INDIAN INSTITUTE OF MANAGEMENT

AHMEDABAD

Assignment 2

West Lake Home Furnishings Ltd.

Evaluation of a proposal to reduce the retail price of the Signature line

In partial fulfillment of the requirements of the course

Written Analysis and Communication I

Presented to

Instructor: Prof. Rohini Patel

Academic Associate: Ms. Atmaja Shah
On

05 July 2008
by

24 May 2007

From,
XYZ,
ABC
Students of WIMWI

To,
Mr. Charles Bowman
CEO, West Lake Home Furnishings Ltd.
Toronto, Ontario,
Canada

Re: Evaluation of a proposal to reduce the retail price of the signature line

Dear Charles,
We have analyzed the proposal by your wholesale customer to reduce the retail price of the signature
line. Please find attached a report containing our evaluation of the proposal and recommendation.

Thanking You,
Yours Sincerely,

XYZ,
ABC

Executive Summary
West Lake Home Furnishings Ltd. (WL) is a manufacturer of table lamps with modern
designs at reasonable prices. One of its largest retailers has proposed a reduction in the price
of its signature line, which accounts for 59.2% of its income, from $69.99 to $ 29.99;
resulting in an expected fivefold increase in sales volume.

WL now needs to decide whether it should accept the proposal or decline. Both options have
been evaluated in terms of the profitability, brand alignment and the reaction of its dealers.
On the basis of this evaluation, it is recommended that WL should accept the proposal and
reduce the price of its signature line.
(Word Count: 109)

Contents
Situation Analysis.....................................................................................................................1
Market Analysis.....................................................................................................................1
Financial Performance..........................................................................................................1
The Signature Line and URC.................................................................................................2
Problem Statement...................................................................................................................2
Available Options.....................................................................................................................2
Criteria for Evaluation............................................................................................................3
Evaluation of Options..............................................................................................................3
Accept the proposal................................................................................................................3
Reject the proposal................................................................................................................4
Recommendation......................................................................................................................5
Action Plan................................................................................................................................5
Exhibits......................................................................................................................................6
References.................................................................................................................................8

Situation Analysis
West Lake Home Furnishings Ltd. (WL) has positioned itself as a manufacturer of table
lamps with modern designs at reasonable prices. It aims to increase customer recall while
growing rates of 10 to 15% p.a. However, after three decades of operation, it has only a
1.24% market share and an annual growth rate of 1.8%, lower than the industry standards of
6.1%. Even its return on investment has decreased from 10.04% in 2005 to 8.98% in 2006.
(See Exhibit 1)

Market Analysis
The market for table lamps is expected to continue its growth till 2011, when the baby
boomers are expected to reach the age of 65 (Statistics Canada, 2006). The $0.9 billion
market for table lamps is extremely fragmented while the retail market, its customer, is a
$236 billion industry of which large chains accounted for about 33.33%. Thus these retailers
have tremendous negotiation advantages over manufacturers, and could change suppliers
frequently if their products did not sell well.
Manufacturers compete on product designs and prices, and WL faces increasing price
competition from new entrants with similar designs, who are targeting its retail accounts.

Financial Performance
The operating margin for wholesalers is 6.95%, accounting for 71.41% of total sales. (See
Exhibit 2) Internet Sales, though with an attractive margin of 39.7% only accounts for 1.78%
of total sales, thus not affecting the bottomline. The retail store is running at a loss with an
operating margin of 10.74%. Thus wholesale revenues, though comprising of 71.41% of
sales, contributes 178% to operating income underlining its importance to the overall
profitability of the firm.

The Signature Line and URC

The signature line of WL, retailed exclusively at a large US-based retail chain (URC),
accounts for 33.33% of wholesale revenues, or 59.2% of operating income. This line,
defining the brand of the firm, is currently priced at $69.99, which falls towards the lower
range of the spectrum of WLs product prices of $45 to $195. Thus the signature product is
priced as a price competitive product, reflecting the company positioning strategy rather than
as a premium product.
URC is aware of the costs, specifications and details of the manufacturer in China for the
signature line, thus giving it the ability to replicate it with a private label line. However,
strong sales volume would discourage it from cannibalizing the sales of a product which
contributes strongly to its own margins.

Problem Statement
A decision needs to be made on whether to accept the proposal by URC to decrease the price
of the signature line from $69.99 to $29.99.

