case study

POP’S INCORPORATED MANAGERIAL ACCOUNTING AS A STRATEGIC DECISION TOOL

Brian Miller

Assistant Professor of accounting

Cedarville University, Cedarville, Ohio

Jon Austin

Associate Professor of Marketing

Cedarville University, Cedarville, Ohio

Kenneth Schappell

Finance Group Manager

The Procter and Gamble company, Cincinnati, Ohio

Background

Paulo “Pops” Gigliotti emigrated from Italy and settled in Dayton, Ohio. In Italy, Mr. Gigliotti had earned both a bachelors and masters degree in food chemistry and worked for several food processing companies. Pops came to the United States when his cousin, Guiseppe Manganaro, offered him the position of senior food chemist at Manganaro foods, a growing producer of Italian cuisine for the American market. Although he enjoyed working with family members, he did not feel challeneged by his new job and therefore began tinkering with various “experiments” at home.

Mr Gigliotti was fascinated by the variety of carbonated beverages available in America. He enjoyed the refreshing sensation caused by carbonation, but felt all of the American soda pops were too sweet and none of them provided the depth of flavor to which he had been accustomed with non-carbonated beverages in Italy. After much experimentation, Mr Gigliotti developed a formula for a semi-sweet, multiple-fruit-flavored carbonated beverage. After sampling his creation, friends and family alike responded in an overwhelmingly positive manner. Many of them encouraged him to bottle the beverage and sell it locally. Indeed Mr. Manganaro was so excited about the beverage that he offered to provide the necessary production equipment, facilities, and capital.

After much discussion, Mr. Gigliotti and Mr. Manganaro decided to call the beverage pop’s punch and began marketing in the Dayton area. Consumer response was very strong. Within five years pop’s punch was selling well throughout the Midwest region. To keep up with demand and to develop a more focused marketing strategy, the cousins detached the beverage operations from Managanaro foods and established Pop’s incorporated. To complete more directly, in the non-cola carbonated soft drink market; Mr. Gigliotti developed several individual fruit-flavored sodas, which were marketed under the pop’s (orange/grape/strawberry/cherry) soda brand name. this strategy proved to be highly successful and after five years, pop’s inc. began selling its beverages on a nation-wide basis.

Over the next 20 years, Pop’s inc. failed to introduce any new products, but experienced steady growth in both sales and profits from the base line-up. During this time period, the company achieved a respectable 4.7% share of the non-cola market and subsequently made its first public offering. After nearly 35 years in business Mr. Gigliotti and Mr. Manganaro both retired and sold all of their holdings. For the next eight years Mr. Giglotti’s son, Paulo, Jr., seved as CEO, but was recently forced to resign after failing to achiever unit dollar sales growth. Michael Newberg, formerly the firm’s chief financial officer, has been appointed C.E.O and charged with growing the company.

CURRENT SITUATION

Upon assuming his new responsibilities, Mr. Newberg and his management team performed a thorough S.W.O.T. analysis. The corporate history and culture had long emphasized slow gradual change. They concluded the company possessed neither the core competencies nor the capacity to change that would be necessary to diversify into an entirely new industry. Accordingly, Pop’s Inc, would need to devise a new strategy by which to achieve growth within the soft drink industry.

The new team carefully considered several alternative ways of revamping its strategy within the non-cola market, but none of them seemed to have the potential for the magnitude of growth the team desired. The team then began to consider the unthinkable- the possibility of entering the cola market. Although the risks were high, so were the possible rewards with ach market share percentage point in the domestic soda market worth approximately $500 million in annual retail sales. Under Mr. Newberg’s leadership, Pop’s inc. began the proc ess of developing a strategy with which to compete directly with the giants of the cola industry.

The research and development team created a formula for pop’s cola that performed very well against pepsi and coke in national blind taste tests. Ecstatic about these results, Mr. Newberg recently met with a group of venture capitalists in an effort to gain financing necessary to launch the new brand. The venture capitalists were intrigued by the idea, were impressed with the preliminary marketing research results and believed Pop’s Inc. possessed several requisite strengths. However, they highlighted the fact that entering the “cola war” was very different battle-field than the non-cola market in terms of the

a. Strength of the competition

b. Ferocity of the bathes fought, and

c. Resources required for successful marketing.

In particular, the venture capitalists had several concerns regarding formula costs, economies of scale, and price points. In order to provide the necessary information in these areas, Mr. Newberg has assigned you to the project described below.

COST ESTIMATION PROJECT

Mr. Newberg has requested that you analyze the cost making pop’s cola and then compare that cost to the current price points offered by coke and pepsi on both the 12 pack of 355ml cans and the 2 liter bottle. Your predecessor recently left the company, but has already pulled together the raw cost data you will need to complete the project.

