Hair Impact

Samantha Wakeham became the owner of Hair Impact in 1991, a business which manufactures and markets hair accessories within St. John's and Mount Pearl. The company had been somewhat successful in the past two years and Samantha was seriously considering expansion in the near future. Samantha was offered a business proposition in April 1993 by a local businessperson, Mr. Jamie Campbell, the owner of a local exercise spa Healthy Living. Jamie was interested in marketing Samantha's products at the spa on a monthly basis. Samantha was definitely interested in Jamie's offer; however, she was concerned about her ability to supply her hair products to the spa at a profit. Jamie, being aware of Samantha's concerns, offered Samantha three choices. Samantha had to determine which, if any, of the choices were profitable and which offer provided her with the largest profit. Samantha was forced to seriously review her total costs and prices of her hair products and the potential profit before she could accept any one of Jamie's offers.

Background Information

Hair Impact had been supplying hair accessory products to a limited market for the past two years. Samantha Wakeham, a first year university student, established the hair business in 1991, during grade 11 high school to save money for her university education. She was selling three types of hair products: scrunches, clips, and headbands. As it currently operated, Hair Impact was a small scale operation, however Samantha was interested in expanding. Jamie Campbell approached Samantha about selling her hair products in the spa after being informed by a friend that Samantha was a hard-working individual who was interested in expansion.

This case was prepared by Heather Ross for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management. Material in this case has been disguised.

Copyright 1993, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.

The Business

As the sole owner and only employee of Hair Impact, Samantha was responsible for all of the company activities. She commenced the manufacturing and marketing operations with her own personal funds and she worked long hours to manufacture the hair accessories. Each of the products required approximately the same amount of time to manufacture, about 25 minutes per unit, with most of the work done on a sewing machine. The sewing machine used was rented for $25.00 a month. Other fixed costs included business cards, $7.50 a month, and a glue gun, $2.00 a month. Fortunately, Samantha worked from her home and did not incur space rental expenses. In addition to these fixed costs, variable production costs which consisted of labour and materials were incurred. These expenses, both fixed and variable, plus Samantha's desired profits, had to be covered by the prices charged for the hair products. Exhibit 1 outlines the actual production costs and product prices in detail.

Samantha conducted market research to determine the types and prices of hair accessories available in the market. From this research, she decided to manufacture clips, headbands and scrunches. Her products were available in all colours; however, the dimensions of the products were restricted. Samantha focused on the quality of her products, because she knew that the existing products in the market were of poorer quality. The prices she set were comparable to the prices she observed while conducting the market research and ranged from $3.75 to $4.50 per unit. With comparable prices, Samantha competed within the market according to the quality and the availability of various colours of her products.

At present, the products were manufactured and sold at a total cost that provided Samantha with a reasonable return. Her main concern now was whether she should consider Jamie's offer and how to adequately analyze each option, given that her objective was to achieve the maximum available profit from the venture. Samantha was uncertain of the analysis she should perform. Although she had recorded all of the related prices and costs of each product (Exhibit 1), she did not know how to determine which offer, if any, was the most profitable.

According to Jamie's offer, the products would be sold on consignment in the spa. This meant that if the products were not sold, Samantha would have to take the products from the spa and sell them elsewhere. This was not a concern to Samantha because the spa catered to approximately 5,000 women. From an analysis of a survey completed by the women at the spa, Samantha concluded that approximately 3,200 women could use her products. In addition, she calculated that an average of 225 units could be sold monthly. The clients were indifferent to the type of products sold in the spa according to the survey, which provided Samantha with the flexibility to choose the products she wanted to give to Jamie. To ensure that all products were sold, Samantha used a more conservative estimate of 150 units sold per month. If this estimate was correct, Samantha would be selling an additional 1800 units during the year. She felt this achievement was reasonable with over 3,000 women interested in the products. If Samantha accepted the order she estimated that her work would increase by approximately 16 hours a week. These increased hours could be achieved easily. As a result, Samantha's main concern was determining the profitability of each offer and deciding which offer to choose.

The Problem

Samantha provided all of the cash that was invested in the company; however this capital was restricted. In addition, she was reinvesting some of the earned profits back into the operation. Consequently, she was not receiving enough profits to fund her university education. Therefore, it was critical that the offer, if accepted, would not result in Samantha losing money.

