Liza Davis Products Case Study

1. Assuming employees and floor space are fully utilized, the opportunity cost of a bargain customer is a full-price sale. However, if a product cannot be sold at full price, the alternative to a discount sale is liquidation. In case the merchandise is not sold at a discount, it will be sold at 50% of invoice value. As shown in Exhibit 2, the value of the discount customer is $ 65,896,000- that would the additional loss to Liza Davis if the 60% discount merchandise is liquidated. Liza Davis should make two main changes (Exhibit 1) to their cost allocation scheme. First, they should allocate all merchandising, logistics (unless for shipments of discount merchandise), and new season replenishment costs to full price merchandise. Those costs are sunk by the time merchandise is sold at a discount. Second, merchandising, logistics, and replenishment costs are all calculated on a unit level using total invoice costs of merchandise sold and not liquidated as the denominator, which then appear in the operating margin. Merchandise sold is therefore subsidizing unsold merchandise. Liza Davis should use invoice costs of all merchandise (sold and liquidated) as the denominator, since costs are incurred regardless of whether or not merchandise is sold. The percentage of these costs allocated to liquidated merchandise should then appear as an overhead expense, to fully absorb costs. 10% of merchandise is liquidated, so using total invoice costs in the denominator would decrease these operating costs by 10%. Those two changes give discounted merchandise a positive contribution margin to reflect their value.

1. Total costs of a merchandise return are $31.65, assuming commissions are not revoked if a product is returned (Exhibit 3). Of that, $2.4 is the cost of an employee’s time, $6.75 is the commission cost, and $22.5 is the cost of merchandise that cannot be resold. Given the high cost of returns, Liza Davis should consider changing its return policy to refuse returns of products that customers have damaged. While defective returns will still not be resalable, a policy of only accepting returns in their original condition might decrease the percent of returns that must be destroyed. That change might increase the amount of time employees spend processing each return to enforce the policy; Liza Davis must monitor that increase to make sure increased employee costs do not outweigh decreased merchandise costs.  

1. If Liza Davis can sell discounted merchandise at margins above those for liquidation, they should continue to sell discounted merchandise. However, they should try to lower the costs of such merchandise. They could push discounted sales online, reducing the employee time and floor space allocated to discount sales. They could also instruct salespeople to focus on full-price customers, and train them to redirect customers to full-price products. Liza Davis should analyze their replenishment processes to make them more efficient. Since these are fixed costs, selling less merchandise at a discount will result in sale replenishment costs increasing on a per-unit basis, driving down profitability.

1. Liza Davis should attempt to incentivize discount purchases as an alternative to liquidation, but not at the expense of full-price sales. They should also incentivize them in the lowest-cost manner. As noted above, they could direct these incentives at online sales. They could also offer incentives at the very end of the product’s season, when it is about to be liquidated, rather than earlier in the season. Alternatively, they could bundle discounted products with full-price items.

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