SALES PROJECTIONS

Over the past 12 months the corporation has been evaluating the product under the brand name pop’s cola in a Denver test market. Lacking any specific pricing expertise the company matched the on-shelf pricing of coke and Pepsi, and determined the following sales estimates.

Sales/Year

Pop’s 12 pack (355ml/12 cans)

100,000,000 cases

Pop’s 2 liter

200,000,000 bottles

Raw Material Costs

POP’S TOP-SECRET FORMULA

Ingredient

% in formula

Cost per liter of ingredient (see below)

Carbonate water

73.0%

$0.08

High fructose corn syrup

11.2%

$0.49

Sugar

6.3%

$0.37

Carmel color

3.0%

$1.40

Phosphoric acid

2.7%

$0.10

Caffeine

2.1%

$0.12

Citric acid

1.1%

$0.15

Cola flavor

0.6%

$4.11

*costs are delivered prices to the plant.

Based on a conversation with the engineering staff the 355-ml cans need to be filled at 357 ml to avoid under-pack, while 2-liter bottle need to be filled at 2.008 liters per bottle. In addition to overfill, the manufacturing engineers expect to incur at 3% loss of raw materials during the making phase of production.

Packing Material Costs

355 ml can $25/ 1000 cans

355ml Lid/with opener $7/ 1000 lids

12 pack carton $170/ 1000 cartons

2 liter bottle $120/ 1000 bottles

2 liter injected model lid $25/ 1000 lids

manufacturing engineers estimate that approximately 2% of all packing materials will be damaged/lost through production and warehousing.

*Cost is open litter of ingredient, net per litter of cola. For example, cola flavor in the formula costs 0.6% ($4.11) = 0.02466 per liter of cola.

In addition to these costs, pop’s will additionally need to purchase several new molds for 2-liter bottles and lids at a total cost of $2,000,000. (Amortized straight line over 3 years). The company considers these expenses a part of packing materials and charges all bottle mold and amortization to only 2-liter bottles.

Manufacturing Expenses

Pop’s fruit-flavored soda volume has maximized the capacity in the current production facilities. Pop’s inc. has maximized the capacity in the current production facilities. Pop’s inc. has decided to avoid hassle associated with building a new plant and utilizes a contract manufacturer to produce pop’s cola. After investigating several contract manufacturers, the purchasing department selected shull enterprises based on their ability to meet rigorous quality measures at a competitive price.

Shull Enterprises will require a $1.5 million supplier advance for new equipment-(pop’s inc expects the equipment to last three years and recommends using straight-line amortization for all suppliers advances). In addition to these costs shull will charge the following fees. Note that both products will be charged a fee for the making and packing process.

Making Fee

$.035/ liter processing (making fee is applicable for both can $ 2 liter processing)

Packaging fee

$.015/ can bottling

$.040/ 2 liter bottling

Distribution

Pop’s inc has decided not to invest in the extensive sales/distribution system of its competitors. Instead pop’s inc will deliver its products in full truck loads directly to its customer’s distribution warehouses. Distribution costs should be allocated based on space utilization, the warehouse supervisor has pulled together the following assumptions:

80 of the 12 pack containers fit on a single pallet

250 of the 2 liter bottles fit on a single pallet

48 pallets of either size fit on a normal truck

the distribution coordinator estimates that the average costs for a trucking company to deliver a full truckload is $1,000/truckload. Additionally, a one-time costs of $10/ pallet will be charged for storage and handling at the warehouse.

Other fixed costs

Several departments will require additional resources on a long term basis to appropriately staff the additional requirements of the new brand. Incremental wages and benefits for incremental purchasing/planning personnel amount to $300,000/year.

Additional non-manufacturing costs are expected to increase as follows:

Research and development $1/2 million / year

General administrative $1 million / year

Advertising and promotional spending $6 million / year

Allocation Basis

Unless otherwise indicated pop’s incorporated allocates all fixed cists based on sales projections (in liters)

REQUIREMENTS

1. Calculate the full product unit costs of both the 12 pack and 2-liter products. Make certain to round to four decimal places and include a detailed analysis by component (raw materials, packaging materials etc)

2. At what price would pop’s inc need to sell the 12 pack and 2-liter products to “the trade” in order to provide a 25% profit mark-up for pop’s inc. shareholders (pre-tax and interest expense)?

3. At what price would the trade sell the 2-liter and 12-pack on-shelf to the final consumer assuming that on average “the trade” requires a 30% mark up?

4. Based on a comparison between your cost analysis competitive benchmarking would you recommend that pop’s inc. enter the “cola market” and compete directly with coke and pepsi? Provide a strong justificiation for your conclusion and discuss what factors influence the difference in on-shelf pricing between coke and pepsi and pop’s cola.

5. Prepare an alternative strategy for gaining market share in the beverage industry. Determine whether pop’s inc. should compete using a “low cost” or a “differentiation” strategy and provide specific examples of how you would implement your strategy