The article “Up Front: More Condensing at the Digest?” in the October 19, 1998, issue of Business-Week reported that Thomas Ryder, CEO of Reader’s Digest Association, was considering a spin-off of Reader’s Digest’s direct-marketing operations into a joint venture with Time Warner. The article’s author, Robert McNatt, noted that the direct marketing of books, music, and videos is a far larger part of the Reader’s Digest business than is its namesake magazine. Furthermore, the article stated that 1998 direct-marketing sales of $1.6 billion were down 11 percent from 1997. The decline in revenue caused the division’s operating profits to decline 58 percent. The article stated that the contemplated alliance with Time Warner could provide some fast help. Gerald Levin, Time Warner chairman, has said that his company’s operations provide customer service and product fulfillment far better than other Web sellers do because of Time Warner’s established 250 websites.

Required

a. Write a memo explaining how an 11 percent decrease in sales could result in a 58 percent decline in operating profits.

b. Explain briefly how the decline in revenue will affect the company’s margin of safety.

c. Explain why a joint venture between Reader’s Digest’s direct-marketing division and Time Warner could work to the advantage of both companies.