CVP the Performance of the Company Last

CVP

The performance of the company last time through was not bad, but with the application of proper management techniques, it could be improved. One such technique is cost volume profit analysis. This is the technique that will be applied to the company in this upcoming simulation. This paper will analyze how CVP analysis contributes to the strategy, including an analysis of its strengths and weaknesses.

CVP Analysis

Cost volume profit analysis is defined as "a method of cost accounting used in managerial economics. It is based on determining the breakeven point of cost and volume of goods (Investopedia, 2012). There are three products in this scenario, each with its own set of fixed and variable costs. What CVP analysis can help us to do is understand decisions like pricing and when to discontinue a product.

It has been determined that, by and large, the performance of the X5 is not going to be affected much by any decision that we make. This product's status as a mature product headed towards the end of the product life cycle means that it will probably come close to selling out by the end of the next four years no matter what happens, as long as the change in price is not dramatic.

This removes the value of CVP analysis from the pricing decision. For example, the main reason to cut the price of the X5 would be to ensure that the product sells out. Yet, it is likely to sell out anyway so there is no real need to cut the price. The price could be increased, but CVP analysis is less concerned with maximizing profit than it is with ensuring that profit is made. There are a few reasons for this. The most important is that to maximize profit, the company must have a means of estimating demand at a given price point. Demand estimation derives from an understanding of the price elasticity of demand, not from CVP analysis. Ideally, the two would be used together so that the price point that is set is deemed by the CVP analysis to be profitable, and by the elasticity of demand analysis to be the most profitable.

The most important area where CVP analysis contributes to the decision-making with respect to the X5 is with the decision to drop the product. The key statistic to keep in mind here is that the X5 has high fixed costs. At $72 million per year, the fixed costs associated with the X5 are equal to the fixed costs of the other two products combined. This has significant implications for the product's future. For example, by the time we reach third year of the simulation, the X5 has reached a saturation level where there is only a few hundred thousand units remaining in the potential market. This figure is actually lower than the breakeven point. The breakeven point is calculated because we know the price ($265) and we know the variable costs per unit ($145 per unit). This gives a contribution margin for each unit of the X5 sold of $120. Assuming that we do not change the price of the X5 (because we do not need to), the breakeven number of units is going to be:

72,000,000 / 120 = 600,000

This also assumes that there will not be any R&D expenses, which is a reasonable assumption for a product entering its last year of life. If the projected sales are expected to dip below 600,000, the product must be discontinued. This is the situation in 2015, so the X5 must be discontinued for that year. If we continue to sell the X5 in that year, the product will take a loss.

The fixed costs associated with the X6 are lower than those associated with the X5. As a result, the breakeven point is lower. The contribution margin is $420 - $260 = $160. The breakeven point for this product therefore is 36,000,000 / 160 = 225,000 units. If the projected sales for this product drop below this level, the product should be discontinued, but that is not the case.

The other decision with respect to the X6 that could be assisted by CVP analysis is setting the floor price. Given that the X6 is positioned as a premium product, there is no need to approach the floor price. If anything the price should be increased. Without knowing the elasticity of demand, we cannot know the point of maximum profit, because we do not know the response that demand will have when the price is increased. We can, however, be certain that this product will be continued and that $260 is our price floor.

The breakeven point for the X7 comes into play in the second year. The X7 lost money in the second year last time, because it did not sell enough units. The contribution margin for this project is $195 - $60 = $135. Thus, $60 represents the price floor, and the breakeven point is 600,000 units. This does not include the R&D expense. However, we can surmise that with 15,000,000 as the potential market for this product, selling 600,000 or a hundred thousand more is not a big deal. The objective for this brand is to get past that level as quickly as possible, perhaps by using a penetration pricing strategy to boost sales. The lower the price, the more sales will need to be boosted because the contribution per unit will be lower.