Available Options
The options available are:

Accept the proposal reduce the price of the signature line from $69.99 to $29.99

Reject the proposal attempt to retain status quo

Criteria for Evaluation

The criteria for evaluation used, in order of importance, are:

Profitability and Liquidity maximize Return on Investment while maintaining

liquidity using valid assumptions

Alignment with Brand Image effect on brand from changes in the signature line

Reaction of URC and other retailers impact on relationship with retailers

Evaluation of Options
Accept the proposal
Profitability and Liquidity
If the proposal is accepted, the revenue per unit is reduced from $48.99 to $25.49 per unit and
operating margin decreases from 6.95% to 3.05%. (See Exhibits 3 and 4) However, if sales
volume quintuples as expected, the overall operating income would increase by 8.4% to
$339,310. The return on investment for WLs shareholders, whose maximization is the aim of
any for-profit organization, would increase from 8.94% to 9.74%.
Inventory for retail products would increase by 30% however the overall inventory would
only increase by 7.14%. (See Exhibit 5) This increase can be financed by a line of credit for
$114, 286 whose interest payments would make no material difference to profitability.

Alignment with Brand Image

The signature line is not priced as a premium product and decreasing the price and increasing
sales volume will help it reflect the price competitiveness of the brand and help it increase
recognition of the brand amongst customers. This could also positively affect its internet sales
due to greater visibility.

Reaction of URC and other retailers

Currently, URC earns a marginal revenue of $21, which is proposed to decrease to a marginal
revenue $4.5. Therefore, to match current profits, sales would have to increase by 4.7 times.
This will incentivize URC to provide prominent displays and promotions.
Other retailers may try and gain similar concessions which will reduce gross margin from
wholesale sales by 29.01%. However, this concession need only be provided if they provide
similar proposals to what URC offers, which leads to a further increase in return on
investment to 11.01%. (See Exhibit 6)

Reject the proposal

Profitability and Liquidity
Under status quo, the firm the firms profits would be expected to remain stable if there is no
reaction to rejection from UCR.
However, new entrants are actively seeking to gain WLs retail accounts, and UCR has the
knowledge to effectively replicate the signature line. Thus, WL could lose UCRs account
which accounts for 59.2% of its overall profits.

Alignment with Brand Image

Under status quo, the growth rate would remain at 1.8%, which would be well under the
stated aim of 10-15%. Also with a market share of only 1.24%, the recognition of the firm
would remain low.
If the firm does lose the URC account, then the loss of the signature line will negatively
impact its brand image and could also have an effect on overall sales due to brand dilution.

Reaction of URC and other retailers

UCR has detailed knowledge of the production process and facilities in China. It could
replace the signature product on its shelves with a private label with similar design or with a
competitor who is willing to follow the model proposed.
Other retailers could view the loss of an account and decrease in sales as a negative, given the
emphasis placed in the industry on product sales. WL could try to market its signature line
through another retailer. However, given its urgency, any such transaction would revert it to
status quo at best or grant the retailer a greater margin.

Recommendation
WL should accept UCRs proposal and reduce the price of its signature product from $69.99
to $ 29.99.

Action Plan

Negotiate with UCR to gain concessions on prominent shelf spaces and other
promotions

Negotiate with the Chinese manufacturer for discounts on signature line production

Bargain for a discount on all its products due to increase in volume

Obtain a line of credit for $114,286 to meet cash requirement for inventory

(Word Count: 1097)

Exhibits
EXHIBIT 1: Calculation of Return on Investment

EXHIBIT 2: Segmented Contributions to Earnings and Margin Ratios

* The various items have been split between sectors as per instructions in the case. Where no instructions were
provided, they have been segmented proportional to sales.
** Operating Margin (%) = Operating Income / Sales

EXHIBIT 3: Calculation of Revenue Given Retailer Margins

EXHIBIT 4: Analysis and Comparison of Proposal

* For 2006, all Signature items are taken as 1/3 of Wholesale items
* For 2007, Signature Sales = (5*2006 Signature Sales*New Per Unit Revenue)/2006 per Unit Revenue
*For 2007, COGS = (5 * 2006 Signature COGS * $ 20)/$30
* For 2007, SGA = 2006 SGA * 1.2
* For 2007 SW = 2006 SW *2.5

EXHIBIT 5: Calculation of Inventory and Loan Amount

EXHIBIT 6: Analysis of the Scenario Where All Retailers Give Similar Proposals

* All Figures calculated as in Exhibit 4, only using Wholesale items as base

References
Census of Canada 2006. (2006). Population gain fastest among the oldest. Retrieved on July
31, 2008, from Statistics Canada online via access:
http://www12.statcan.ca/english/census01/Products/Analytic/companion/age/canada.cfm