January 29, 2013

Kaley's Knits: The Profit Problem

Remember the profit and loss statement?

Look at the fixed costs line.  Fixed costs are increasing at a fast rate, from $3.5 million in 2010 to $3.7 million in 2011 to $4.2 million in 2012 ... a 20% increase in just two years.

The increase in fixed costs puts pressure on the entire profit and loss statement.  We know this by looking at the variable profit line.  In 2012, $5,654,610 of variable profit was generated.  In 2011, $5,616,541 of variable profit was generated.  Basically, the number is the same, right?  Kaley's Knits is generating the same amount of profit, prior to fixed costs, in 2012 as in 2011.

We have a business that has several fundamental problems.
  1. Fixed costs are growing faster than top-line demand/sales are growing.
  2. To partially account for this problem, Management decided to slash the marketing line in 2012.
  3. Consequently, new customer acquisition dried up, putting even more pressure on top-line demand/sales.
  4. Management tried to "squeeze more out of the lemon", by increasing price points.
  5. Customers responded, somewhat, by buying more expensive items, at the expense of other metrics (orders per buyer per year, items per order).
  6. Management responded by countering increases in price points with discounts/promotions, which caused a slight increase in orders per buyer per year.
Management had a healthy business with a satisfying mix of new and existing buyers, purchasing at reasonable price points.

Management traded this for a less healthy business, one being starved of new buyers, one of existing buyers being asked to pay more for items, then being given discounts and promotions to encourage the customer to come back.

Assuming that fixed costs remain flat, or continue to grow, what prescription would you write to fix this business?  Use the comments section to describe how you, the prospective CEO, would approach further diagnosis of business problems and ultimately how you would fix this business?

Discuss.

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