Generate a breakeven analysis and a margin of safety analysis for Chicken Sensations

The Opportunity

Richard Larson was excited about the challenge of improving PFVC’s profitability.  He just completed the difficult task reorganizing and consolidating PFVC’s office in Sturgeon Bay with several long-term, highly-valued employees from the individually acquired vegetable companies no longer being severed.  His assembled team in Sturgeon Bay was ready to tackle the task at hand.  Several months ago, Carlos Rico, a marketing manager approached him with an innovative new convenience food product idea combining frozen vegetables, spaetzels (a coated seasoned pasta), and chicken in the same bag. It was designed to compete against other convenience foods such a frozen pizza.  Based on preliminary analysis, the new product represented a potential homerun for PFVC with company sales expected to increase by 20 percent and predicted gross margins nearly double the current vegetable offerings.  While the potential for this new product was palpable, Richard was a realist given PFVC’s history of new product introductions. The latest was Soup-in-a-Flash—a microwaveable soup starter kit introduced by PFVC’s predecessor Anchor Vegetables that failed miserably.  It ended with the write-off of $10 million of unsold finished goods, packaging and manufacturing lines during the company reorganization. This represented half of the company’s profits from the prior year and served as a painful reminder to Richard of the team’s challenge.  As a result, Parson Company executives were cautious and not enthusiastic about investing in another PFVC new product even though the management team associated with Soup-in-a-Flash was no longer with the company.  Richard mused, “If this new product fails, my tenure as the CEO of the largest vegetable company in the United States may be short-lived.”  Failure was not an option. 

The Team

Richard decided to assemble a cross functional team of PFVC’s best sales, production and financial professionals to pursue this apparent golden opportunity of a new, healthy frozen convenience meal.  Richard addressed the team, “Congratulations and welcome.  You have been selected to participate in potentially the most important new product initiative in PFVC’s history.  As you might recall, our last new product initiative Soup-in-a-Flashwas not a rousing success.  The new product you will be working on has the potential to create a whole new category of higher-margin convenience foods for PFVC. Initial projections look promising.  This is Carlos’ idea, so I will let him explain.” 

As Richard gestured, Carlos stood and moved to the front of the conference room. “Thanks, Richard. Good afternoon.  As many of you aware, we currently produce Pasta Done, a microwaveable product consisting of vegetables and spaetzels.  But this innovative new product idea is going to take that concept one step further and is unlike anything on the market.  We are going to add protein—in this case cooked chicken—to the vegetables and spaetzels in the same bag.  In the past, similar products separated chicken from vegetables using multiple pouches.  Combining all ingredients in a single bag simplifies the process for consumers offering them improved, value-added convenience. It takes only six minutes to cook in the microwave, and is a nutritious alternative to traditional convenience foods such as frozen dinners or pizza.  I have been calling it Chicken Sensations.  Some of the big hurdles with this new innovation: USDA approval for both our processing facility and the insertion of chicken combined with other ingredients into one bag are significant challenges to getting Chicken Sensations to market.  The last time we sought USDA approval was more than 30 years ago when we began processing canned meat for the government.  Since then, everyone associated with that process retired or was not retained in the reorganization.  Therefore, we have no in-house institutional knowledge of the USDA approval process.  But enough about the operational challenges of the product, that delicious aroma you smell from the test kitchen is a sample of the product that our research and development team prepared for us.  Let’s eat!” 

