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Select Service Inc.

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Submitted By ACCY301
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Select Service, Inc
REVISED September 12, 2012

The Setting

Select Service, Inc is an authorized retail distributor of a computerized control device, the Process King 2000. The Process King 2000 is a programmable device that controls automated packaging machines used to weigh and pour a variety of food products into containers that are then heat-sealed to ensure product freshness. Currently, only one company in North America produces the Process King 2000, StatTech Corporation. Select Service and its industry competitors act as rental agents for the manufacturer and operate as post-sale service providers.

Service Contracts

Select Service customers choose either the Platinum contract with an annual price of $990 or the Gold contract with an annual price of $750. The two types of contracts both include annual rental of the Process King 2000 device, but offer different levels of post-sale service. Certified trained Service Technicians program the Process King 2000 to adjust the operating parameters to the packaging specifications required for customers’ products. Some customers use the Process King 2000 to package multiple different food products that require different machine set-ups in the programming. Service Technicians also provide regular operation analysis. The Gold Contract includes annual programming of up to 10 new machine set-ups and bi-monthly operation analysis reports to the customer. The Platinum Contract includes programming of unlimited machine set-ups and monthly operation analysis reports to the customer. In recent years, demand for the two types of contracts has remained stable at 60% Platinum and 40% Gold.

Operation analysis uses an internet connection between the Process King 2000 at the customer location and the mainframe computer at Select Service. Service Technicians download data from the customer’s Process King 2000 and perform analysis on the data to determine if the customer’s packaging machine is operating within the pre-set statistical control limits. When packaging machines are not operating within acceptable limits, Service Technicians may adjust the Process King 2000’s program using the internet connection or recommend an in-person maintenance service of the Process King device at the customer location. All contracts include one in-person service call per customer, per year. StatTech’s retail distributor contract with Select Service, Inc promises that the producer will replace a rented unit at no additional cost to Select Service if more than 1 in-person service call is required within a year. The crew of 200 Service Technicians each work with a mix of customers who purchased Platinum and Gold contracts that is proportional to the total number of the type of contracts sold.

Profit Planning at Select Service, Inc

The executive group at Select Service is preparing for the annual strategic planning meeting. VP of Accounting and Finance, Jessica Chwang has asked you, a team of interns, to prepare an analysis of profit and bonuses.

In a discussion with the CEO Fran Davies your team learned that Fran believes that based on previous market conditions Select should aim for a pre-bonus, pre-tax profit of $650,000. Marcus Ariego, VP of Marketing and Supply Chain provided you with the following information:

1) The variable cost of contracts is the rental payment Select Service collects from customers and pays to StatTech Corporation. Over the past seven years StatTech has not increased the rental payment. Other costs the company incurs include employee salaries, a licensing fee paid to StatTech, rental on office space, utilities, used office supplies, employee bonuses and corporate income taxes.

2) It is reasonably possible StatTech will increase the rental payment this year. If it does, the cost is not likely to increase more than 10% of the previous rental payment. The bargaining power of this supplier is very high relative to the industry in which Select Service, Inc operates because StatTech is the only company producing the Process King 2000 in North America. Marcus indicated it would not be possible for Select Service to switch to a different supplier next year.

a. (increase in VS, and SP) Up until now, Select Service, Inc has not experienced significant rivalry from its competitors. Companies in this industry operate in geographically distinct regions to keep the cost of in-person service calls at customer locations low. Continued low rivalry would make it feasible to pass a projected cost increase of 10% to the customers by raising the price of contracts just enough to maintain the weighted average contribution margin Select Service achieved over the past seven years.

i. (increase in VC) However, it is possible that if StatTech raises the rental price the pressure on profits will induce competitors to expand their marketing region. Select Service could choose to not raise its contract price. Keeping the contract price the same should sustain Select’s market share and is not likely to impact customer’s choice of contract.

ii. (increase in VC) Another possibility is that with an increase in price Select Service could maintain its market share, but experience a shift in demand for the two types of contracts. Marcus estimates that if the price of both contracts is raised by an equal amount, 12% of total customers would choose the Gold contract next year rather than the Platinum contract they previously purchased.

