Question During the planning process for starting a gift shop in a local resort town you began to question and consider different compensation plans for the retail clerks. It was fairly standard in the area to pay retail clerks $6.25 an hour. However, as you visited gift shops that were paying these rather low wages you noticed that the clerks simply took orders and did not sell or try to answer any questions for customers. In a visit to a gift shop in Ft. Lauderdale last spring you struck up a conversation with the owner. She was more than willing to share her experiences about retail clerks. In fact, after a lot of trial and error she decided to pay upper-quartile compensation. This consisted of a base wage of $9.50 an hour and a 3 percent commission on all sales. She mentioned that when she went to this type of system her average transaction size increased by 20 percent and that closure went from 28 percent to 40 percent. More importantly, she found that her bottom line profit rose by 32 percent. In short, by paying more for retail clerks she increased employee productivity and the profits of her store. For the gift shop you are planning you initially estimated that traffic would be 30,000 visitors annually and that closure would be 24 percent. You estimated your average transaction size at $32. Your gross margin percent would be 60 percent and fixed operating expenses would be $60,000 annually. Variable operating expenses would be 20 percent of sales. Under this plan you would pay two full-time clerks $6.25 an hour and you would fill-in when things got busy. Your new plan, which you want to evaluate, calls for paying the clerks $9 per hour plus 4 percent commission on all sales. Thus, your fixed operating expenses would go up by $3,000 and variable operating expenses would rise to 24 percent of sales. You believe that closure would rise to 32 percent and average transaction size would rise to $36. Based on the impact each compensation strategy has on the net profit of the business, which one should you pursue? Illustrate your work, to include the net profit calculations of each strategy.
FIRST CASE: Details mentioned in the question –
No of clerks = 2 rate = 6.25$/hour. (With my assistance)
Total visitors: 30000
Given Closure rate: 24%
Avg. Transaction size is 32$
Gross Margin = 60 percent
F.O.E. (Fixed operating expenses) amount to $60000/annum
V.O.E. (Variable operating expenses) = 20% of all sales
Number of users that would end up buying = Closure*Total = 0.24* 30000 = 7200.
Generated revenue (total) = (No of buyers in the previous step*Avg. transaction size) = 7200*32 = 230400$
Calculated gross profit = [(Gross Margin)/100]*revenue = 0.6* Total revenue = 138240$
V.O.C. (Variable operating expenses) = VOE*revenue = 0.2*230400 = 46080$
Net operating profit = Gross – (Fixed operating expenses + Variable operating expenses)
Net = 138240$ – 60000$ – 46080$ = 32160.00 $
SECOND CASE: details mentioned in the question –
No of clerks: 2
Rate: 9$ an hour
Commission : 4pc
Total visitors: 30000
Given closure rate: 32%
Average Transaction size: 36$ per transaction
Percentage of gross margin = 60 percent.
F.O.E. (Fixed operating expenses) = $63000/year
V.O.E. (Variable operating expenses) = 24 percent of sales.
Number of buyers in all= 0.32* 30000 = 9600 buyers
Revenue in dollars = (buyers)*(transaction size) = 9600*36 = 345600$
Gross Profit = 0.6 * Total revenue = 207360$
V.O.E. (Variable operating expenses) = (VOE percentage)*Revenue = 0.24*345600= 82944$
Profit (net) = Profit (Gross) – FOE (Fixed operating expenses) – V.O.E. (Variable operating expenses)
= 207360$– (63000$ + 82944$) = 61416$
Going by the numbers, the second case is a lot more profitable. It is better therefore to award the staff compensation of 9$/hour and a commission (4pc). This results in a greater incentive to perform, leading to more sales and higher productivity.