With that, staff emerged from the test kitchen and served the team sample meals of Chicken Sensations. While the team was enjoying their meal, Richard continued, “Thanks Carlos.  I think this could be a winner, but we need to make certain everything’s right since we will be creating a new category of convenience foods. Execution is key to turn this potential idea into a successful reality; everyone on this team must execute. If we elect to pursue Chicken Sensations, we need to insure we are price competitive with current convenience food offerings, have the ability to produce a high quality product at a reasonable cost, and most importantly make a profit.  Before our next meeting, I would like to address the feasibility of us pursuing Chicken Sensations.  Carlos, I would like for you to evaluate the price per ounce of alternative convenience foods as well as configurations varying the mix of chicken, vegetables, and spaetzels.  In addition, provide a sales forecast with recommended pricing.”  Addressing Gary Smits, the production manager, Richard said, “Gary would you please provide the expected packaging, labor, and variable overhead costs, any additional capital investments, anticipated costs to get USDA approval and inventory needed to produce and support Chicken Sensations.”  Finally, Richard directed his comments towards, Vicki Hoerning, the sole financial analyst on the team saying, “Vicki would you please take the inputs from Carlos, and Gary to determine the financial feasibility of Chicken Sensations. Include sales forecasts, contribution margin income statements, and profitability analyses.” 

Vicki said, “Richard you can count on me.  I think I speak for the entire team; we are excited to be included on this team and will do everything possible not to repeat the Soup-in-a-Flash debacle.  I will get everything put together as soon as possible.  Carlos and Gary, let’s get together when you have your information ready.”

Addressing the entire team, Richard reminded, “I do not think I need to remind you the importance of this project.  Because of our failure with Soup-in-a-Flash and limited financial resources, Parson corporate is increasingly reluctant to authorize the pursuit of any new products.  We need to insure our analysis is rock solid.  Our goal for Chicken Sensations is to breakeven in less than one year.” 

The Meeting

“Good afternoon gentlemen,” Vicki began addressing Carlos and Gary. “Thanks for meeting with me so quickly I know you have very busy schedules.  My goal for the meeting today is to gather information necessary to generate Richard’s financial analysis.  When we are finished, I anticipate providing an in-depth evaluation of the feasibility of Chicken Sensations.  Carlos, what did you find out about anticipated pricing and size of Chicken Sensations relative to other convenience foods?”

“Well Vicki, based on my market analysis the retail price per ounce of other convenience foods ranges from 16 to 20 cents with package sizes ranging from 20 to 30 ounces. As a result, individual item prices range from $3.20 to $6.00 at retail.  Based on my analysis and the greater perceived nutritional value of the Chicken Sensations relative to other convenience products, I suggest we target a retail sales price $3.75 per 20-ounce bag.  With retailers requiring a minimum 20 percent gross margin for new products, we need to sell Chicken Sensations for around $3.00 per bag or $36.00 per case of 12 20-ounce bags.” Vicki recorded this information on sales prices and revenue projections.

Carlos continued to explain some of the sales expenses and other costs, “To gain consumer trial in the first year only, we will have to offer coupons of $0.20 per bag or $2.40 per case for all cases sold. To gain access to convenience food distribution channels, we will have to pay 6 percent commission on the sales price for the life of the Chicken Sensations.  In addition, retailers (in total) require a one-time slotting allowance of $6,000,000 to purchase shelf space for Chicken Sensations.” Vicki noted that the slotting allowance costs would be expensed in the first years. 

Carlos continued to explain estimates for other Chicken Sensations costs, “Package design costs of $2,000,000 will be paid and expensed in the first year. To support Chicken Sensations, three additional sales people will need to be hired with annual salaries totaling $400,000.”  “Carlos, that sounds terrific. The last thing I need from you is forecasted case sales.” 

Carlos continued, “Sure Vicki. I anticipate first month sales to be 65,000 cases in January and increase by 15,000 cases each month for the first year to a maximum of 230,000 cases per month by December with a potential forecast error of 25 percent.  For the subsequent years 2 through 8, I forecast sales to be 2,760,000 cases per year.” 

“Wow those numbers are much higher than I would have expected,” Vicki exclaimed. “One more thing Carlos, how much do you think accounts receivables will change to support the new product?”  “Well, Vicki, based on our credit terms of net 30 days, I expect the accounts receivables required to support Chicken Sensations to be 100% of the prior month’s sales dollars.”  “Thanks Carlos.  Please review my summary of our discussion to insure I accurately captured your sales and marketing assumptions.  I do not want to misinterpret you.”