Question:

Question 3  Strategic Management Accounting Case Study 

This question builds on prior studies of Cost Volume Profit (CVP) analysis and relates to learning material and objectives from Topics 1 and 2.

Important: For assistance on how to answer this question you are advised to undertake the case study from Mars Petcare Ltd which is provided on the subject Interact site)

‘O Sole Mio’ Pasta Sauce

You have been invited to join the cross-discipline Strategic Management Committee of Jupiter Australasia Ltd as the management accounting representative. The key issue facing this top level management committee at the moment is how to improve profitability in several key product categories.

The product currently under discussion is the ‘O Sole Mio’ range of pasta sauces sold through the major supermarket chains in Australia and New Zealand. Internationally, across the whole of the Jupiter Group, the expected Return on Total Assets (ROTA) for every product category is 20%. Despite being a successful brand over a long period of time the ROTA for ‘O Sole Mio’ has fallen below the investment return hurdle rate and the Committee is considering whether to continue with the product or exit this market niche.

As the Management Accounting representative you have provided the Strategic Management Committee with the following breakdown of revenues and costs for the ‘O Sole Mio’ pasta line for the just completed 2020 year:

The O Sole Mio Marketing team advises you that at the end of the 2020 financial year O Sole Mio’s market share had fallen in 12 months from 80% to 60% of the total Australasian pasta sauce market of 10 million units. The Marketing team noted that a new product in the market ‘Dullmio’ pasta sauce (manufactured by international FMCG competitor Heinzzze) has grabbed 25% of the total market by aggressively discounting their product and advertising heavily. The total size of the pasta sauce market is expected to remain stable at 10 million units per annum.

The O Sole Mio Marketing team believe that by discounting the current O Sole Mio wholesale price by $0.50 from $4.75 to $4.25 the product will be much more competitive and they predict that O Sole Mio unit sales will increase by 25% from their 2020 levels. The research and development team have identified that by changing suppliers and slightly altering the raw ingredient mix a saving of 10% can be made on prime costs.

The CEO of Jupiter Australasia Ltd who chairs the Strategic Committee advises that, even allowing for the 10% reduction in prime costs, discounting the product by $0.50 per unit will mean that the O Sole Mio product will no longer achieve the firm’s required return on total assets (ROTA) of 20%. ROTA is calculated by dividing Gross Profit by Total Assets and currently sits at 18%. The CEO argues that if this remains the case the previously successful ‘O Sole Mio’ product line may have to be discontinued.

You advise the Committee that you are aware that the ‘O Sole Mio’ manufacturing facility is currently running at only 65% of its practical capacity and that the warehouse facility (logistics) is running at 45% capacity. Because of the high level of automation in manufacturing the pasta sauce, whilst the ‘O Sole Mio’ product Prime Costs are 100% variable,  Other Manufacturing Costs and Logistic Costs are made up of 90% Fixed costs and 10% Variable costs.

It can be assumed that this cost break-down between variable and fixed costs will hold consistently across the industry (including for the competitor ‘Dullmio’). Assume 75% of the predicted ‘O Sole Mio’ unit sales increase will be made at the expense of ‘Dullmio’, their main competitor’s unit sales. Finally, assume that ‘Dullmio’ product costs start out the same as ‘O Sole Mio’ and that the competitors make no immediate competitive adjustment to their offering.

You ask if you can be given time to prepare a report for the Strategic Committee on the cost and profit implications of the proposed changes and the resultant increase in sales and production.

Required:

(a) Using excel prepare a ‘before and after’ comparative analysis of the revenues and costs of the ‘O Sole Mio’ product line incorporating the 25% predicted sales increase and the 10% predicted savings in prime costs (Ensure you include any impact of the production increase on manufacturing and logistics costs in your analysis).  (15 marks)

(b) Prepare a brief report (approx. 300 words) for the Strategic Management Committee outlining the key points of your findings. Include some discussion on:  

The likely impact of the changes on the cost and profit structure of the O Sole Mio product line (derived from your answer to (a)).

Calculate and discuss the likely impact of the changes on the cost structure (and profitability) of ‘Dullmio’ our main competitor (use Excel).

Make a recommendation to the Committee on whether to go ahead with the planned changes. Include any other strategic advice that you consider relevant to the Committee’s decision making.

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