The Case of Butterfly Home Appliances In May 2010, Ms.

Susy Ley, Marketing VP of Butterfly home appliances was mulling over the discussion she had the previous day with Mr.Peter , a buyer from Big Bazaar. Big Bazaar operated a chain of discount department stores . Big Bazaars sales volume had grown to the extent that it was beginning to add house brand (also called private label ) merchandise to the product lines of several of its departments . Mr. Peter, Big Bazaars buyer for pressure cookers had approached Ms. Susy Ley about the possibility of Butterfly s producing pressure cookers for Big Bazaar .The pressure cookers would bear the name Samrat which Big Bazaar planned to use for all of its house brand kitchen equipments. Butterfly had been making pressure cookers for almost forty years. In 2010, the companys line included ten models, ranging from a simple model to deluxe models . Sales were at an annual rate of about Rs. 100 million. The companys 2010 financial statements appear in the exhibit-1 . Most of the butterflys sales were thru independently owned retailers (home appliances stores, Vessel dealers, gift stores ,etc). Butterfly had never distributed its products thru Big Bazaar chain stores ( more so in a discount stores with a different brand name) . Ms.Susy felt that Butterflys pressure cookers had the image of being above average in quality and price , but not a top of the line product. Big Bazaars proposal to Butterfly had features that made it quite different from Butterflys normal way of doing business . First it was very important to Big Bazaar to have access to a large inventory of pressure cookers, because Big Bazaar had great difficulty in predicting Pressure cookers sales both by stores and by month. Big Bazaar wanted to carry these inventories in its regional warehouses , but did not want title on a pressure cookers to pass from Butterfly to Big Bazaar until the Pressure cookers was shipped from one of its regional warehouses to a specific Big Bazaar store. At that point , Big Bazaar would regard the Pressure cookers as having been purchased from Butterfly and would pay for it within thirty days. However , Big Bazaar would agree to take title to any Pressure cookers that had been in one of its warehouses for four months , again paying for it within 30 days. Mr. Peter estimated that on an average , a Pressure cooker would remain in a Big Bazaar warehouse for 2 months. Second Big Bazaar wanted to sell its Samrat Pressure cookers at lower prices than the other brands it carried . The rationale was that Samrat Pressure cookers sales would take away from the sales of the other brands. Thus Big Bazaar wanted to purchase Pressure cookers from Butterfly at lower prices than the wholesale prices of comparable Pressure cooker sold thru Butterflys usual channels. Finally Big Bazaar wanted the Samrat Pressure cookers to be somewhat different in appearance from others.. The logo Big Bazaar should appear on the lid & handles & packed in boxes printed Big Bazaars Samrat . Ms. Susy expected these requirements to increase Butterfly purchasing , inventorying and production costs over & above the added costs of its regular products. On the positive side , Ms. Susy was acutely aware that the Pressure cookers boom had flattened out , and this trend plus a poor economy had caused Butterfly sales volume to fall during the past two years . As a result Butterfly was operating its plant at about 75% of one shifts capacity. Thus the added volume from Big Bazaar purchases possibly could be very attractive. If agreement could be reached on prices, Big Bazaar would sign a contract guaranteeing to Butterfly that Big Bazaar would buy its house brand Pressure cookers only from Butterfly for a three year period. The contract would then be automatically extended on a year to year basis , unless one party gave the other at least three months notice that it did not wish to extend the contract . Susy realized that she needed to do some preliminary financial analysis of this proposal before having any further discussions with Mr. Peter. She had written some information on a pad for her initial analysis, as shown in exhibit 2.

Exhibit 1 FINANCIAL STATEMENTS Butterfly Company Limited Balance Sheet as on 31.03.10 (000 Rs) Liabilities Accounts Payable Accrued Expenses Short Term Bank Loans Long Term Note Payable Owners Capital Rs 5120 3400 26260 15120 31020 80920 Assets Cash Accounts Receivable Inventories Plant & Equipment Rs. 3420 13590 27560 36350 80920

Income Statement for the year Ended 31.03.2010 Sales Revenues Rs. Cost of sales Gross Margin Selling & administrative expenses Income before taxes Income tax Net income

108720 80450 28270 23540 4730 2180 2550

Exhibit 2 Data pertaining to Big Bazaar Proposal (Taken from Ms. Susys Notes) 1.Estimated first year cost of producing Pressure Cooker (average unit cost assuming a constant mix of models): Materials Rs.398 Labor 196 Overhead (125% of DL) 245 Total 839 Note: Materials includes items specific to models for Big Bazaar not used in our standard models. Accountant says about 40% of total production overhead cost is variable;125% of DL cost rate is based on volume of 100,000 pressure cookers per year. 2.Unit Price & annual volume; Big Bazaar estimates it will need 25000 pressure cookers a year and proposes to pay us (based on the assumed mix of models)an average of Rs.922.9 per Pressure cooker for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflation of costs. Thus the margin is well defined. And Mr. Peter feels there is very little scope for negotiation. 3. Asset related costs( annual variable costs , as percent of Rs. Value of assets): Pretax cost of funds Record keeping costs(for receivables & inventory) Inventory Insurance Inventory handling labour & equipment Pilferage ,obsolescence, breakage 18% 1.0 0.3 3.0 0.5

4.Assumptions for Samrat related added inventories( average over the year): Materials: two months supply. Work in Process 1000 Pressure cookers half completed but all materials for them issued Finished goods: 500 Pressure cookers (awaiting next car load lot shipment to a Big Bazaar warehouse) 5. Impact on our regular sales: Some customers compare shops for brands, many of them are likely to recognize a Samrat Pressure cooker as a good value when compared to similar Pressure cookers. In 200910, we sold 98791 pressure cookers . My best guess is that our sales over the next 3 years will be about 1,00,000 Pressure cookers a year if we forgo the Big Bazaar deal . If we accept it , I think we will lose about 3000 units of our regular sales volume a year, since our retail distribution is quite strong in Big Bazaar market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we are making Pressure cookers for Big Bazaar .