Hallstead Jewelers Case Study

Summary

Hallstead Jewelers was one of the largest jewelry and gift stores in the United States for 83 years. Customers came from throughout the region to buy from extensive collections in each department. Any gift from Hallstead’s had an extra cache attached to it as they were known for having the best.

Even though the principal retail shopping areas shifted two blocks west, Hallstead’s reputation and selection still brought in customers. In 1999 however, sales became stagnate and profits were starting to slip. The owners (two sisters, Gretchen and Michaela) made several changes in an effort to revitalize the store back to its full glory. The largest decision they made was to move the stores location, expanding it by 50% more space and selling staff. This move resulted in a five-year lease as well as extensive and expensive renovations.

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They also made some changes in product offerings and offered more sales potential at the cost of minor reductions in margins. During the year it took to complete the Hallstead’s renovation the industry started showing major changes toward internet based jewelry sales. Tiffany & Company, a business with an origin much like Hallstead Jewelers, grew into an international powerhouse. At the same time, a start-up internet seller, Blue Nile, became the second largest diamond seller in the U. S.

While Hallstead’s was growing their fixed costs by doubling their rent payments, Tiffany and Blue Nile were increasing their revenue with “virtual” storefronts allowing them to increase sales with very little increase in expense. In an effort to explore ideas in strategy that would return the business to profitability, the sisters compiled some questions for their accountant to analyze using some additional operating statistics. The following answers will take a deeper look into the mechanics of the business and provide Gretchen and Michaela with recommendations to get their business back on track.

Changes in Breakeven and Margin of Safety

The following table shows that while the breakeven in both sales dollars and number of sales tickets has continued to rise from 2003, to 2004, and to 2006, the margin of safety has decreased over the same period of time. What caused this change? 3. 0Reduction in Price One idea the consultant had was to reduce prices to bring in more customers. The following table illustrates that by reducing prices 10% and increasing sales to 7,500 tickets, the company’s operating income significantly decreases, losing an additional $580K over the previous year’s income/loss.

Breakeven in sales tickets is 9,337 – an increase of 1,832 from the previous year. Breakeven in sales dollars increases $1. 47 million to a total of $13. 12 million needed.

Elimination of Sales Commissions

Another idea that Gretchen had was to eliminate sales commissions even though both her Grandfather and Father insisted that commissions were one of the reasons for their success in the past. The figure below illustrates that the elimination of sales commission greatly affects operating income.

By eliminating the sales commission in a projection of the three previously reported years, we can see that operating income is in the positive for all three periods. Although Gretchen’s father and grandfather perceived commission to give them a competitive edge, calculations prove that the commission payments are definitely hurting Halstead’s bottom line. Further consideration should be given to eliminate them if possible.

Advertising

Michaela felt that a bigger store could benefit from greater advertising and suggested that advertising be increased by $200,000.

If advertising expenses were increased by $200,000, the breakeven point in both sales dollars and sales tickets would increase. For Fiscal Year (FY) 2006, Hallstead spent $257,000 on advertising. If this were increased to $457,000, the breakeven point would be as follows: Breakeven in sales tickets = Breakeven sales dollars / Average sales tickets 7,805 = $12,120,525. 73 / $1,553 Breakeven in sales dollars = Total Fixed Costs / Contribution margin ratio $12,120,525. 73 = $5,211,000 / 0. 430

The affect of the increases in advertising expenditures on the breakeven point in sales dollars would be an increase from $11,655,335. 72 to $12,120,525. 73, a difference of $465,190. 01. It would probably be a good idea for Hallstead Jewelers to try the increase in advertising. Although the company is currently struggling with a negative operating income, the increase in breakeven dollars is relatively nominal. Competition from much larger companies, such as Tiffany & Company, as well as internet jewelry sales from companies such as Blue Nile has taken some of their business.

Perhaps some of this increased advertising budget should be spent on expanding their business to the internet and advertising there; allowing Hallstead to compete more directly with Blue Nile and boost sales. Increased advertising may also help bring in more customers who are not yet aware of the company’s new Washington St. location and larger renovated store.

Average Sales Tickets

The following overview takes a look at how much the average sales ticket would have to increase to breakeven if the fixed cost remained the same in 2007 as it was in 2006.

• Average sales ticket for 2006 is $1,553
• 6,897 tickets for an Operating loss of $406,000.
• #of tickets x Average sales ticket = Sales revenue
• 6,897 tickets x $1,553 = $10,711,041
• Average ticket sale dollar amount needed to break even = Sales revenue needed to break even / # of sales tickets for 2006
• Average ticket sale dollar amount needed to break even = (Fixed Cost / Contribution Margin Ratio) / # of sales tickets for 2006
• Average ticket sale dollar amount needed to break even = ($5,011,000 / 0. 43) / 6,897
• Average ticket sale dollar amount needed to break even = $1689. 2
• Average sales ticket increase to break-even = Average ticket sale needed to break even - Average sales ticket for 2006
• Average sales ticket increase to break-even = $1690 - $1,553 = $137

By reducing prices 10% and increasing sales to 7,500 tickets, the company’s operating income significantly decreases, losing an additional $580K over the previous year’s income/loss. Breakeven in sales tickets is 9,337 – an increase of 1,832 from the previous year. Breakeven in sales dollars raises $1. 47 million to a total of $13. 12 million needed.

Recommendations

In our analysis of Hallstead Jewelers we found that Income was steadily declining and the move to the new location, with increased fixed costs, resulted in a loss for 2006. We implemented several options to see what variances would occur. A consultant recommended a 10% reduction in prices which would lead to an increase in sales. We showed this to be a bad idea as operating income significantly decreased with the price reduction. Another idea was to eliminate sales commission. Eliminating sales commission greatly enhanced operating income and resulted in positive operating income for all three years.

Michaela suggested increasing the advertising budget by $200,000. Increasing the advertising budget increased the breakeven in sales dollars by $465,190; if increasing the advertising budget results in increased sales it would be justifiable. Based on our analysis of Hallstead Jewelers we would recommend that they discontinue the practice of paying sales commissions. Although Gretchen’s father and grandfather perceived sales commission to give them a competitive edge and drive sales, calculations prove that the commission payments are definitely hurting Halstead’s bottom line.

Elimination of sales commission in 2006 would have resulted in $1,215,184 less in breakeven sales dollars. The company's name and reputation should be asset enough to drive Hallstead Jewelers sales. In addition, we would recommend Hallstead Jewelers use $200,000 from the elimination of the sales commissions and apply it to increasing the advertisement budget combating stiff competition from large retailers such as Tiffany and Company and the internet business, Blue Nile.

The increased advertising budget should be assessed on an annual basis to validate its effectiveness.

References

1. Jiambalvo, James. Managerial Accounting 4th ed. New Jersey: John Wiley, 2010.
2. “Break-Even Analysis. ” Wikipedia Online http://en. wikipedia. org/wiki/Break_even_analysis. (11 APR. 2010)
3. “Contribution Margin. ” Wikipedia Online http://en. wikipedia. org/wiki/Contribution_margin. (10 APR. 2010)

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