Reference no: EM132627926

Hohner Musikinstrumente GmbH & Co. KG:

Break-Even Analysis

Helmut Schmidt recently had been promoted to product manager for Hohner Musikinstrumente GmbH & Co. KG, the world's foremost manufacturer of harmonicas, accordions, melodicas, and ukuleles. He was sitting at his desk in Trossingen, Germany, reviewing his first assignment, which had just come from the company's senior executive team. Schmidt, a marketing major who had barely survived Finance I, had just two days to calculate the break-even point for the company's flagship product, the Marine Band harmonica.

A Brief History of the Harmonica

• Most historians track the harmonica's roots to ancient China, where either Empress Nyu-kwa or Emperor Huang Tri-depending on the source-invented the sheng in about 3000 B.C. This predecessor to the harmonica used a similar "free-reed" design, in which reeds were affixed to one end of a small, handheld base (the wind chamber); by blowing into the mouthpiece, the player produced a tone when the reeds vibrated. Over the next few thousand years, such free-reed instruments became popular throughout Asia, ultimately making their way to Europe, where organ makers such as John Buschmann and his son Christian Friedrich Buschmann began producing smaller and smaller versions in the early nineteenth century.

• In the 1850s, Joseph Richter, an American immigrant from the Czechoslovakian region of Bohemia, invented the modern "diatonic" harmonica by adding a second set of reeds on the other side of a cedar "comb," which were activated by breathing in rather than by blowing out (see Exhibit 1). Today, this so-called Richter tuning remains the most common tuning for harmonicas all over the world. The design for the Richter-tuned harmonica, which combines layers of reeds, a comb, and top and bottom cover plates, prompted harmonica players to nickname it the "tin sandwich."

• The Richter tuning originally was designed to play Eastern European folk music, but the diatonic harmonica changed forever when its popularity grew among American country musicians in the 1920s and '30s.sok Harmonica players such as Jaybird Coleman pioneered the technique of playing the harmonica in a key a musical fifth above the key the instrument was intended to be played-for example, playing in the key of G on a harmonica tuned to the key of C. This intentional corruption of the Richter tuning allowed players to produce a variety of expressive bent notes now known as the "blues scale."

• The instrument's low price made it extremely popular, especially among African American players, who called it the "Mississippi Saxophone." As they migrated in large numbers from the American South to northern urban areas such as Chicago in the 1940s and '50s, the harmonica found its way into blues and jazz music. This new style of playing combined with the cheap tweed amplifiers and crystal element microphones popular at the time led to the now-familiar compressed, squawking tone associated with blues harmonica, or blues harp.

Hohner Musikinstrumente GmbH & Co. KG

• In 1857 the 24-year-old son of a German family of weavers purchased one of the early handcrafted harmonicas and decided to go into business manufacturing his own brand. During his first year of business, Matthias Hohner, his wife, and one employee manufactured 650 harmonicas in their kitchen. Demand spiked after Hohner sent some to cousins who had emigrated to the United States, and soon after, Hohner Musikinstrumente GmbH & Co. KG built the largest harmonica fabrication facility in the world. The Hohner Marine Band harmonica, named after the band led by John Philip Sousa, was introduced in 1896 and went on to become the most popular harmonica in the world.

• After he died in 1893, Matthias Hohner's sons began expanding the product line to include accordions, later adding recorders and melodicas (essentially, recorder-type woodwind instruments with a keyboard layout like a piano just below the mouthpiece). In the 1980s, Hohner expanded further, offering a line of guitars and partnering to distribute Sabian cymbals and Sonor drums.

• This product-line expansion was matched by a steady global expansion, with subsidiaries in the United States, United Kingdom, China, Japan, and Brazil. Hohner began to struggle, however, after the rise of rock music in the 1960s depressed global harmonica demand just as Asian competitors started offering lower-cost harmonicas. The company implemented drastic layoffs in 1986 amidst two decades of losses that forced the Hohner family to sell a controlling interest to Kunz-Holding GmbH & Co., a wood-products manufacturer, while retaining just 8% ownership. Kunz later sold Hohner to a Virgin Islands-based subsidiary of K.H.S. Musical Instrument Co. Ltd. of Taiwan. New management from K.H.S. helped the company enact an aggressive restructuring and turnaround plan at the turn of the twenty-first century, resulting in Hohner's first profitable year in more than two decades.

