Essay About Contribution Margin And Mr. Johnson

Fineprint Memo
Introduction:In this memorandum, I evaluate the three alternatives Mr. Johnsons company FinePrint Company has encountered. FinePrint is a high-quality brochure printing company that operates at full capacity. Mr. Johnson is presented with three choices on how to allocate FinePrint Companys current production under some special cases. The special cases include a special order from his friend Abbie Jenkins, and outsourcing opportunity from a small local printing shop ran by Ernest Bradley, and outsourcing Abbies order to Ernest. My assessment of Mr. Johnson alternatives includes calculated relevant costs and benefit for each choice and an evaluation of the relevant constraint for the company. Finally, I provide a recommendation for Mr. Johnson on which alternative to choose.Special Order:         FinePrint currently runs at full capacity that is 150,000 brochures. If he chooses to take the special order from Abbie, he would have to print 25,000 brochures for her and 125,000 for the company. After computing the relevant costs and benefit, I recommend that Mr. Johnson reject the special order. As shown in Exhibit 2, I used the contribution margin per unit (100 brochures in this case), the difference between the sales price and the variable cost, to evaluate the two alternatives, in order to help Mr. Johnson make a decision. FinePrint Company has an average sales price per 100 brochures of $17 and total variable cost per 100 brochures of $7. This results in a contribution margin per 100 brochures of $10 (Exhibit 2). Over the phone call Abbie informed Mr. Johnson that she could not go any higher than $10 per 100 brochures so if he decides to accept the special order, sales price per 100 brochures for the special order will fall to $10. Since Abbie reached out to Mr. Johnson, he would not need to pay his sales representative. This changes the variable cost to $6 resulting in a contribution margin per 100 brochures of $4 (Exhibit 2). This contribution margin is significantly lower than the original, so it is unfavorable for Mr. Johnson if he accepts the special order. The opportunity cost of printing 25,000 for Abbie instead of 25,000 for the company also shows a loss of $150,000. Also, Abbie expressed doubt when Mr. Johnson questioned her about future printing needs. It is unnecessary for Mr. Johnson to sacrifice current benefit for long-term benefits because FinePrint Company is unlikely to have any further business with Abbie. Taking all these into consideration I suggest that he reject the special order from Abbies small company.Outsourcing:         It is important that Mr. Johnson looks at cost and benefit under the companies limitation that is the total capacity of units. Mr. Johnson can only produce 150,000 at capacity. If he decides to outsource, he would only print 120,000 and let Bradley print the other 30,000 brochures. For this alternative, I used the contribution margin, again, to analyze the relevant costs and benefits. However, because the limitation determines how much FinePrint can produce, I classify the outsourcing problem into two situations. The first situation occurs when full capacity is equal or less than 150,000 brochures, and the other occurs when the full capacity exceeds 150,000 brochures. I compare the original contribution margin per 100 brochures with the new contribution margin if the company chooses to outsource. The original contribution margin is $10 (Exhibit 2). If Mr. Johnson decides to decrease FinePrints current production, the new relevant cost and sales price would be $8 and $17 respectfully, which lead to a contribution margin of $9 (Exhibit 3). The contribution margin decreases by 1 as a result of producing under full capacity by outsourcing 30,000 brochures. Therefore, the company should not outsource under a limitation of 150,000 units. In the second situation, if market demand where to exceed 150,000 brochures (for example 180,000) while still only being able to produce full capacity of 150,000 brochures I would advise Mr. Johnson to outsource the remaining amount to Ernest because he could get a small profit of $9 per 100 brochures (Exhibit 3). Since Mr. Johnson alternative falls under situation 1 I would not advise him to outsource to Ernest.Outsourcing the Special Order:         The third alternative allows for Mr. Johnson to outsource the special order to SmallPrint. In this case, FinePrint has no opportunity cost. The company would only incur a cost of $8 per 100 brochures and keep sales price at $10 for Abbie (Exhibit 4). This results in a contribution margin at this is the $2, which is higher than zero. With no fixed cost being relevant in this decision, a contribution margin higher than 0 is profitable for FinePrint. Refer to Exhibit 3 for the profits FinePrint could obtain. Mr. Johnson has used SmallPrint before and knows they are dependable and do high-quality jobs so his reputation would not be hurt. With that being said, I suggest that FinePrint outsource the special order to SmallPrint.