Sheridan Carpet Company

© 1996
ISBN 0-538-88992-6

Case Teaching Package
A case teaching package is available for this case. It includes strategies for case presentation, key concepts, solutions to the assignment questions in the case, and suggestions for the most effective ways to work this case into your course.

Length
This case is 4 pages in length and its case teaching package is 8 pages.

Abstract

This case is set in the automotive carpeting business in 1983. The issue is cost analysis for pricing.

The major "message" in this case is practice in the uses and the pitfalls of contribution analysis. Product level marginal contribution information has gained widespread popularity in cost accounting textbooks as the basis for so-called "short run decision making." It has come to be seen as the correct way to assess the profit impact of day to day pricing and product emphasis decisions. Since the fixed costs of operating the company do not change in the short run as the volume or product mix change, the "correct" approach to maximizing profit is to maximize marginal contribution. This argument is absolutely correct at a conceptual level. At a practical level, however, given an intensely competitive market place, we have come to the conclusion that marginal contribution becomes little more than a convenient excuse to charge lower prices, which all too often fail to generate an acceptable level of return on investment for the firm as a whole.

Linkages to Textbooks or Journal Articles/Fit Within a Course

We teach this case in one 90-minute class period very early in the term. The case discussion will easily fill a full class if time is allowed for students to pursue all of the twists and turns of the analysis.

We start with a "cold call" on question 1 which typically yields the marginal cost analysis shown in the Teaching Note. At Tuck, our students are already steeped in incremental analysis from earlier courses by the time the managerial accounting course starts. We don't have to "teach" incremental costing.

Even if some students start with a "full cost" framework for question 1, it is our experience that most students will reject it in favor of the "contribution" framework. Particularly when this case is used early in the term, the discussion of question 1 is a good chance to cover the basic ideas on variable vs. fixed costs and on allocation of fixed costs to products.

Study Questions

1. Assuming no intermediate prices are to be considered, should Sheridan price 104 at $3.90 or $5.20?
2. If Sheridan's competitors hold their prices at $3.90, how many square yards of 104 would Sheridan need to sell at a price of $5.20 in order to earn the same profit as selling 150,000 square yards at a price of $3.90?
3. What additional information would you wish to have before making this pricing decision? (Despite the absence of this information, still answer Question 1!)
4. With hindsight, was the decision to raise the price in January of 1982 a good one?