YSL Marketing research is a small firm located in Seattle. On behalf of its clients, the firm conducts focus group meetings, telephone and mail opinion surveys, and evaluations of marketing strategies. The firm has three partners and six nonpartner professionals. At the start of the year, the company estimated total professional compensation (related to the three partners and six nonpartner professional) to be $1,500,000.
To evaluate the profitability of its engagements, the firm traces actual professional compensation to each engagement along with so-called direct charges. Direct charges consist of travel costs and costs of conducting surveys (e.g., paper and postage). In addition, engagement receives an allocation of overhead based on professional compensation charges. Overhead consists of all support costs including rent, utilities and depreciation. At the start of the year, these costs were estimated to be $450,000.
Recently, Connie Bachmann an YSL partner was asked to conduct a survey for Surenex, a new high-tech company. Connie is excited about this opportunity since she expects that this hot, small company will in three to five years, become a hot, big company with premium billing opportunities. At this point however, Connie wants to quote a low fee since Surenex has cash-flow problems and is clearly unwilling to pay YSL’s normal rates. On most jobs, YSL’s fee is 1.5 times professional compensation. In addition, the company is reimbursed for all out of pocket costs related to travel and paper and postage costs for surveys. YSL is in high demand, and if the Surenex job is undertaken, another potential client will be turned down for service.
Connie estimates that the Surenex engagement will require the following cost in addition to overhead support costs.
Connie Bachmann (partner), 40 hours at a salary averaging $110 per hour = $4,400
Ambrose Bundy (professional staff) 100 hours at a salary of $35 per hour = $3,500
Direct charges for actual travel, mailing, and postage = $2,800
Total of above = $10,700
Required
a. Calculate the expected full cost of the Surenex engagement including an allocation of overhead
b. What is the lowest amount that Connie can bill on this engagement without hurting company profit?
c. In deciding on a price for the engagement, what should Connie consider in addition to the amount calculated in (b)?
a. To calculate the expected full cost of the Surenex engagement, we need to include the allocated overhead costs.
First, we calculate the total professional compensation for Connie Bachmann and Ambrose Bundy:
Connie Bachmann's salary: 40 hours * $110 per hour = $4,400
Ambrose Bundy's salary: 100 hours * $35 per hour = $3,500
Next, we add the direct charges for travel, mailing, and postage:
Direct charges = $2,800
The total professional compensation and direct charges amount to:
Total professional compensation and direct charges = $4,400 + $3,500 + $2,800 = $10,700
To calculate the allocation of overhead, we need to determine the proportion of the total professional compensation charges that the Surenex engagement represents.
Total professional compensation charges for the year = $1,500,000
Professional compensation charges for the Surenex engagement = $10,700
Allocation of overhead = (Professional compensation charges for the Surenex engagement / Total professional compensation charges for the year) * Overhead costs
Allocation of overhead = ($10,700 / $1,500,000) * $450,000 = $3,210
Therefore, the expected full cost of the Surenex engagement, including an allocation of overhead, is:
Expected full cost = Total professional compensation and direct charges + Allocation of overhead
Expected full cost = $10,700 + $3,210 = $13,910
b. The lowest amount that Connie can bill on this engagement without hurting company profit depends on the minimum fee at which the company can cover its costs, including overhead.
YSL firm's normal fee is 1.5 times professional compensation, so if the Surenex engagement were charged at the normal rate, the fee would be:
Normal fee = 1.5 * Total professional compensation and direct charges
Normal fee = 1.5 * $10,700 = $16,050
However, Connie wants to quote a low fee for Surenex due to their cash-flow problems. So, the lowest amount that Connie can bill on this engagement without hurting company profit would be slightly higher than the expected full cost, taking into account a small profit margin. Let's assume a 10% profit margin:
Lowest billable amount = Expected full cost + (Profit margin * Expected full cost)
Lowest billable amount = $13,910 + (0.10 * $13,910) = $15,301
Therefore, the lowest amount that Connie can bill on this engagement without hurting company profit is approximately $15,301.
c. In deciding on a price for the engagement, Connie should consider various factors in addition to the amount calculated in (b). These factors can include:
1. The market rate for similar services: Connie should research and consider the prevailing market rates for similar surveys and marketing research engagements. This will help ensure that the price is competitive and reflects the value provided.
2. Client's budget and cash-flow constraints: Since Surenex has cash-flow problems, Connie should take into account their budgetary constraints and offer a pricing structure that accommodates their financial situation while still covering the company's costs.
3. Potential future opportunities from the client: Connie anticipates that Surenex will become a hot, big company in the future. Therefore, she may want to consider the long-term potential of the client and the possibility of securing premium billing opportunities in the future. Offering a lower initial fee might help establish a relationship with the client and lay the groundwork for future business opportunities.
4. Competitive advantage: Connie should also consider YSL's competitive advantage and the unique value proposition they bring to the table. If YSL offers specialized expertise or a track record of successful engagements in the high-tech industry, they may be able to justify a higher price compared to competitors.
By considering these additional factors, Connie can make an informed decision about the price to quote for the Surenex engagement, balancing the client's constraints, company profitability, and long-term relationship potential.