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Special Orders
When an order is placed a price that is below the typical selling price, management must decide if this order is worth accepting or if accepting will cause them to lose money.
Things to consider:
- Capacity: Can this order be met with the current available capacity?
- If not, what is the opportunity cost of accepting the order?
- Added fixed costs
- Lost CM from cancelling existing sales
- Is the discounted price enough to at least cover the variable costs
- If not, reject immediately
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Example: Special Order
ABC Company produces 100,000 automatic blenders per month, which is 80% of plant capacity. Variable manufacturing costs are $8 per unit. Fixed manufacturing costs are $400,000, or $4 per unit. The blenders are normally sold directly to retailers at $20 each. ABC has an offer from XYZ Co. to purchase an additional 30,000 blenders at $17 per unit. Management would have to cancel orders to existing customers if capacity is exceeded. What should management do?
Practice: Special Orders
Barnabus Enterprises produces giant stuffed lion. Each lion consists of $12 of variable costs and $9 of fixed costs and sells for $45. An online retailer offers to buy 8,000 units at $14 each, of which Barnabus has the capacity to produce only half. Barnabus will incur extra shipping costs of $1.25 per lion. Determine the incremental income or loss that Barnabus Enterprises would realize by accepting the special order. (Enter answer as a negative number for a loss)