The America Online division of Time Warner has fueled its growthby using aggress

Question

The America Online division of Time Warner has fueled its growthby using aggressive promotion strategies. One of thesestrategies is to send compact disk software to potential customers,offering free AOL service for a period of time. Assume thatduring a given promotional campaign, AOL mailed 3,200,000 disks topotential customers, offering three months’ freeservice. In addition, assume the following information:

Cost per disk (includingmailing)                                           1.50

Number of months an average new customer stays

With the service (including the three freemonths)                30 months

Revenue per month per customeraccount                             10.00

Variable cost per month per customeraccount                      1.00

Determine the number of new customer accounts needed tobreak even on the cost of the promotional campaign. In formingyour answer, (1) treat the cost of mailing the disk as a fixedcost, and (2) treat the revenue less variable cost per account forthe service period as the unit contribution margin.

Explanation / Answer

Break even units calculation Fixed cost    =Break even contribution margin Fixed cost = 1.50 / unit 3,200,000 * 1.50 = $ 4,800,000 / mth. AOL won't make money for 3 months. Fixed cost for three months =4,800,000 * 3                                                                                                   = 14,400,000 Plug in all the numbers to the formula,         14,400,000            10 - 1     = 1,600,000 AOL needs to get 1,600,000 new customer accounts to breakeven on the cost of the promotional campaign.

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