Case Analysis – Colonial Homes by Shrija Srivastava

Problem Definition:

Noel Desautels’, president of Colonial Homes, primary objective is to be

profitable for 1989 since currently the company has barely been on a profitable track.

Recently, however, his only lumber supplier, Davey Lumber, has insisted on an 8 % price

increase, which may significantly impact the company’s profits. As a result, this serves as

an obstacle for the company to achieve its goals. Noel Desautels must now consider the

implication to sales with a revised price list and whether it would be more feasible to

adhere to the 8% price increase or find a new supplier. If Noel Desautels’ chooses to go

with another supplier, this will affect his long-term relationship with Davey Lumber.

Alternatives:

There are two options Noel Desautels’ is debating between: should Colonial

Homes draw up a new price list or find a new supplier i.e. Northland Build-it. A third

option Noel Desautels can consider is dividing the supply between Davey Lumber and

Northland Build-it.

Alternative 1: Revising the price list

There are many advantages and disadvantages to this alternative. One of the

advantages is that if the company picks this alternative, then this will not jeopardize their

relationship with Davey Lumber in the long term, which was one of the concerns Noel

had. Another advantage with going with Davey Lumber is that they offer the security of a

six-month fixed price guarantee whereas the other supplier only offers a 3-month fixed

price guarantee. One of the disadvantages is that Colonial Homes has very high price

elasticity. As shown in table A, an approximate price percentage increase of 5.5 % (8%-

2.5%) results in a decrease in sales by about 9 %. This is assuming that an increase in unit

price matches with an increase in the cost of lumber. As a result, the projected number of

houses sold would decrease to 120 and projected profit would decrease to -238,815 (see

exhibit 1). Also, a revised price list at such a short notice may impact the relationship

with their dealers.

Alternative 2: Going with Northland Build-it as the new lumber supplier

The obvious advantage with going with this supplier is that the profit will be

higher in the short run. Also if we observe exhibit 2, we can see that over the past 10

years prices have fluctuated but not by a significant amount, therefore, after 3 months

even if Northland Build-It increased their price after 3 months, we will assume that they

will not raise the price by more than 2.5 % which was the initial anticipated price

increase. In addition, since there is not a price increase, the dealer relationship will not be

impacted. Furthermore, since Colonial Homes will not be exhibiting an 8% price

increase, this will result in higher profits for the firm. The disadvantage with going this

supplier is that this will impact the long-term relationship with Davey Lumber. Also,

Davey Lumber offers a longer price-fixed guarantee. In addition, there are transactional

costs associated with changing suppliers.

Alternative 3: Divide the supply between Davey Lumber and Northland Build-it

There are many advantages for choosing this option. One of the pros is that both

supplier relationships can be maintained. Also, the unit price will not increase as much as

it would have if Colonial Homes chose only Davey Lumber, who wanted a price increase

of 8%. There will be an average price increase of 1.75%, which is also factoring the

initial 2.5% price increase anticipation (see exhibit 3 for calculations). This means

anticipated profits will be 43,547 (exhibit 1). The con is that Colonial Homes will still

incur transactional costs for using a second supplier and the company will still have to

release a revised price list.

Solution: Alternative 3

When conducting a profitability sensitivity analysis with respect to price we can

see from exhibit 1 that alternative 3 is the best option because you are not jeopardizing

the relationship with Davey Lumber and you are still earning positive profits. The option

is also the best alternative because having a partial supply contract with Northland Build-

it offsets Davey’s price increase. In addition, a 6-month supplier contract with Davie

Lumber creates price stability and eliminates volatility. It is also recommended that

Colonial Homes try to negotiate a lower price increase by Davey Lumber. Furthermore, it

is recommended that Colonial Homes look into their marketing efforts by analyzing the

effectiveness of the brochures and evaluating dealer relations.

Appendix

Exhibit 1

Exhibit 2

Exhibit 3 – This is for alternative 3

Exhibit 4

First 3 MonthsSecond 3 Months

Davey's Price Increase 8% 8%

Northland Build-it Price Increase -5% -2.50%

(Assuming that after 3 months there will be an increase in price of 2.5%)

Difference in Price Increase 3% 5.50%Anticipated price increase factored in 2.50% 2.50%Resulting Price change 0.50% 3%Average over 6 months 1.75%