Question:
Using fixed cost as a competitive business strategy
The following income statements illustrate different cost structures for two competing companies.
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Income Statements
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Company Name
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Vector
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Sector
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Number of customers (a)
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70
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70
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Sales revenue (a x $200)
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$14,000
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$14,000
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Variable cost (a x $160)
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N/A
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(11,200)
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Variable cost (a x $0)
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0
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N/A
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Contribution margin
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14,000
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2,800
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Fixed cost
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(11,200)
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0
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Net income
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$2,800
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$2,800
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Required
a. Reconstruct Vector's income statement, assuming that it serves 140 customers when it lures 70 customers away from Sector by lowering the sales price to $120 per customer.
b. Reconstruct Sector's income statement, assuming that it serves 140 customers when it lures 70 customers away from Vector by lowering the sales price to $120 per customer.
c. Explain why the price-cutting strategy increased Vector Company's profits but caused a net loss for Sector Company.