Using fixed cost as a competitive business strategy
The following income statements illustrate different cost structures for two competing companies.
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Income Statements |
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Company Name |
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Vector |
Sector |
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Number of customers (a) |
70 |
70 |
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Sales revenue (a x $200) |
$14,000 |
$14,000 |
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Variable cost (a x $160) |
N/A |
(11,200) |
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Variable cost (a x $0) |
0 |
N/A |
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Contribution margin |
14,000 |
2,800 |
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Fixed cost |
(11,200) |
0 |
|
Net income |
$2,800 |
$2,800 |
Required
a. Reconstruct Vector’s income statement, assuming that it serves 140 customers when it lures 70 customers away from Sector by lowering the sales price to $120 per customer.
b. Reconstruct Sector’s income statement, assuming that it serves 140 customers when it lures 70 customers away from Vector by lowering the sales price to $120 per customer.
c. Explain why the price cutting strategy increased Vector Company’s profits but caused a net loss for Sector Company.