Factors to consider before pursuing a supply arrangement Flashcards
operating capacity
is this realistic?
Would it not impact the quality of the final product?
What will the impact be on repairs and maintenance.
DMG will not be able to take on any other (potentially more lucrative) offers if this contract is taken, as it will be at close to capacity
consider any relevant opportunity costs, for example the strategic expansion into Mauritius.
Does DMG have sufficient resources to fund the additional investment that will be required to
increase production from 40 000 to 100 000 units including the increased working capital
requirements, raw materials availability etc.
The current selling price of R199 per bottle is a wholesale price. DMG will be reducing its selling
price per bottle from R199 to R189. The fact that YupD want to sell direct to the public at R189
will definitely create a problem with the current business model. Will other customers insist on
lower prices too?
In the longer term, would existing customers switch to buying online, thereby cannibalising
current revenue?
Consider the long-term sustainability of YupD, especially given stiff competition from other online
websites such as Takealot (with an established brand name) and monthly wine clubs.
There is a reputational risk of being associated with YupD – if YupD’s credibility is tarnished for
whatever reason, DMG could be at risk.
Alt. DMG is a new and small company who could benefit
from the reputation of YupD
Risk relating to annual renegotiations of the selling price – unless there are certain set standards
in the contract, YupD could raise or lower the selling prices at will and DMG will have no control
over the process.
No mention is made of whether or not YupD also sells other gins – DMG should consider what
exclusivity would cost them.
DMG will derive the majority of its profits from YupD (R3,097m versus R0,567m previously).
There is a risk that DMG will become overly dependent on YupD and place it at risk should the
contract be terminated.
Alt. Entering into the agreement with YupD provides DMG with the
opportunity to significantly increase its profits.
YupD is insisting on a 20% sales commission, which is double that paid to the independent third
party and there is an additional R15 000 monthly fee.
Alt. Paying a 20% sales commission,
although it is double the existing sales commission, is worth it given the increase in profits that
are expected to arise from the YupD agreement.
Will DMG be under pressure to pay higher commissions to current and any future sales
channels?
How reliable are the forecast revenues and costs with regard to the YupD initiative - the increase
in EBIT margin is considerable (7.1% vs 19%) and could be a result of inaccurate forecasts? The
quantitative factors could lead to incorrect decisions being made
Is the demand for 60 000 bottles realistic and supported by a feasibility study, especially given
that the company was only founded in 2017; the current demand is only 40 000 bottles; and there
is lots of competition in the market
Why does YupD need R500 000 for advertising? It will be earning more than R2,2 million in
commission – surely they should invest in their own advertising of DMG products? Alternatively:
what guarantees are they giving that advertising and promotions will be done / what does the
contract specify (e.g. two emails per week…?)
How much would it cost DMG if it wanted to extricate itself from the contract after a year (or two)?
Any penalty payments?
The shift from B2B to retail is a large change in DMG’s business strategy. For example, a more
complex order fulfilment and returns process will be required; distribution of smaller volumes on a
more frequent basis may change the distribution and courier costs; and It may change the amount
of warehouse and storage space needed, and the attendant costs.
DMG will be required to carry all the inventory risk and given the significant increase in production
levels, inventory levels are likely to increase significantly too thereby increasing inventory risk
To date, DMG has sold to wholesalers and retailers and now it will be selling directly to customers
(potentially individuals): DMG should consider whether there are any laws it needs to comply with
or licences it needs to obtain with regard to this change in the distribution system.
DMG need to explore the terms of the agreement in more detail. For example, who will receive
the payment from customers? If its YupD, when will it be payable to DMG? If it is DMG, when will
the sales commission be paid over to YupD?
The agreement will have a low break-even point given the relatively small increase in fixed costs
in comparison with existing fixed costs and the increase in contribution per bottle
summary
Production capacity
Pricing
Reliance on YupD
Sales commission and subscription fees
Accuracy of forecasts
Advertising budget
Contractual and regulatory considerations
Strategic and risk considerations
Operating leverage
