method
affect to their profit and it will be a valuable features that Secconz are willing to pay.
Target costing is the proactive methods that will help CC to determine their cost
management on the production, minimize non value-added activities and encourages
selection of lowest cost value added activities.

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Question 4: Assume that Secconz has decided not to renew the contract. Provide FOUR (4)
alternative courses of action that can be taken by Cold Cuts Ltd.?

The first alternative is Cold Cuts Ltd can take their parts to China and focuses to expand
the company there. Since the company already have a success in China for the past few years,
they should consider focuses more on the Chinese market. . Besides, they may get a lower price
for their raw material and also cheapest labour cost. They can increase their sales and get a
higher profit if they produce much more advance technologies.

Secondly, Cold Cuts Ltd can focus on increasing the price of their product that is selling
to the European market. They already receive the payback on their investment now they can
become the price setter. They can offer the amount that matches the other company that is selling
the same product even though the product is quickly becoming obsolete. The quality of their
technologies is far better than any other in the market then they will be able to be a price setter
and increase the profitability of their company.

Thirdly, Cold Cuts can improve their technologies that is used for their FFA component.
The technologies are quickly become obsolete thus the company should consider improving their
technologies. Thus, the company can once again become the trend setter in the refrigerator
industry. Cold Cuts can improve their technology by joint venture their business in China since
China has advance more in technology. Besides, by improving their technology, they may reduce
their cost where they not need to hired more employees to develop their product. They also be
able to produce more product in a short time where this may increase their quantity of the
product produce in a specific time.

Lastly, they could explore other company as new potential customers. By not renewing
their contracts they have open up new potential customers. They can sell the technologies to the
new customers at the same price as the one they sell to Secconz. Furthermore, Cold Cuts also not
only depend to their one major customer if they have many more potential customer that may
contribute to their sales of the company. They will not facing this problem and by perform this
way they can still retain the profit that they made with Secconz.

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Question 5: What are the implications on the financial statements? What accounting
standards are relevant to present a better picture of the Cold Cuts performance and
valuation of its assets?

Cold Cuts Ltd will facing a tremendous impact if they losing their major customer which
is Secconz in Singapore. Huge impact will effected to the company financial especially on the
revenue. The revenue of Cold Cuts Ltd (CC) will drop about one third of all Fruzzy Frost Alpha
(FFA) sales of CC. If this happens it will affect the company profit as well. The selling price of
FFA models to Secconz is much higher than European customers. Furthermore, the annual
requirement of Secconz was 25,000 units of FFA which is one third of the sales of CC.
Meanwhile, CC might lose $ 3,500,000 yearly which is almost 41% from the total sales.

It is adviseable for Cold Cuts Ltd by implement just in time manufacturing or lean
manufacturing production strategy to cut down their cost in manufacturing.

Just in time manufacturing is a strategy used in the manufacturing industry to reduce

costs by reducing the in-process inventory level. Furthermore, just in time inventory is a
management system in which materials or products are produced or acquired only as demand
requires. It is driven by a series of signals that tell the production line to make the next piece for
the product and when it is needed. The signals used are usually simple visual signals, such as the
absence or presence of a piece that is needed in the manufacturing process. In just-in-time
manufacturing, reorder levels for certain inventory items are set and new stock is ordered only
when those levels are reached. There is no overstocking of parts or items, which saves on space
in the warehouse. This manufacturing strategy can lead to improvements in quality and
efficiency. It also can lead to higher profits and a larger return on the company's investment.

While, lean manufacturing is being utilized by businesses of all sizes today. Although it
took a few years to become mainstream, the success stories from mid-size to large corporations
have pushed lean manufacturing down to very small organizations. Most of the large
corporations employ a few lean experts. Many mid-size and most small businesses do not have
lean manufacturing expertise in the company. They also providing total satisfaction to your
customers by pulling value from the value stream when required by your customers using the
minimum amount of resources. This is achieved through the involvement and respect of all

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employees and is a never ending journey towards perfection. Just-in-time manufacturing is

focused on efficiency, while lean manufacturing is focused on using efficiency to add value for
the customer.

CC has their reporting obligation and also accounting standard that they follow. In
Section 45 Companies (Auditing and Accounting) Act 2003 will, when commenced impose an
obligation on directors on certain companies to prepare statements on their company’s
compliance with its relevant obligations. Relevant obligations consist of all obligations under the
Companies Acts and under tax law, together with obligations under certain other enactments.

In addition to the obligation specified, a company is obliged under a number of

provisions to do certain things when so required by notice from the Revenue Commissioners or
one of their officers.

In a conclusion, CC financial statement show that the sales will drop if their major client,
Secconz going to reduce the price lower than the price they pay. Although, they reduce the price
but the quality of the product they use are still in a high quality. So, to overcome this problem,
the CC must deduct the cost of the operation department such as reducing employees. Thus, they
are still able to maintain their profitability.

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Question 6: How should the request for a bribe be handled and what are the potential
consequences of the various options open to them?

United States International Trade Commission are saying that CC are pricing their products
much lower than the fair value. However, they have acted according to the law. If CC found to be
guilty, they will either close down or CC should pay a huge anti-dumping tax at least. The staff
want some bribes to smoothen things out for them. If CC made some personal arrangements with
the staff, he can close the case. However, the authorities might still close down their business for
them to get into trouble even if they're not do anything wrong.

Bribery can lead to the consequences which can be very bad. The company’s name will be bad
because of the bribe. Bribery would affect the profitability of the company and can give big
impacts in the long run. Apart from that, CC should look at a few possible option that they can
consider at;

i. Takes action towards the person who commit bribe

CC are recommended to do report to the top management of United States International Trade
Commission or report to local authorities so that action can be taken towards the person who
commit bribe. This is because the authorities are responsible to take action towards the person who
are guilty to commit bribe even though do not intent to do so. In Malaysia, bribery can be reported
to Malaysian Anti-Corruption Commission (MACC) while for international stage, the company
can refer to INTERPOL or International Associate of Anti-Corruption Authorities (IAACA). The
person who commit bribe will be charged a large fines and imprisonment even though as a first
time offender.

ii. Ignore the bribes

CC can totally ignore the bribe from United States International Trade Commission’s staff. CC
deserves clear basis on the accusation. CC should seek for any legal advice about the matter.
Besides, CC can seek for legal advices from World Trade Organization (WTO) instead of paying
the huge anti-dumping tax. WTO is responsible to give legal advices about the anti-dumping tax
and revise the product price which is refer to “Anti-Dumping Agreement”. This will eliminate the
matter from any unethical issue of CC’s employees. So, the employees will have a knowledge

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about the matter involved and able to understand the working principle in the company. CC should
implement a strategy for possible action of bribery that might happen in the future as for the
company ethical itself.

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