In order to improve their net income, Flores has suggested three options as follows. Option 1 is to increase the price to $1,000 per hour while reduce demand by 30%; option 2 is to reduce the price to $600 per hour while increase demand by 30%; option 3 is to increase revenue hours by up to 30% through increasing their promotion cost. Each option will affect net income in the following ways:
For option 1:
Profit 1 = 205 hours * $400 per hour + $1,000 per hour * (138 * 70%) hours – total hours (205 + 138 * 70%) * variable cost $28.7 per hour – total fixed cost $212,939= -$42,994.92 For option 2:
Profit 2 = 205(400) +600(138 * 130%)-(179.4 +205)*(28.7) -212,939= -$34,331.28 For option 3:
Profit 3 =205(400) +800(179.4)-(205 + 179.4)*(28.7) -212,939 = $1,548.72
In conclusion, for option1 and 2, both will decrease in net income. Option 1 will decrease net income by (-30,383) – (-42,994.92) = $12,611.82, and option 2 will decrease net income by (-30,383) – (-34,331.28) = $3,948.18. For option3, net income will increase to a benefit amount. If the promotion expense is equal to or less than 1548.72, this option should be taken consideration. On the other hand, if the promotion expense exceeds 1,548.72, the net income will turn into negative. However, as long as it is more profitable than -$30,383, option 3 is the optimal choice.
Since option 1 and 2 make their net income even worse and option 3 requires them to spend very little on promotion, there is a suggestion to close SDS instead of keeping it. However, if they close SDS, the change in their net income will be:
They will save costs in maintenance, power, and so on, but they will lose the rent profit $8,000 if there is no other company rents that floor. Besides, they need to outsource and the outsourcing cost will be 205 hours * $800 per hour = $164,000. Therefore, as it is shown in Exhibit 5, their extra cost of closing SDS will be $94,356. If they don’t rent the place to other companies, they will suffer more loss than keep SDS. As a result, they should keep SDS instead of closing it.
What they can do to make their income better is to use option 3, which is to increase commercial revenue hours by up to 30% through putting more money on promotion. This may be unrealistic because if we look into their promotion cost in March, we find out that they spent $8,083 (increased 15% compared to February) on promotion and they increased commercial revenue hours by only very few percentages (only roughly 2%). In order to control their increase in promotion cost fewer than 1548.72, they need to increase only roughly 20% of promotion costs to reach a 30% increase in commercial revenue hours.
Assume the relationship between promotion costs with commercial revenue hours is what we observed in February and March (15% increase in promotion cost brings an 2% increase in commercial revenue hours), they need to increase (30% / 2%) * 15% = 225% in promotion costs, which would be 8083 * (1 + 225%) = 26,270. Under this assumption, net income of choosing option 3 will turn out to be 1548.72 – 26,270 = -24,721.28. Still, option 3 would bring them least loss and it is the optimal choice.