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MCS - First Visayas Holding Company

LT - 9
Situation:
FV Holdings point of view:
At the company level, the main problem is that the prawn export business has
become competitive. Price of prawns in Japan has dropped while farm prices of
prawns have been increasing leading to lower profits. The president, Mr. Garcia,
now has to decide how to maintain profits while keeping each subsidiary
profitable.
FV Tradings point of view:
FV Trading has received an order from Saki Co Ltd, their biggest buyer, for 15000
kilograms (1.5 tonnes) of prawns at an average price of P250. However their
total cost is P261. As a result, if they accept this offer they will make a loss of
P11 per kilogram. Major costs include materials purchased from FV Processing,
FV Aquaculture and FV Processing at market price. If they dont supply to Saki Co
Ltd, they stand the risk of being tagged as unreliable.
FV Processings point of view:
For the Saki order, FV Processing charged FV Trading Co P20.50 per kilogram,
same as what it charges other prawn traders and producers in the area. Their
total cost is P17 per kilogram.
FV Aquacultures point of view:
For the Saki order, FV Aquaculture charged FV trading Co P205 per kilogram,
same as market price. Their total cost is P102 per kilogram.
FV Aquafeeds point of view:
For the Saki order, FV Aquafeed sold the feed to FV Aquaculture for P66 per
kilogram, while their cost is actually P68. They are selling at a price of 5% below
market price to gain market share.

FT Trading Co.
FV Processing
Co
FV Aquaculture
Co
FV Aquafeed Co
FV Holding Co

Per kilogram
Selling
Cost
Profi
Price
Price
t
250
261
-11
20.5

17

3.5

205
66
541.5

102
68
448

103
-2
93.5

Profit
%
-4.2%
20.6%
101.0
%
-2.9%
17.3%

If FT Trading decides to complete the Saki order and bear the loss, the entire
company will make a profit of 17.3%.

Solutions:
1) Temporary reduction in selling price:
FV Aquaculture makes up 78.5% of FT Tradings cost price and is selling prawns
at 101% profit margin. Since Saki is a major customer and has placed an order of
15000 kgs, FV Aquaculture can temporarily reduce its selling price by P10.5 so
that FT Trading Co. can breakeven.

FT Trading Co.
FV Processing
Co
FV Aquaculture
Co
FV Aquafeed Co
FV Holding Co

Per kilogram
Cost
Price
Profit
249.9
0.1

Profit
%
0.0%

20.5

17

3.5

20.6%

194.5
66
531

102
68
436.9

92.5
-2
94.1

90.7%
-2.9%
17.7%

Selling
Price
250

By taking this step, even though the profit margin of FT Aquaculture reduces, the
overall company profit increases. However, the point to be noted is that Saki is a
major customer and once they start buying at a reduced price of P250, it will be
very difficult to increase the price again. Hence, this is just a temporary solution.
2) Profit Sharing between FV Aquaculture and FV Trading:
FV Aquaculture can sell the prawns at cost price to FV Trading and they can share
the profits from the final sale. Note: FV Aquaculture will continue selling to other
customers at market rate.

FT Trading Co.
FV Processing Co
FV Aquaculture
Co
FV Aquafeed Co
FV Holding Co

Selling Price
250.0
20.5
102.0
66.0
438.5

Per kilogram
Cost Price Profit Profit %
152.8 97.2
63.6%
17.0
3.5
20.6%
102.0
68.0
339.8

0.0
-2.0
98.7

0.0%
-2.9%
22.5%

If we do this, then the overall profits of FV Holding increase to 22.5%. However,


this will lead to reduction in profits of FV Aquaculture. This is acceptable if
internal sales are a small fraction of total sales and the bulk of the profit can be
recovered from external sales. Also, this will drive FV aquaculture towards
becoming more efficient and reducing its own costs to gain more profits.
Other issues are:
a. How will the profits be shared?
They can be shared based on the percentage of cost of each subsidiary
b. Could such a situation arise with other subsidiaries as well?

It could, hence profit sharing can be done between all subsidiaries.

3) Profit Sharing between all 4 subsidiaries:


This will lead to a further increase in overall profits of FV Holding to 23.1%.
However all subsidiaries will have to come to a consensus on how the profit will
be shared.
Per kilogram
Cost
Price
Profit
100.
250.0
149.1
9

Selling
Price
FT Trading Co.
FV Processing
Co
FV Aquaculture
Co
FV Aquafeed Co
FV Holding Co

Profit
%
67.7%

17.0

17.0

0.0

0.0%

102.0
68.0

102.0
68.0

0.0%
0.0%

437.0

336.1

0.0
0.0
100.
9

23.1%

4) Two step pricing:


All subsidiaries can negotiate and use two step pricing for internal sales. In this
scenario, the buying subsidiary will use the out of pocket costs of the seller as its
buying price and reimburse the associated fixed costs along with profits on a
monthly basis.
If we use the internal buying price as the out of pocket costs of each subsidiary,
then the costs of FV Trading will be as follows:
Per kilogram
Profit
%

Selling Price

Cost Price

FT Trading Co.
FV Processing
Co
FV Aquaculture
Co
FV Aquafeed Co

250.0

149.1

Profit
100.
9

17.0

17.0

0.0

0.0%

75.0
56.0

75.0
56.0

0.0%
0.0%

FV Holding Co

398.0

297.1

0.0
0.0
100.
9

67.7%

25.4%

This will enable them to accept the offer given by Saki. However, they will have
to sell prawns to other buyers at a higher margin so as to be able to reimburse
other subsidiaries.
5) Change in Evaluation metrics:
To drive the solutions above, evaluation should also be changed. Instead of being
treated as profit centers, evaluation per subsidiary can be based on value added
to the holding company to reinforce prioritizing internal sales over external sales.
This means that they will be evaluated based on revenues generated by the
subsidiary for the overall holding company or on the costs saved rather than
profits generated.

Recommendations:
In the short run, Profit Sharing between FV Aquaculture and FV Trading is most
feasible for all internal sales. However, for the solution to be feasible in the long
run, Profit sharing between all subsidiaries should be implemented for all internal
sales along with change in measurement metrics.