Upon their father’s death, three siblings, Gretchen Reeves, Michaela Hurd, and James [Hallstead], inherited the Hallstead family jewelry business that has been in operation for the past 83 years. Hallstead Jewelers, located in the largest city of the tri-state region, has an established reputation for quality and selection and has grown into one of the largest jewelers in the United States. Nonetheless, since 1999, Hallstead Jewelers’ profits have been slipping and sales have stagnated.
Two years ago it was decided to move the business a couple of blocks to keep the store in the main shopping district of the city and to increase retail space. In 2005, the new location was found and renovated. The new store opened in 2006 and as expected, sales picked up. However, after a review of the preliminary fiscal year 2006 financial reports the sisters are not happy with what they see. The profits were not simply diminished, but rather non-existent. The business had experienced a significant and unexpected loss. The sisters want to understand what has happened since 2004 and what can be done to get Hallstead Jewelers back on track.
It has been suggested that the new location has changed the economics of the company. Questions have been raised concerning the appropriate pricing, promotional, and compensation schemes needed to bring Hallstead Jewelers back into a place of success. This paper will answer those questions and bring up additional considerations. Discussion To help the sisters understand the situation Hallstead Jewelers face and to make recommendations, we were provided with two supporting documents. The preliminary income statements for fiscal years ended 2003, 2004, and 2006 are shown in Table 1.
Additional operational statistics are shown in Table 2. To help the Gretchen and Michaela understand what has changed between 2003, 2004, and 2006 a breakeven analysis (see Table 3) was performed on both sales tickets and sales dollars. The sales ticket break-even point increased from 4,535 to 5,000 to 7,505 respectively. At the same time, the sales dollars break-even point has increased from $7,287,043 to $7,621,696 to $11,655,277 respectively over the same period. From 2003 to 2004 the change in sales ticket break-even point increased 10 percent while the sales ollar break-even point increased 5 percent. We see the biggest jump from 2004 to 2006 where break-even sales tickets and break-even sales dollars jumped 50 percent and 53 percent respectively. Figure 1 below shows the increasing break-even points for both sales tickets and sales dollars. Figure 1 – Hallstead Breakeven Analysis Increases in the break-even points reduced, or even eliminated, the margin of safety that Hallstead desired. In 2003 the margin of safety was 806 sales tickets (or 1,295,956 sales dollars). In 2004 that margin had been reduced to 316 sales tickets (or 481,304 sales dollars).
Last year, despite increasing sales by more than $2,600,000, the margin of safety was eliminated. Hallstead was 608 sales tickets short of the break-even point (or 944,277 sales dollars). Figure 2 below depicts the falling margin of safety of Hallstead Jewelers. Figure 1 – Hallstead Margin of Safety It is easy to see that relocation of the store has significantly driven much, if not all, of the increased costs. Salaries have ballooned by more than $1,100,000 to cover the additional sales staff. Rent has doubled; depreciation has almost doubled, and miscellaneous expenses have increased by roughly one-third.
In fact, every fixed expense category increased and contributed to the change. Hallstead has done a good job of controlling variable costs. While the fixed costs have increased, the variable costs are roughly equivalent to 2003 level. Unfortunately, the average sales ticket price has fallen short of the 2003 level during the same period. This means that, all else being equal, more sales will need to be realized in order to cover the increased fixed costs. If Hallstead’s is committed to their new location, they must realize the increased costs that come with that decision.
Assuming the miscellaneous charges will remain at the 2006 level and were not inflated by one-time expenses related to the move, Hallstead needs to formulate a plan to cover an additional $1,658,000 per year in fixed expenses. Thankfully, we have some ideas that will help Hallstead formulate such a plan. Hallstead’s consultant has asked us to look into the feasibility of reducing prices 10 percent across the board. We have been told that the new pricing would generate new sales. If prices are cut by 10 percent sales tickets are projected to jump from 6,897 to 7,500 (an 8. % increase). Without even running a scenario it is obvious that this pricing scheme would not work. With Hallstead’s current operating situation 7,505 sales are needed to break even. Reducing the prices will not even lift sales to this required threshold and worse yet, the sales dollars per ticket would be reduced, resulting in even more sales needed to breakeven. Nonetheless, the results of the scenario suggested by the consultant are shown in Table 4. As expected, the increase in sales would not be enough to offset the reduction in price.
The result of such a move would be catastrophic. Hallstead’s losses would increase another $704k from this plan. In order to breakeven, 9,634 sales tickets would need to be realized (or $13,464,872 in sales). See Table 5 for additional breakeven data for this scenario. Gretchen has never been a firm believer in the commission compensation scheme that her grandfather instituted and her father supported. Now that the opportunity to question “business as usual” has presented itself, Gretchen has taken this opportunity to question the benefit of continuing to pay commissions at Hallstead’s.
With over 83 years of service and reputation, Hallstead Jewelers is now an iconic figure in the jewel industry, certainly locally, if not nationally. As stated by the sisters, “A gift from Hallstead’s had an extra cache attached to it. It was presumed to be the best. ” This designation resulted from a combination of superior customer service, quality, and owner loyalty to its customers. With this observation, Gretchen’s idea to eliminate the sales commission is a great suggestion.
Due to the stated reputation of Hallstead Jewelers, the consumer walking through the door has most likely decided that they would be making a purchase from Hallstead’s. There is really no additional effort required from the salesperson, thus no need to compensate them for every sale. Hallstead’s product essentially sells itself. In fact, Hallstead would be the final jeweler to eliminate such as pay structure. As noted in the case, Tiffany & Co. , who has a similar history to Hallstead Jewelers and now the largest diamond seller in the United States, does not pay sales commissions.
In addition, Blue Nile, an internet startup; now the second largest diamond seller in the United States cannot offer sales commissions as all transactions are done electronically. It is also our belief that since the name Hallstead sells itself that there will be no interruption in the current amount of sales. In fact, sales may increase because the salesperson can now focus solely on customer service versus how much commission can be made in a given month. Furthermore, there was no data provided that suggests sales were due to the commissions being paid to sales personnel.
All observations conclude that Hallstead Jeweler’s legacy is the overall revenue driver and not commisssions. The elimination of commissions (with all else being equal) would have a positive impact on the bottom line. In 2006, Hallstead could have saved $536k, which would have put the company into the black. Table 6 shows how the elimination of commissions would affect the break-even point. The difference is significant. The sales tickets required to breakeven would drop from 7,505 to 6,723 and the sales dollars required to breakeven would drop from $11,655,277 to $10,440,109.
Not to be outdone by her sister, Michaela has suggested that an additional $200,000 be spent on advertising. Unfortunately, without knowing the expected sales increase per advertising dollar spent, we cannot offer an opinion on the exact amount proposed. We can; however, let Hallstead know the amount required to make the increased expenditure a good investment. As shown in Table 7, sales would need to increase by at least $465,188 to cover the cost of this additional expenditure. Lastly we were asked to calculate the amount of the average ticket sale that would be required to break-even if fixed costs remained the same.
This could happen if customers decided to buy bigger ticket items, or if Hallstead chose to raise prices. If the market will accept a price increase, this may be a feasible option. As shown in Table 8, if nothing else changes, but price, Hallstead’s could breakeven with the same sales volume if they were able to increase the average sales ticket price to $1,690 (an 8. 82% increase). While we do not have perfect or complete information, the knowledge that we have been able to gain concerning Hallstead’s business is sufficient enough to allow our group to confidently recommend a course of action for Hallstead Jewelers.