What is going on with this Cost Calculation ?

Question

Dear Community,

I have a confusion when doing madflix.com case. I realized the solution assume that the variable cost will be the same for Business model S1,S2 and S3. However, I believe it should be different because (look at the variable cost explanations), because the total variable cost for S3 will be higher for each rental as they only need one shipping/distribution and 3 times of content amortazitation,allowance and others (as they ship 3dvds for 1 shipping). So we cant just use 1.75 for the S2 and S3 for cost/rental. We should use

S2 Var cost : $1(delivery)+(0.75*2 (amortazitation,allowance and others) )= $2.5/Rental

S2 Var cost : $1(delivery)+(0.75*3 (amortazitation,allowance and others) )= $3.25/Rental

Assuming that everyone in S1 will rent only 1 DVD once, everyone in S2 will rent 2 DVD/ship, in S3 will rent 3 DVD/Ship

Components of variable cost: Distribution: Primarily mailing costs----> Based on each shipping time (if we assume shipping 3 DVDs same with shipping 1 DVD) Content amortization: Usable life of movies is 30 rentals.---> Based on Each DVD Allowances: allowance for movies to be lost in mail---> ---> Based on Each DVD Other: DVD cases repair, etc.------> Based on Each DVD

I still dont see why the variable cost for each model will be the same as they ship different numbers of DVD (which will affect the distribution cost, allowance,amortazation,others)

I know we need to stick with the case prompt which says

A unique feature of this case is that the variable costs of Madflix do not depend on sales volume, but on other drivers (e.g. average number of movies returned each month).

But, for each DVD movie return it will apply the same right ? Basically the customer will give the same number of DVD as the madflix.com already gave them.So,

Customer S1 will return 1 movie/rental, S2 will return 2 movies/rental,, S3 will return 3 MOvies/rental,. Thus the variable cost should be different

How do you explain this problems ? Thank you for your explanaitons,

Answer 1

Hi,

I think the problem stems from the fact that you are assuming that the customer in model S3 receives/watches all the 3 DVDs at once. My take on the S3 model is simply that the customer can have up to 3 DVDs rented at once but that the consumption pattern can vary. For example, ordering one DVD at a time, 2, or 3.

The amortization costs should be driven by the total rentals per month in each model (table 3) and delivery costs would then depend on the ordering pattern.

-A