Hallstead Jewelers Harvard Business Case Review

Hallstead Jewelers

To determine the breakeven points, the company must analyze its variable and fixed costs in relation to its average ticket. The variable costs are the COGS, the selling expense and the commissions. The other costs are fixed, given that advertising levels are not strongly tied to the sales figures, nor is administrative expense. The breakeven point in tickets is calculated by dividing the fixed costs by the contribution per ticket. The breakeven point in dollars is calculated by multiplying the breakeven number of tickets by the average ticket. For 2003, 2004 and 2006 this is as follows:

Hallstead

Breakeven Analysis

Sales

$8,583,000

$8,102,000

$10,711,000

Avg ticket

$1,607

$1,524

$1,553

Variable costs % of sales

Average Variable Costs

$1,267.92

$1,244.80

$1,351.11

Contribution per ticket

$339.08

$279.20

$201.89

Fixed Costs

$1,229,000

$1,272,000

$1,796,000

Breakeven point ($)

$5,824,645

$6,943,231

$13,815,385

Breakeven point (tickets)

3,624.55

4,555.93

8,895.93

At Hallstead, the variable costs as a percentage of sales have steadily increased. The average ticket has decreased and as a result the contribution per ticket has decreased. When this is combined with higher fixed costs, the company's breakeven point has increased significantly. The implication for this is that although the new location has seen an increase in volume, that volume increase has not been sufficient enough to cover the increased costs associated with operating the new store.

The margin of safety has decreased steadily over the course of the past few years at Hallstead, as illustrated below, on an extension of the previous chart:

Breakeven Analysis

2003

2004

2006

Breakeven point (tickets)

3,624.55

4,555.93

8,895.93

Actual # of tickets

Margin of Safety

-1999

These changes have been caused by a combination of a higher cost structure, lower average ticket and higher variable costs per ticket.

Graphically, the 2007 breakeven analysis can be represented as follows:

2. The prospective 2007 figures were calculated on the 2006 figure for variable costs per ticket, which was $1,351.11. Fixed costs were assumed to hold the same for 2007. This gives the following figures:

Hallstead

Breakeven Analysis

2007

Sales

$9,783,900

Avg ticket

$1,398

Variable costs % of sales

97%

Average Variable Costs

$1,351.11

Contribution per ticket

$46.59

Fixed Costs

$1,796,000

Breakeven point ($)

$53,880,000

Breakeven point (tickets)

38,549.04

Actual # of tickets

Margin of Safety

-31549

The new breakeven point is 38,549 units. This occurred because the 10% reduction in prices under the consultant's recommendation resulted in only a miniscule increase in the number of tickets. The price reduction wiped out most of the contribution margin per ticket, which dramatically increases the breakeven point. The new breakeven point in dollars would be $53,880,000.

3. Sales commissions represent $536,000 of cost, or $77.71 in variable costs per sale. If it is assumed that sales levels would not be affected by this change, and otherwise 2007 figures would be the same as 2006 figures, the new breakeven volume would be 6423 tickets, or $9,975,637 in volume. Gretchen's doubts are reasonable, however. Eliminating commission would almost certainly result in a reduction in total sales. The new figures show a margin of safety of 474, which is 6.9% of total tickets, it is reasonable that sales could decline by more than 7% as the result of eliminating the commission. Key sales people could defect as the result of this reduction in their income, and those who remain lack incentive to push for higher sales.

Hallstead

Breakeven Analysis

2007

Sales

$10,711,000

Avg ticket

$1,553

Variable costs % of sales

87%

Average Variable Costs

$1,273.40

Contribution per ticket

$279.60

Fixed Costs

$1,796,000

Breakeven point ($)

$9,975,637

Breakeven point (tickets)

6,423.46

Actual # of tickets

Margin of Safety

4. By increasing advertising, Michaela would increase the firm's cost structure. This would raise the breakeven point. The calculation is as follows:

Hallstead

Breakeven Analysis

2007

Sales

$10,711,000

Avg ticket

$1,553

Variable costs % of sales

87%

Average Variable Costs

$1,351.11

Contribution per ticket

$201.89

Fixed Costs

$1,996,000

Breakeven point ($)

$15,353,846

Breakeven point (tickets)

9,886.57

Actual # of tickets

Margin of Safety

-2990

This shows that the new breakeven point for sales would be 9887 tickets, or $15,353,846. Thus, the increased advertising spending would need to increase ticket sales by 2990 over current levels, as that is the new margin of safety.

5. Sales in dollars would need to be $13,815,385 in order for Hallstead to break even in 2007, if all cost figures remained as they were in 2006. If it is assumed that the number of tickets is to remain the same, then the average ticket would need to increase. The fixed costs are $1,796,000. These should be divided by the number of tickets -- 6897 -- giving an average contribution of $260.40 needed to break even. If it assumed that all variable costs remain the same, then the average ticket price will need to increase by the same amount that the contribution margin needs to increase. In this case, that figure is:

$260.40 - $201.89 = $58.51

This would give the store an average ticket of $1,611. This average ticket level is roughly the same as the store had in 2003, a year in which Hallstead turned a profit and had a healthy margin of safety.

6. From this analysis, the most logical recommendation is that Hallstead should focus on increasing its average ticket, and on reducing its variable costs. The average ticket has slipped from $1,607 in 2003 to $1,553 in 2006, a drop that has knocked $54 from its contribution margin. The remaining reduction in contribution per ticket has come from rapidly escalating variable costs. It is assumed that the fixed costs are more difficult to change, largely because the increase in fixed costs was specifically related to the move to the newer, larger store.

Variable costs have escalated from 78.9% of sales in 2003 to 87% of sales in 2006. The company's cost of goods sold has not changed significantly -- in 2003 it was 50.4% and in 2006 it has actually increased to 52%. Salaries, however, increased from $2,021,000 to $3,215,000, an increase of 59%. Sales only increased 24.7% over the same time period. It is recommended, therefore, that Hallstead reduce salaries by 25%, in addition to restoring the previous product lines that had delivered the higher average tickets prior to the move. In boosting the average ticket to $1,575 and reducing the salaries 25%, the financials for Hallstead improve dramatically.