Generation of Options
- Expand, hence open retail store in new shopping mall in Wardlow by taking loan from bank.
- Specialize in standard sound system like Stan’s Sounds.
- Specialize in components and custom designed system like Cen-Tex Audio Sounds.
- Don’t expand right now, hence not open new store in Wardlow and take measure to minimize operating expenses hence improve net profit and liquidity ratio of current stores, so as to be in better position for expansion in future.
Evaluation of Options
Market Analysis of Wardlow for expected market share and sales required
Assumptions:
-
Within a region (here Texas) a city with lower population has living standard or median household EBI lower in comparison to city with higher population.
The above assumption implies that within a region Total Effective Buying Income (EBI) is upper bounded by linear proportionality to the population.
Hence, total EBI of Wardlow is at most 1/4.6 (population ratio) times that of Westville.
- Total retail sale is directly proportional to total EBI.
- The expansion is a good choice if the expected profit is of the order of profit achieved by already existing store. Essentially what this implies is the use of profit by one of Stain’s Sound store in Westville as the benchmark for evaluation of the expected profit by new store in Wardlow.
- For the profit evaluation cost incurred and other expenses are assumed to be same as that of Stan’s Sound in Westville.
Average case scenario
Median household EBI of Wardlow is less than that of Westville; hence total EBI of Wardlow is strictly less than 1/4.6 (population ratio) times that of Westville.
The market share of new store in Wardlow should be at least 4.6 times that of the Stan’s Sound market share in Westville in order to generate the profit of same order. Assuming additional expanses of startup (traveling etc) and 15% discount on rent balances each other. This means that the least market share gain factor of 4.6 has to come from the competition advantage offered by the trade area and the shopping mall.
Since median EBI of Wardlow is less compared with Westville, demand for quality audio components and custom designed systems (higher price) would be less in comparison with Westville. Therefore standard sound system will be safer option to start with.
The above analysis shows that for expansion to be a success competitive advantage must increase market share in Wardlow significantly compared with current market share in Westville.
Current financial position of the business for expansion
After analyzing the various opportunities associated with the location and various expectations, situation come down to whether the business is in position to invest or not?
The business has only 7% of cash compared with total asset. 74.2% of assets are in the form inventory. Current ratio (Current assets / Current liabilities) is 2.04 and Quick ratio (remove inventory from current assets) is .26. This shows that at the moment business is too much dependent on inventories. Previous year (1976) these figures were much better. The reason is investments in Cen-Tex Audio. See Exhibit I for exact figures
From the previous two expansions (Northtown Shopping centre and Cen-Tex Audio) it could be found out that on an average investment of 22000$ is required for the expansion. It implies that generation of cash for investments in new store would be one of major problems. Bank or other loan is one option, but already leverage ratios (Debt-to-assets ratio) are very high (42%).
The business has low profit margins as shown by low return on sales (7 to 5%) but the return on total assets is good (28 to 19%), this shows that on investment business is capable of generating cash.
Though, retailer has much more discretion in setting prices on components and custom designed systems but the 2 months return figure from Cen-Tax Audio is not very encouraging in fact both it’s gross profit margin and return on sales is less compared with San’s sounds figure for the year 1977. But, the larger amount of sales (in 2 months) for Cen-Tax shows it’s potential to grow at significant pace on investment.
To conclude because of the Cen-Tex Audio expansion most of the figures are in decline compared with 1976, so back to back expansion at this point of time could turn out to be really costly affairs due to low operating profit margin for covering interest charges that will accrue from the capital structure after expansion. Meanwhile, the current stores also require investment for recovering with the declines.
Decision Making
Financial analysis clearly shows that right now business is not in good position to make investment in unknown territory. Also, considering average case scenario of the market analysis of Wardlow shows that market may not be good for custom designed systems and the success is very much dependent on capturing large market share.
So based on criteria and constraints mentioned above right now final decision has to “Not open new store in Wardlow and take measure to minimize operating expenses hence improve net profit and liquidity ratio of business, so as to be in better position for expansion in future”.
The Action Plan
- As concluded by financial analysis that despite low return on sales the return on total assets is good (28 to 19%), hence there is need to invest more to generate more asset, hence more return.
- To improve merchandise buying procedures for reducing operating expenses go for common inventory control system.
- Invest more in Cen-Tex Audio Centre because of rapid developing market for quality audio components. This is supported by the encouraging result obtained by Cen-Tex Audio in last 2 months of 1977 average profit of $1131 per month compared with $950 per month by one of the Stan’s Sound store.
- The aim is to expand business in the next year, 1979 depending on the performance of Cen-Tex Audio and market response to customized products.
Contingency Planning
- Market analysis of different cities in Texas to explore various possibilities for expansion.
- More creative ideas like customized designed system to make product according to test for the customer.
- Possibility of franchised outlet could also be explored while deciding on expansion.
Exhibit 1 Stan’s Sounds and Cen-Tex Audio Centre financial analysis
