IDIS 424 VALUE OF PURCHASING Spring 2004

How will the company compete in a changing competitive environment? How companies make money: Raise Prices INCREASE REVENUE Increase Volume Reduce Personnel (downsize) DECREASE COSTSReduce process waste cost Reduce materials cost

OPTION 1: INCEASE REVENUE KEEPING COSTS STEADY –Not easy. Number of lower-priced, higher-quality products is always increasing OPTION 2: (More proactive) REDUCE COSTS AND PASS THE SAVINGS TO THE CUSTOMER WHILE PRESERVING A PROFIT MARGIN AND MAINTAING RETURN TO SHAREHOLDERS –First reaction: Reduce workforce size –Next: Reengineering processes (identify & attack non-value-added activities) –System integration, System simplification, Standardization, Performing processes in parallel, increased automation etc.

Increasing Price

Scenario Analysis If we increase Net Sales (selling price) by 1%, how do you think this will affect our Net Profit Before Tax amount?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year $1,010,000 New Case 730, ,000 20,000 $30, ,000 10,000

Scenario Analysis What changed? By how much? Was the outcome different than you had expected it to be?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year New Case $10,000 ____0 10, ,000 ____0 $10,000 1% 0% 3.7% _05 100% _0% 50% $ Change % Change 1% Increase in Selling Price = 50% Increase in Net Profit Before Tax ! $1,010, , , ,000 20,000 10,000 $30,000

Increasing Product Mix and Penetration

Scenario Analysis Start with base year information. If we increase sales volume by 1%, what effect do we EXPECT this to have on our profit? What effect does this change ACTUALLY have on our net profit before tax?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year

Scenario Analysis If we increase Sales Volume by 1%, how do you think this will affect our Net Profit Before Tax amount? Presume that the rate of COGS remains the same percentage of sales and that 50% of Operating Expenses are fixed and does not change with sales volume.

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year $1,010, , , ,300 11,400 10,000 $21,400 New Case

Scenario Analysis Operating Expense : $260,000 (50 % Fixed Cost) Prior Period: Fixed -- $130,000 Variable -- $130,000 This Period: Fixed -- $130,000 Variable -- $130,000 x 1.01 = $131,300 Total fixed & variable = $130, ,300 = $261,300

Scenario Analysis What changed? By how much? Was the outcome different than you had expected it to be?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year $1,010, , , ,300 11,400 10,000 $21,400 New Case $10,000 7,300 2,700 1,300 1,400 ___0 $1,400 1% 0.5% 14% 0% 7% $ Change % Change

Scenario Analysis Wow! A 1% increase in our sales volume results in a 7% increase in Net Profit! What are some of the ways in which sales volume can be increased?

Improving Purchasing

Scenario Analysis Start with base year information. If we reduce Cost of Goods Sold by 2%, what effect do we EXPECT this to have on our profit before tax? What effect does this change ACTUALLY have on our net profit before tax?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year

Scenario Analysis If we improve in Purchasing and are able to reduce our Cost of Goods Sold by 2%, how do you think this will affect our Net Profit Before Tax amount?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year $1,000,000 New Case 715, ,600 24,600 $34, ,000 10,000

Scenario Analysis What changed? By how much? Was the outcome different than you had expected it to be?

Scenario Analysis Net Sales Cost of Goods Sold Gross Profit Operating Expenses Operating Profit Other Income/Expense Net Profit Before Tax $1,000, , , ,000 10,000 $20,000 Base Year New Case $0 (14,600) 14,600 _____0 14,600 ___0 $14,600 1% (2%) 5.4% 0% 146% 0% 73% $ Change % Change $1,000, , , ,000 24,600 10,000 $34,600 A 2% reduction in COGS Results In a 73% increase in Net Profit Before Tax !

Scenario Analysis Wow! A 2% reduction in our COGS results in a 73% increase in Net Profit Before Tax! How can we reduce COGS?