The Harmonica Market

• Since 2000, Hohner's share of the global harmonica market had been fairly steady at approximately 75%, despite the growth of upstart competitors such as Lee Oskar, the brand launched by the harmonica player for the band War, which had about 10% market share. Other competitors tended to focus on specific regions, such as Suzuki in Asia or Hering in Brazil. Hohner did not sell directly to end users or even to retailers but instead sold exclusively through distributors, which then supplied both online and brick-and-mortar musical instrument retailers.

KEL682 HOHNER MUSIKINSTRUMENTE GMBH & CO. KG

• "While we do not sell directly to retailers, we have started to think about what we can do to increase their sales. We've recently started partnerships with large retailers like Guitar Center," said one Hohner representative. "Typically, the way you would buy a harmonica was to ask for it [at a store] because it was either in a drawer behind the desk or in a case under glass. What we've found-what the research suggests-is that you can drive sales by having the harmonicas out in a case with blister cards explaining what kind of harmonica it is, why it's better or worse than the other ones, and so on. That's the 'silent salesman.'"

• Hohner had identified two basic buyer profiles, which were distinguished by the player's seriousness about the instrument. The vast majority (about 95%) of buyers were casual players who made an impulse purchase of a less expensive harmonica (under €10). Such players typically owned only one harmonica.

• On the other hand, more serious players tended to buy more expensive (at least €20) harmonicas in higher volumes. Many serious players owned as many as forty or fifty harmonicas in different keys, with alternate tunings and by different brands. Such customers also tended to perform their own instrument repairs and retuning, which extended the lifetime of the harmonica. Though they represented a small minority of the customer base, one Hohner representative suggested these buyers accounted for as much as 30% of harmonica sales in Germany.

• Hohner's biggest challenge had always been converting the first type of buyer to the second type. "There's a low barrier to entry on the first harmonica; you can play it if you can breathe, and it's not very expensive," observed a Hohner representative. "The hard part is getting [customers] to buy a second one, [which won't happen unless] they realize they need different keys to play along with Bob Dylan songs on the radio, or because they realize they need a better one if they want to bend notes and play blues."

• The representative continued, "Popular music definitely helps; there was a slight increase in sales every time Bob Dylan started playing harmonica, or [in] the blues revival of the early 1980s with the Fabulous Thunderbirds and George Thorogood. . . . My dream right now is that Taylor Swift comes out with a song playing harmonica. Or if I can get Nick Jonas to play harmonica on just one hit song, you can imagine that it would be very good for us."

Costs and Demand

• The Hohner Marine Band harmonica retailed for €30 in Germany (see Exhibit 2). German retailers generally insisted on a 33% margin, and distributors took a 12% margin, based on the selling price of each. Hohner and its direct competitors sold a total of 800,000 units annually, with Hohner's share at 75%.

• Hohner faced variable manufacturing costs of €2.70 per Marine Band, with fixed manufacturing costs of €900,000 and an annual advertising budget of €500,000. The Marine Band manager's salary and expenses totaled €35,000. Marine Band salespeople working for Hohner were paid solely by a 10% commission on Hohner's sales. Shipping costs, breakage, and insurance were €0.60 per unit.

HOHNER MUSIKINSTRUMENTE GMBH & CO. KG KEL682

Assignment

Assume you are the manufacturer and answer the following questions using the information in the case. Calculate answers to at least three decimal places except for unit calculations, which should be rounded up to the next full unit.

Question 1: What is the unit contribution for Hohner?

Question 2: What is Hohner's break-even point?

Question 3: What market share does Hohner need to break even?

Question 4: What is Hohner's profit?

Question 5: Industry demand is expected to increase to 900,000 units next year. Schmidt is considering raising his advertising budget to €1 million.

Question 6: If the advertising budget is raised, how many units must Hohner sell to break even?

Question 7: How many units must Hohner sell to achieve the same profit (in terms of dollar amount) next year as it earned this year?

Question 8: What must Hohner's market share be next year for its profit (in terms of dollar amount) to be the same as this year?

Question 9: After some reflection, Schmidt decided not to increase Hohner's advertising budget. With industry demand expected to increase to 900,000 units next year, Schmidt thought he would give retailers an incentive to promote the Marine Band by raising their margins from 33% to 40%. The margin increase would be accomplished by lowering the manufacturer's price of the product to retailers. Distributor margins would remain at 12%.