This solution will look at the concept of profit and business model strategy using simple terms, and a business example with 4 different scenarios. The solution will walk the student through a sole proprietorship that develops into a corporation and starts to grow its business. Different factors will be reviewed, such as variable costs (material inputs) and fixed costs, as well as production targets, strategy, and diversification of the products customer base. The solution intends to show the student how a business owner has to seriously consider its cost and revenue strategy to determine the daily profit and the yearly profit and verify whether the business model works for the business.Explaining the concept of profit and strategy through a small business exampleAs a business manager or owner, determining whether you should pursue a business strategy is centered around maximizing profits (revenues – costs). In these four scenarios, the cost and revenue strategies are evaluated, and provide the reader an idea into the factors that should be considered when determining a companys business model.Scenario 1: Stone, Jessica (Sole proprietorship that sells flower pots)Imagine you are running a small sole proprietorship in the home décor industry. Your sole product line is customized flower pots (with unique engravings). On average, you produce 5 flower pots a day. The selling price for each flower pot is $30. You are a first-time business owner, and putting in a lot of your personal investment into this venture. You can afford to take a wage cut and initially make a $8/hour wage ($64/day). The cost of making each flower pot is $10. In addition to the costs of making the product, your business other costs (fixed costs, i.e. overhead), which include rent, electricity, Internet, and expensive accounting software, is a total of $20 per day. In this scenario, your companys daily profit is:P = (30×5) – (64+50+20) = 150 – 134 = $16(Note: Your wage is $64/day and the material inputs to make 5 pots are a total of $50/day)Using the assumption that you work full-time for 5 days a week and for 50 weeks each year, your business yearly profit is $4000.Scenario 2: Stone, Jessica decides to expand productionIn addition to running your flower business, you formerly ran a nightclub business. However, you have now decided to cut this evening venture out of your life and focus only on the flower pot making business. You have some more time on your hands and- through learning the skills of the trade- and will now produce 3 more flower pots above your previous daily targets. This entails a production of 8 flower pots per day. To reach this target, you plan to work 12-hour days, but to accommodate for these extended hours, you decide to increase your wage to $9/hour ($108/day). The selling price for each pot remains at $30, and the cost of making each flower pot is still $10. You are paying $20/day in overhead as before. In this scenario, your companys daily profit is:P = (30×8) – (108+80+20) = 240 – 208 = $32Using the assumption that you work extended hours (12 hours/day) for 5 days a week, and 50 weeks a year, your companys yearly profit is $8000. In this case, by increasing production, despite an increase in labor costs due to working extended hours at a higher wage rate, you have boosted your companys profits significantly (100\% increase from Scenario 1).Scenario 3: Stone, Jessica restructures to Ms. Flower Pot Inc. due to increased demand in the UKYou go to a trade show and encounter significant demand for your customized flower pots from multiple UK gift shops. Afterwards, you are sent 3 orders for your products, with an indicated interest of 80 flower pots-to start- for each of these 3 gift shops in London, UK. This would mean a shipment of 240 flower pots in a very short period of time (one week), which would have been a full month of labor for you working at 12 hours/day (see Scenario 2). Plus, if each of these 3 gift shops are satisfied with their initial 80 flower pots, then they may continue to order more flower pots every week. In addition, you also have interest from at least 20 other gift shops in the Netherlands and in Germany. To take advantage of this foreign demand, you must expand your business, hire more people, and raise a sizeable inventory to fulfill these current orders and be ready for future orders. Hence, you incorporate your company and hire 9 people full-time. There is a total of 10 people employed by your company (including yourself) who are now working 8 hours per day at a rate of $10/hour. You have increased the wage as you can afford to, given that you will have larger orders coming in. Plus, your company is in a growth phase and needs to attract talented employees to work on the customized products. In terms of production targets, as initially set up (Scenario 1), each employee produces 5 flower pots each day (summing 50 pots). Nevertheless, the flower pots selling price is higher at $40, with the same material input cost of $10 per pot. Daily fixed costs are substantially larger due to more electricity and Internet being used, with a larger rental space to pay for. In this case, the new daily overhead is $40 per day. In this scenario, your companys daily profit is: P = (40×50) – (800+500+40) = 2000 – 1340 = $660Using the assumption that each employee works 8 hours/day for 5 days a week, and 50 weeks a year, your companys yearly profit is $165000. In this case, by massively increasing production and employing more people to respond to foreign demand, your strategy has paid off. In fact, the yearly profit growth from Scenario 2 is almost an astounding 1963\%!Scenario 4: Ms. Flower Pot Inc. considers doubling production due to increased domestic and foreign demandThe foreign business is reaping benefits for your company and you are looking to expand your presence domestically and into new markets abroad. You encounter some interest from a few gift shops in your local area, as well as in Asia; however, these new orders request further customization and detailed engravings on your flower pots. This would mean an increase in variable costs (material inputs) for each flower pot. Also, the complexity of these revamped flower pots would inevitably come with a demand for a higher wage from your employees. In addition, you would certainly need to hire even more employees at this heightened wage due to respond to a doubling in production.With this in mind, you sit down and make a quick business model. Tentatively, if you were to increase to a total of 20 employees (including yourself) producing an average of 5 flower pots per day, that would be a production count of 100 pots/day. The increase in the pots selling price is incremental this time, and would only rise by $5 ($45/pot). With 20 people working at 8 hours a day, at a higher wage of $12/hour, this would be a daily wage cost of $1920 for the business. In terms of the variable cost to produce the detailed flower pot, the original $10 would rise to $15 per pot. For this scenario, the daily overhead costs would remain the same ($40/day) as you predict to be using the same location and you have already maxed out the amount of electricity and Internet you would be using.Thus, with these modifications (keeping the rest of the parameters the same as Scenario 3), your business daily profit would be:P = (45×100) – (1920+1500+40) = 4500 – 3460 = $1040Using the assumption that each employee works 8 hours/day for 5 days a week, and 50 weeks a year, your companys yearly profit is $260000. In this case, by massively increasing production and employing more people to respond to foreign demand, your strategy has paid off. You would have doubled your workforce and doubled your production targets from Scenario 3; however, your yearly profit would have only risen by 58\%, a significant decrease from the previous growth between Scenarios 2 and 3. Perhaps it is time to start asking yourself, is this investment worth it? As you start to produce more and increase your costs, the growth may start to decline. It is key to always look at your bottom line and see whether it is worthwhile to increase your input, given your revenue and cost strategy.
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