Employee Bonuses

Select Service pays all employees an annual salary. In addition to salaries, employees earn a profit-sharing bonus. The profit-sharing bonus pool is determined using a company-wide bonus rate and profit after bonuses and taxes. This method ensures that when the company is profitable, some of the profit is available to pay dividends to company owners and to reinvest in the company. The profit-pool is allocated to individual employees using the employee bonus rates. The company has four employee categories, each with its own employee bonus rate.

Exhibit 1. Schedule of Employee Bonus Rates and Number of Employees

| Employee Bonus Rate | Number of Employees | Service Technicians | 1.5% | 200 | Account Managers | 6.0% | 2 | Vice Presidents | 8.0% | 2 | CEO | 12.0% | 1 |

Rod Bolinger is the newly hired Platinum Account Manager. Sarah Kim, the Gold Account Manager, has worked for the company since it started business seven years ago. Last week Rod talked with Jessica. He suggested that since he and Sarah are responsible for managing the relationship with customers who purchase one type of contract or the other, their bonuses should be based on a share of profit proportionate to the type of contracts they each manage (Rod’s Suggestion).

Your Task

Jessica and Marcus (exec board) are concerned about uncertainty in the Select Service business environment. In addition, because Rod is new and came to the company with an MBA from a highly-respected University Jessica believes it is important to consider Rod’s suggestion about bonuses. Jessica would like you to prepare an analysis of profit and bonuses for the Select Service, Inc Executive Group.

Crane’s business magazine for a nearby major metropolitan area ran a story of the top 100 businesses in the region to watch. The executive group at Select Service, Inc was very excited to make this list of businesses that are considered to have significant future potential. As interns, your team is eager to prove that you have what it takes to become full-fledged employees at this up and coming business. To make a good impression, your report should include a recommendation for the executive group that reflects the environment in which the company is operating and the high ethical standards that are consistently communicated to all employees by the actions of the executive group.

Knowing it is important that anything your report to the executive group is prepared and presented in a professional manner your group will use the guidelines for written business memos provided in your Accy 201 course syllabus policies file.

Additional Financial Information

Jessica has provided you with some additional financial information.

When determining the proportion of profits attributable to the Platinum and Gold contracts, Select Service allocates fixed costs to the two contract lines using the proportion of each contract sold. If Rod’s suggestion is implemented, the company would use the same profit-sharing bonus pool. However, when calculating Rod and Sarah’s bonuses, the bonus pool would be split proportionate to the respective contract sales. The proportional split would be based on the amount of total profits before taxes and bonuses attributable to the different contracts.

Select Service, Inc’s corporate income tax rate is 20%.

Jessica recommends that you should not prematurely round off any estimations in your analysis.

Exhibit 2. Schedule of the Number of Contracts Sold Annually and Total Costs

| # ofContracts | Total Costs | Bonus Pool | Taxes | Profit After Bonuses & Tax | 2005 | 13,200 | $11,879,003 | $0.00 | $0.00 | ($78,203.00) | 2006 | 14,000 | $12,087,901 | $312,396.90 | $22,970.36 | $91,881.44 | 2007 | 14,750 | $12,298,154 | $658,875.90 | $48,446.76 | $193,787.03 | 2008 | 15,250 | $12,416,483 | $889,861.89 | $65,431.02 | $261,724.09 | 2009 | 14,950 | $12,342,075 | $751,270.30 | $55,240.46 | $220,961.85 | 2010 | 13,800 | $12,050,183 | $220,002.51 | $16,176.65 | $64,706.62 | 2011 | 14,400 | $12,196,685 | $497,185.70 | $36,557.77 | $146,231.09 |

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