Originally, the hair products had been sold to family and friends. This escalated into individuals approaching Samantha to purchase hair products. As a result of this demand, Samantha setup a display area in her home where she frequently displayed products to potential customers. The market that she catered to, however, was restricted. Therefore, the company was successful only on a small scale. With low sales volume, Samantha was unable to receive profit at the level which she desired. If she accepted the offer, the increased sales volume of 150 units monthly would boost sales to a level where she would make slightly more profit than she had planned. She was in a situation where she wanted to expand into the spa market that Jamie was making available to her, but she did not want to lose money in the process. Samantha had to determine which, if any, of Jamie's offers was the most profitable.

Jamie was willing to offer Samantha a choice of one of three options to sell her products in the spa. The three options were as follows:

  1. He would charge Samantha a fixed monthly service fee of $120.00 to sell 50 clips, 50 headbands and 50 scrunches (150 items) in the spa;
  2. He would charge Samantha a monthly variable service fee of 25 percent of earned revenue from selling 50 clips, 50 headbands and 50 scrunches (150 items) in the spa, [variable fee=0.25*(Price per unit)*(# of units sold)]; or
  3. He would charge Samantha either the fixed service fee in Option 1 or the variable service fee in Option 2, however Samantha could choose the number of each product. With 150 units of either clips, scrunches or headbands, it was Samantha's choice how many units of each product she would sell in the spa, i.e. one choice could be to sell 150 clips and zero headbands and scrunches, or another choice could be to sell 70 clips, 55 headbands and 25 scrunches.

The service fee was for Jamie's assistance in the operation of her company through the promotion of the products in the spa. Jamie's service fee for the three offers consisted of fixed, variable, and either fixed or variable service fees, whichever Samantha preferred.

Samantha had to review the prices and costs included in Exhibit I to determine which of the options resulted in the greatest profit for the company. Samantha would answer the following questions to determine the profitability of the three options.

Study Questions

  1. Using the data in Exhibit 1:
  1. Calculate the monthly service fees that Samantha would have to pay Jamie under Option 1 and 2, assuming that Jamie will sell 50 scrunches, 50 clips and 50 headbands.
  2. Considering the service fees from the previous question, which service fee option should Samantha choose; Option 1 or Option 2? What is a drawback of this option?
  3. Jamie's service fee for Option 3 is either the fixed service fee in Option 1 ($120.00) or the variable service fee in Option 2 (25 percent of earned revenue). Calculate the variable service fee if Samantha provides Jamie with:
  1. 150 scrunches;
  2. 150 clips;
  3. 150 headbands.

Note: The variable service fee is calculated as 25 percent of earned revenue. Earned revenue is calculated as: (Price per unit)*(# of units). Since each product had a unique price, each will consequently have a different revenue and variable service fee. How does each situation compare with the fixed service fee of $120.00?

  1. Rank the various service fees included in part a), b) and c) from the lowest to the highest.
  1. a) Once Samantha determined the fixed and variable service fees of the various options, she could begin to analyze the options with respect to profit. Calculate the profit that Samantha would receive if she accepted Option 1. Note: Profit=(Price-Variable costs)*(# of units) - fixed costs - Jamie's service fee

b) Calculate the profit that Samantha would receive if she accepted Option 2.

c) If Samantha had to choose between Option 1 and Option 2, which option would she choose?

  1. a) Option 3 provides Samantha with the opportunity to choose what type of product to sell in the spa. Therefore, Samantha should determine which product would provide her with the largest profit. One method to determine how much revenue must be realized to break even is the breakeven point. The breakeven point is the number of products she must sell so that revenue earned equals costs. Any units sold above the breakeven point contribute to profit. It can also be defined as the amount of revenue required to recover both fixed and variable costs. Any revenue earned above the breakeven point is profit. The breakeven point can be calculated using the contribution margin method. This method consists of the following three steps:
  1. Calculation of Unit Contribution Margin:
    Unit Sales Price - Unit Variable Costs
  2. Calculation of Breakeven Point in Units:
    Total Fixed Costs / Unit Contribution Margin
  3. Calculation of Breakeven Point in Sales Dollars:
    Breakeven Point in Units * Unit Sales Price

Calculate the breakeven points for the three scenarios presented previously, i) 150 scrunches, ii) 150 clips or iii) 150 headbands. The lowest service fee paid to Jamie, calculated in question 1a), should be used.

b) The breakeven point calculated in part a) indicates the amount of sales earned or units sold that must be generated to break even and cover variable costs, fixed costs and the service fee. Therefore, Samantha would be interested in providing the product that had the lowest breakeven point since this would require the least amount of sales earned or units sold to generate a profit. What product should Samantha provide to Jamie to sell in the spa? How much profit will she receive, assuming all 150 items are sold?

Exhibit 1

Hair Impact: Production Costs and Product Prices