Company is a business division of a mid-sized company focused on manufacturing and selling a high quality consumer electronic device through high-end marketing channels such as specialty shops and exclusive department stores. These specialty outlets advise and educate customers about the desirable features of different electronic devices. Elektra charges on average 500 per unit to its distributors, who mark it up to 899 when selling to retail customers. After many years of high sales, Elektra sales in the last year had slumped to 150,000 units per year using only 75 of its manufacturing capacity.
The decline in demand was because of fast changing technologies and consumer habits, and the recent introduction of a new generation of the electronic device had not increased sales appreciably. Consequently, Elektra senior management believes it is unlikely that the demand for its products will increase significantly in the next three years until conditions improve substantially and Elektra and its high-end competitors introduce the next generation technology. Nonetheless, they remained confident about the long term prospects of their product.
Elektra has recently received a proposal from Megawatt Stores, Inc. A leading national chain of discount retail stores. Megawatt wants to buy Elektra product of the same quality as that sold at present through specialty retailers. Megawatt has offered to purchase 50,000 units annually for a three-year period at 374 per unit. It cannot pay a higher price because it plans to retail the product at only 549. While costs are not expected to increase, an inflation clause will allow Elektra to pass on exogenous cost increases.
After extensive negotiations, Megawatt has made a take-it-or-leave-it offer and threatened to explore other strategic partners n case Elektra does not accept its offer. Although Megastars offer is 25 below Elektra normal price, it may be attractive for Elektra to be an early mover in the low- end market because Elektra has considerable surplus capacity, and the Megawatt contract may allow it to accumulate experience in what may emerge as the dominant segment of the market.
Elektra variable product costs for sales through its present high-end distribution channel are estimated to be 300, including direct materials 150, direct labor 60, variable manufacturing overhead 70, and sales commission 20 at 4 of sales price. Annual fixed overhead costs are 17,000,000, and are not expected to increase with the increased production required if the Megawatt offer is accepted. By scaling down to a capacity of 150,000 units from the present 200,000, however, Elektra would be able to save about of the annual fixed costs.
Variable costs for the Megawatt order are expected to be similar. Direct material costs, however, will increase by 10 because of special casing and packaging with embossing of Megastars private label logo instead of the Elektra brand name. Also, variable costs for the Megawatt order will exclude the 4 commission normally paid to the ales staff because no salesperson is involved in sales to Megawatt. Some Elektra executives are concerned that when customers comparison shop they will find the same quality device as Elektra own brand name product sold through specialty retailers.
If the devices are available at a much lower price at Megawatt Stores, many price conscious customers may buy the devices at Megawatt instead of the specialty retailers. Elektra senior managers are very confident that no more than 6 of Elektra present sales will be lost because of the comparison shopping if Megastars proposal is accepted. Comparison shoppers are price conscious customers who shop around to find the cheapest product with the requisite level of quality.
Most of Elektra customers are quality enthusiasts who visit only the specialty shops to evaluate the features of different products, rather than the price, before making their purchase decision. Elektra top management is more concerned about these quality enthusiasts but does not believe any of them would shop at Megawatt. If 6 of Elektra high-end channel sales are cannibalized, total sales will be 191,000 units including 50,000 units sold through Megawatt, but no reduction will be possible in axed costs.
Another group of Elektra executives is concerned about selling at a discounted price the same quality products as the products sold at present through specialty retailers, and the impact that such a move will have on the special relationship that has been cultivated with the high-end retailers. These executives believe that sales may decrease if the specialty retailers do not push the Elektra brand product as much as its competitors products. Megawatt has insisted on nothing but the best quality product that Elektra sells at present through the peculiarly retailers, and will withdraw its offer otherwise.
New technology is developed by Elektra(and also its competitors) on a three-year cycle to increase the value of the product to high-end customers. An alternative considered by Elektra is to invest more on RD immediately and bring the new technology to the market within a year. The fixed and variable cost structure is not expected to change significantly for the new Reproduced with permission from the faculty product that incorporates the new technology. Some Elektra executives are concerned that accelerating the RD may exult in more defects creeping in the product and some complementary products provided by other suppliers not being ready.
This increased the risk of customers being dissatisfied with the new generation and hurts Elektra reputation. However, because the new product will likely be substantially more useful to the high-end customers, Elektra could replace the existing product with the new product in the specialty retail channel. By accelerating the new technology, Elektra is not likely to gain significant market share in the specialty channel as competitors will try and attach Elektra technology as soon as possible by introducing their new models with the new technology early.
Required What will be the annual profit if the Megawatt offer is rejected What will be the increase or decrease in its annual profit if it accepts Megastars offer Should Elektra accept Megastars proposal What strategic factors should be considered in evaluating the Megawatt offer Should Elektra agree to having its product branded as a Megawatt product and incur the additional 10 increase in direct materials cost How attractive is the potential opportunity to accumulate experience in the low-end market through the proposed strategic alliance with Megawatt Should Elektra accelerate the development of the new technology and bring it to market within a year Is there a difference between the sales lost due to centralization of price-sensitive customers and the sales lost because specially retailers may no longer push Elektra products if Elektra accepts the Megawatt offer Reproduced with permission from the faculty September 2012. Professor Rajah D. Banker prepared this case to provide a basis for class discussion.