Costing Strategies and Break-Even Analysis: Nippers Case

Introduction

This analysis is based on the Nippers case, in which owner Mrs. Dibsa is presented with the opportunities of expanding her business, maintaining it as it is, or selling it. Considering that she decides against selling, the owner and manager of this gardening manufacturer and service provider then faces the opportunity of launching a new special product on the market. As a brief overview, Nippers is a small enterprise that is extremely successful, offering high-quality products and services at competitive prices. Given that Mrs. Dibsa intends to retire within six years, she is faced with the difficult challenge of selecting the next best course of action.

In order to assist with this decision, an analysis of several financial and non-financial factors has been conducted, beginning with the net present value and concluding with the break-even analysis and its limitations. Despite the rather clear conclusion of the NPV analysis, Mrs. Dibsa should also consider non-financial factors before making her decisions — factors relating to the future of the business and its employees, the company's prestige, and the current state of the economy.

Aside from the decision of whether to extend the building or not, Mrs. Dibsa must also focus on the approaching launch of Nippers' new product: the 3-in-1 Lawnmower. A major decision revolves around identifying the most suitable pricing strategy. The available options include transfer, skimming, market-based, and cost-based strategies. The recommended solution is a combination of skimming and market-based pricing strategies. Should Mrs. Dibsa adopt this approach, it is important to correlate it with the costing system used. Specifically, it is advisable that she asks her accountant to organize costs using the marginal costing system rather than absorption costing. The marginal system allows for selective incorporation of costs, whereas absorption includes all expenditure within the final retail price. Marginal costing also enables Mrs. Dibsa to track the relationship between sales, costs, and profits, supporting better-informed decisions.

The launch of the new 3-in-1 Lawnmower must also account for numerous costs incurred in its manufacturing and distribution. While the initial costing schedule is broadly comprehensive, some figures have been revised in accordance with updated estimations. Three new categories of relevant costs have also been introduced: testing and correction costs (R20,000), marketing expenses (R50,000), and bank loan costs (R236,000). Although this costing structure is relevant to the overall business process, Mrs. Dibsa is advised to consider additional factors when setting the product's retail price, since relevant costs are most effective for short-term pricing and may prove less reliable over the long term.

A final financial tool available to Mrs. Dibsa involves identifying the number of unit sales required for the company to begin generating a profit — this is the break-even analysis. Despite its importance, this tool also carries certain limitations that must be acknowledged.

Net Present Value

The Net Present Value (NPV) is generally the most widely used tool for assessing investment decisions, and it is therefore highly relevant to Mrs. Dibsa's challenge. Through the use of NPV, Nippers benefits from three key advantages: (1) the method considers the time value of money by discounting future cash flows to reveal their present value; (2) NPV accounts for the cost of capital to the business; and (3) it satisfies the need to compare initial cash outlays with the present value of the return (Berman, Knight, and Case, 2006, p. 188).

The computation of NPV is generally more complex than that of other capital budgeting tools, but its advantages are clearly superior. In its most basic formulation, NPV is obtained by subtracting the present value of cash outflows from the present value of cash inflows.

NPV with building extension: 1,350,000 / (1 + 0.2) − 862,000 = 263,000

NPV without building extension: [calculation not provided in source data]

Non-Financial Factors

Despite the clear conclusion offered by the NPV computation, Mrs. Dibsa ought to also consider a range of non-financial factors before making her final decision. These include the following:

On a personal level, Mrs. Dibsa is deeply attached to her business and to the employees she has hired — many of whom are family members or close friends. An extension of the building would allow the business to continue flourishing and would provide an improved working environment for her staff.

The extension would increase the prestige of the company by creating more employment opportunities and supporting the development of the local community. However, business growth also implies greater risks than initially foreseen, and the project could ultimately require more investment than first estimated.

Given her age, Mrs. Dibsa may not be well-positioned to manage the stress and pressure associated with a business extension. Furthermore, the current state of the economy is generally precarious, which would suggest a preference for savings and protectionist policies rather than new investment.

Alternative Pricing Strategies for the 3-in-1 Lawnmower

On the other hand, an extension would allow Nippers to serve more customers and develop additional products, strengthening its competitive position in the market. Ultimately, the actual benefits — both financial and non-financial — could prove greater than those initially projected.

Nippers' 3-in-1 Lawnmower is a distinctive new product that, at the time of its launch, would face no direct competition in the market. The lawnmower differentiates itself from existing products through its higher levels of operating efficiency. A key challenge associated with this product is identifying the most appropriate pricing strategy for establishing its retail price. The available alternatives are presented below.

Transfer pricing strategy: This strategy would allow Nippers to transfer part of the costs incurred in manufacturing the new lawnmower to other products, thereby increasing the retail prices of those items while keeping the 3-in-1's retail price highly competitive (Bolander, Gooding, and Mister, 1999). The main disadvantage lies in the rising prices of other goods, which could generate customer dissatisfaction and create difficulties in internal accounting.

Market-based vs. cost-based pricing strategies: Nippers could implement a retail price based on market conditions — namely product demand and the presence of competitors — with the goal of offering a competitive price. At the opposite end, the cost-based pricing strategy allows the company to set price according to the costs incurred in manufacturing and delivery (Goetz Jr., 1985).

Skimming pricing strategy: This approach involves setting a high initial retail price with the intent of generating rapid profits. The strategy offers several advantages that are directly applicable to the 3-in-1 Lawnmower. For instance, it enables Mrs. Dibsa's company to "take advantage of the novelty appeal of a new product … a skimming pricing policy offers a safeguard against unexpected future increases in costs, or a large fall in demand after the novelty appeal has declined" (Drudy, 2004, p. 432).