Jim Vermeer is a flower whole-saler. Jim prices his product (as is the industry custom) at 12 cents over the price he pays to the exporter. Current volume is 50,000 stems per day. Jim is happy with his state of affairs as it costs him only 10 cents per stem in overhead charges (i.e. his overhead cost is $150,000 per month or $5,000 per day).
Jim daughter recently joined the business. Exploiting her artistic talents, JoAnne expanded the product line to include bouquets. The average bouquet contains 24 stems and yields a contribution of 15 cents per stem.
Jim is delighted at this change to increase his profit per stem. Indeed, his is considering expanding the bouquet business from 10 to 30% of his overall volume. However, his enthusiasm is somewhat tempered because his profit has dropped to only $750 a day, even though total daily volume is steady at 50,000 stems. He knows that there is more work in assembling a bouquet but has no reason to doubt the cost system that has worked well for many years.
a. Compute Jim's overhead using the new product mix, profit, and contribution margins.
b. How could expanding into a product line with higher contribution margin erode the firm's profit margin?
c. What features of the new business line might account for the surge in overhead?