Use the following excerpts from an article in the Sydney Morning Herald to help
ID: 1136098 • Letter: U
Question
Use the following excerpts from an article in the Sydney Morning Herald to help you answer the following questions.
a)Explain the difference between economic profit and accounting profit and explain which is being referred to in this article.(2marks)
b)Define variable costs and fixed costs and categorise the following items from the article: smartphone handset; chicken; electricity; and commercial lease.(4marks)
c)Using a clearly labelled diagram to illustrate, explain how increased costs of variable inputs such as petrol and chicken has reduced profits of Fuku Japanese when the price remained unchanged.(4marks)
d)With the aid of a clearly labelled diagram, explain why Alan Associates does not want to raise the price.(4marks)
e)Use clearly labelled diagrams to show how Exodus Wear used diversification to maintain overall profits when the input costs of jackets rose. (5marks)
Today's headlines are dominated by stories on rising living costs; real estate, electricity, petrol. However, many small businesses are reluctant to follow suit, with some leaving prices for services and products unchanged for more than a decade.
Using technology to keep costs down
Melbourne business owner Alan Schwarz quickly embraced 21st-century technology when he founded B2B credit management business Alan Associates in 2003 and today he runs his venture via his smartphone and email thanks to a virtual private network. He says his tech tools enable him to keep running costs low, which means he still makes profit even though he has never increased his service fees. He has two clients; a manufacturing business and an accounting industry service provider and charges each a flat weekly fee.
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According to Schwarz, his clients use his services because of their long-term relationships.
"Both managers have now become friends and that does make it [raising prices] a bit difficult, too, once you have that social connection."
He says he has raised the frozen fees issue "once or twice" with his clients over the past 10 years, but nothing has changed.
"I am frightened that if I raise my weekly fees, they may doubt the value. All the work is done by VPN with me picking up the outgoings for my electricity, phone, internet, so even though phone and electricity has gone up I am still stuck with my prices from early in the 2000s [but]I don't want to rock the boat."
A price sensitive customer base
Catchy-named Gold Coast fast food outlet, Fuku Japanese last lifted its menu prices in 2011, according to manager Mary Courtney.
Courtney has worked for the 26-year-old establishment since 1995 and does all supplier food ordering, notably large quantities of chicken.
She says customer prices have increased over her 21 years with the business "but not by a lot".
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"You still get one out of 100 customers complaining but you try to explain that some costs –petrol, deliveries etc –have grown," Courtney says.
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Asked how prices can stay capped for so long Courtney says she works closely with three poultrysuppliers and multiple vegetable suppliers to negotiate prices "but you do have to keep an eye on it" because her customer base is very price sensitive.
This year, a rental discount in recognition of minor renovations including painting and new menus has helped protect profit margin.
"We understand our customers do not like price increases ... but at the moment we are watching [the market] closely, maintaining relationships with suppliers, understanding prices do fluctuate depending on seasons but expecting that will even out when viewed on an annual scale so we can keep prices steady....
Transparency is key
Melissa Jreige launched women's hair salon Reborn Hair in 2013. The four-seat salon in Melbourne's inner north suburb of Thornbury has annual turnover under $100,000, she says, and this month increased haircut prices for the first time –by a flat 10 per cent –to counter the fact its commercial lease costs went up by about $1500 a month in 2016."We have not had a price increase since we opened but as commercial leases have gone up this year we have decided to cover this extra cost by introducing one transparent increase to our cuts, just enough to cover that lease increase," Jreige says.
"I have been determined to be very transparent with pricing so my clients can see the rise; it's the only way to do it."
Diversifying to maintain profits
Elyse Daniels founded her custom school leave jacket business Exodus Wear in 2009.Today her Sydney-based national business sells about 2000 jackets each month and turns over morethan $2 million.
Daniels reveals her profit margin on her custom jackets has reduced in recent years because of the weaker Australian dollar.
She says she "pushed back on suppliers" for a while but eventually decided to diversify and offer other complementary garments including leggings and crop tops.
It's meant she has maintained her original profit margin and kept her original advertised price of $90 flat including GST for 100 units of custom jackets.
"When we entered the market everyone else was about $20 cheaper but the quality was rubbish," Daniels says.
"We decided to adopt a different, very transparent pricing model and now we have become so well known for this easy to remember price we have actually turned it into a unique selling point and have no plan to raise prices.
"While our jacket margin is lower now than it was 12 months ago we have offset this by introducing special products with higher margins and our profit margin has come back in other ways.
This story was found at: http://www.smh.com.au/small-business/finance/the-big-price-freeze-for-small-business-20160324-gnq6xf.html
Explanation / Answer
Variable costs are corporate expenses that vary in direct proportion to the quantity of output. Unlike fixed costs, which remain constant regardless of output, variable costs are a direct function of production volume, rising whenever production expands and falling whenever it contracts. Examples of common variable costs include raw materials, packaging, and labor directly involved in a company's manufacturing process.
The formula for calculating total variable cost is:
Total Variable Cost = Total Quantity of Output xVariable Cost Per Unit of Output
The term variable cost is not to be confused with variable costing, which is an accounting method related to reporting variable costs.
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