Harrington: Cost and Variable Costs
Harrington Case Analysis Issue Stagnant sales performance has caused Harrington Collection to explore new avenues for improved performance, including the launch of a new active-wear line. Recognizing an emerging trend of low price and rapid style turnover in the women’s apparel market, along with tremendous growth in the active-wear segment, Harrington needs to work strategically to capture this profitable market opportunity. After careful analysis, it was determined that Harrington should implement a new active-wear line. Financial Analysis
While doing the financial analysis it is important to calculate the unit price first. Using the wholesale price rather than the retail price, the calculated unit price is $95. Next, we sum up the start-up costs and operating costs, both fixed and variable, and use these numbers to calculate the breakeven units. After calculation, the breakeven point is 289,846 units. Appendix A shows the details of our process. Active-wear sales are expected to double by 2009, and 40% of those sales are expected to be classified as ‘better’ active-wear.
Assuming that Harrington Vigor maintains their 7% market share, we can deduce that Vigor can expect to sell 420,000 units of active-wear in its first year. Over half of all apparel purchased is sold “on sale. ” We accounted for these markdowns by assuming that half the units will be sold for full price, and the other half will be sold at a discount. A sensitivity analysis was conducted by calculating the discount rates at 20%, 40% and 60% separately. From Appendix B, we can see that even for the 60% discount rate, the profit margin is still up to 21%, which is quite attractive.
Therefore, Harrington has strong financial forecast to support its new launch in active-wear segment. Market trend After the economic downturn in the early 2000s, the trend of price-sensitive and more than 50% discount sales volume drive the mature market to a low-cost and outsourcing competition area. Thus, majority of apparel companies choose to outsource their production in low-cost labor areas such as China. Another trend is the fast growing needs for the superior styling, fresh, and fashionable active-wears. Quality strengths and Opportunities
Having established their brand in the1960s, Harrington became well known for its superior quality, knowledgeable sales staff, and designer styles. With fairly high loyalty customers, Harrington possesses premium brand reputation. In addition, donning Harrington labels represents an instant status upgrade and the cutting edge of fashion. Generally speaking, the active-wear market is a rapid growth field with a relatively small segment in the “better” category. In order to seize the opportunity for diversity in its marketshare, Harrington should enter the market as soon as possible.
Considering its brand influence and exceptional quality and styling, together with its cutting-edge technology, Harrington has a substantial opportunity to become a critical player in this profitable segment. Channel conflicts and Challenges By 2007 specialty stores and department stores are still the main retailing channels in the women’s clothing market. Department stores may benefit by the lucrative inventory turnover rate produced by Harrington’s extensive national advertising.
Alternatively, department stores could be weary of stocking the active-wear products since this is a relatively new market and could mean more risk for the retailers. Harrington will need to rely on their relationships with the retailers and expertise in marketing to diminish this potential conflict. From the survey, the possibility to cheapen Harrington’s brand is really trivial by launching a new active-wear line. Recommendation Despite the conflicts and challenges, Harrington has a significant opportunity to advance their business into the active-wear segment.
By upscaling the active-wear into the “better” category, Harrington could apply the comfort and fashion image which the Vigor division has already formed into the new segment. In addition, by outsourcing the production in Mexico, it can not only decrease costs, but also provide the possibility to respond more swiftly to changes in demand. With this in mind, it is strongly suggested that Harrington launches a new active-wear line. Appendix A Start Up Costs:| | | Start-up Costs (Pants Plant)| $ 1,200,000 | | Start-up Costs (Hoodie and Tee-shirt Plant)| $ 2,500,000 | | Equipment (Pants Plant)| $ 2,000,000 | Equipment (Hoodie and Tee-shirt Plant)| $ 2,500,000 | | Launch-PR, Advertising| $ 2,000,000 | | Fixtures for Company Stores| $ 2,500,000 | Total Start-up Costs | $ 12,700,000 | Annual Depreciated Start-up Costs | $ 2,540,000 | | | | Annual Ongoing Operating Costs-Fixed:| | | Overhead (Pants Plant)| $ 3,000,000 | | Overhead (Hoodie and Tee-shirt Plant)| $ 3,500,000 | | Rent (Pants Plant)| $ 500,000 | | Rent (Hoodie and Tee-shirt Plant)| $ 500,000 | | Management/Support| $ 1,000,000 | | Advertising| $ 3,000,000 | Total Fixed Operating Costs| $ 11,500,000| | |
Direct Variable Costs:| Hoodie| Tee-shirt| Pants| | Sew and press| $ 3. 25| $ 2. 00| $ 2. 85| | Cut| $ 1. 15| $ 0. 40| $ 0. 70| | Other variable labor| $ 3. 20| $ 2. 40| $ 3. 05| | Fabric| $ 9. 10| $ 2. 20| $ 7. 50| | Findings| $ 3. 85| $ 0. 50| $ 2. 30| Total Variable Cost| $ 20. 55| $ 7. 50| $ 16. 40| | | | | Direct variable costs translated into “unit” cost| Hoodie| Tee-shirt| Pants| | Total Variable Cost| $ 20. 55| $ 7. 50| $ 16. 40| | * measure| 0. 5| 1. 5| 1. 0| | Unit Cost| $ 10. 28| $ 11. 25| $ 16. 40| Indirect variable costs:| | | Wholesale “unit” price| $ 95. 00 | Total variable costs as % of wholesale price| 40%| Indirect variable costs per “unit”| $ 8. 64 | | | | | Direct variable costs per “unit”| $ 37. 93 | | Indirect variable costs per “unit”| $ 8. 64 | Total variable costs per “unit”| $ 46. 56 | | | | Contribution:| | | Wholesale price per “unit”| $ 95. 00 | | Less total variable costs per “unit”| $ 47. 00 | | Contribution per “unit”| $ 48. 00 | | | | Breakeven:| | | Fixed annual costs(operating and depreciated start up)| $ 14,040,000 | | Contribution per “unit”| $ 48. 00 | | = Breakeven Units| $ 289,846 | Appendix B
Unit Price = $95. 00, Unit Quantity = 210,000 * ((7,500,000 * 2 * 0. 4 * 7%) / 2) Profit Margin*| | | | | Discount Rate (40%)| Discount Rate (20%)| Discount Rate (60%)| Revenue| $ 31,920,000| $ 35,910,000| $ 27,930,000| less fixed annual costs| $ 2,540,000| $ 2,540,000| $ 2,540,000| less total variable costs| $ 19,555,410| $ 19,555,410| $ 19,555,410| Profit before tax| $ 9,824,590| $ 13,814,590| $ 5,834,590| Profit margin before tax| 30. 78%| 38. 47%| 20. 89%| * Assumes half of inventory is sold at full price, and other half is sold at subsequent discount rates. |