BALDWIN Case Barnali

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BALDWIN BICYCLE COMPANY

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BALDWIN BICYCLE COMPANY

• WHO?• Ms. Suzanne Leister (SL), BALDWIN

BICYCLE COMPANY (BBC)• Karl Knott (KK), HI-VALUE STORES

INC. (HVS)

• WHEN?• May 1983

• WHERE?

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CASE FACTS• Baldwin Bicycles Company (BBC): 40 years in

bicycle business.

• In 1983 made 10 models - beginners to 12 speed adult.

• $10 million in annual sales.

• Most sales through independently owned toy stores and bicycle shops.

• Never before distributed through department stores.

• Image - above average in price and quality but not top of the line.

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HI-VALU

• Chain of discount department stores in the northwest.

• Adding house brands.• Approached Baldwin about having

Baldwin produce bicycles.• Would bear the name

“challenger”.

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HI-VALU PROPOSAL

1. Need ready access to large inventory,

(HVS has difficulty in predicting sales)

2. HVS would store inventory in regional warehouses.

3. Title would not pass until shipped to a particular store.

4. Upon shipment, payment will be due in 30 days.

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HI-VALU PROPOSAL (contd.)

5. Title passes automatically when bicycle has been in warehouse 120 days.

6. HVS pays in 30 days.7. HVS estimated an average bicycle would

remain in the warehouse 2 months.8. HVS desired to sell Challenger bicycles at

lower prices than their name-brand bicycles. Did not want to take sales away from their name brands.

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HI-VALU PROPOSAL (contd.)

9. Wanted BBC to sell them at prices lower than the wholesale prices sold through normal channels.

10.Wanted the Challenger to be different from other BBC bicycles.

11.Wanted different fenders, seats, and handlebars.

12.Wanted the Challenger name on the bicycle.13.The packing boxes would have the HVS and

Challenger names

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HI-VALU PROPOSAL (contd.)

14.Ms. SL (Baldwin’s Mktg. VP) thought those requirements would increase purchasing, inventory, and production costs over and above costs of a similar increase in BBC volume.

15.Bicycle boom has flattened.

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• BBC Plant at 75% capacity.

• Added volume is attractive.

• HVS will agree to buy house brand bicycles exclusively from BBC for 3-year period, with automatic extension unless either party gives notice.

THE CURRENT STATUS

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QUESTIONS FOR BBC

1. What is the expected added profit from the Challenger line for BBC?

2. What is the expected impact of cannibalization of existing sales?

3. What costs will be incurred on a one-time basis only?

4. What are the additional assets and related carrying costs?

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QUESTIONS (contd.)

5. What is the overall impact of the company in terms of profit, return on sales, return on assets, and return on equity?

6. What are the strategic risks and rewards?

7. WHAT SHOULD BBC DO?8. WHY?

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BBC BALANCE SHEET

ASSETS

CASH $ 342

ACCOUNTS RECEIVABLE 1,359

INVENTORIES 2,756

PLANT & EQUIPMENT (NET) 3,635

TOTAL $ 8,092

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BBC BALANCE SHEET

LIABILITIES AND OWNERS EQUITY

CURRENT LIABILITIES $ 3,478

NONCURRENT LIABILITIES 1,512

OWNERS EQUITY 3,102

TOTAL $ 8,092

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BBC INCOME STATEMENT

SALES $ 10,872

COST OF SALES 8,045

GROSS MARGIN $ 2,827

OTHER EXPENSES 2.345

INCOME BEFORE TAXES $ 473

INCOME TAXES 218

NET INCOME $ 255

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PERTINENT DATA (EX-3-2)

(1) ESTIMATED FIRST YEAR COSTS OF PRODUCING CHALLENGER BICYCLES.

MATERIALS $ 39.80 * LABOUR 19.60 OVERHEAD (125% OF LABOR) 24.50TOTAL $ 83.90 !

* Includes items specific to hvs models.! Accountant estimate 40% of overhead is variable ($18) and that

the 125% of the direct labor rate is based on a volume of 10,000 per year.

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(2) ONE TIME ADDED COSTS of preparing drawings, and/or arranging for fenders, seats, handlebars, tires, and shipping boxed that differ from those used in standard models is estimated at $5,000 (2-months @ 2,500).

(2) UNIT PRICE AND ANNUAL VOLUME:25,000 bicycles per year.Will pay average of $92.29 per bicycle.Will be adjusted for inflation.HVS appears firm on price.

PERTINENT DATA (contd.)

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(4) ASSET RELATED COSTSPretax funds for rec and inv 18.0%.

Recordeeping costs - rec and inventory 1.0%

Inventory insurance 0.3%

State property taxes 0.7%

Inventory handling, etc. 3.0%

Pilferage, etc. 0.5%

PERTINENT DATA (contd.)

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(5) AVERAGE ADDED INVENTORY

Materials - two months

Work in process - 1,000 half complete as to labor and overhead, fully complete as to materials.

Finished goods - 500 bicycles awaiting shipment to HVS warehouse.

PERTINENT DATA (contd.)

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(6) IMPACT ON REGULAR SALES• In 1982 BBC sold 98,971.• Comparison shopers will see HVS as a good buy.• Estimate sales of 100,000 per year without HVS.

(7) ESTIMATE LOSS • 3,000 units TO CHALLENGER.• MAY LOSE SOME DEALERS AS WELL.

PERTINENT DATA (contd.)

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RELEVANT COST ANALYSIS

CONTRIBUTION (per cycle):REVENUE $92.29

VARIABLE COSTS MATERIALS $39.80

LABOUR 19.60

OVERHEAD (40% of $24.5) 9.80 *

TOTAL VC $69.20

UNIT CONTRIBUTION $23.09

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RELEVANT COST ANALYSIS

ANNUAL VOLUME EXPECTED 25,000

TOTAL CONTRIBUTION $ 577,250

(25000 * 23.09)

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RELEVANT COST ANALYSIS

CONTRIBUTION FROM 3000 LOST SALES

REVENUE $ 113.38 *

VARIABLE COST (same) 69.20

CONTRIBUTION MARGIN $ 44.18

TOTAL ($44.18 * 3,000) $ 132,540

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RCA - RevenueCOMPUTATION OF REVENUEMARGIN % = MARGIN/SALESMARGIN = 2827/10872 = 26%Assume, SP per unit = xSales Revenue – Cost of Sales = Gross Margin x – COS = 0.26x x – 0.26x = COS 0.74x = COS 0.74x = $ 83.9 x = $113.38.

Assumption: COS=COM

Back

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RELEVANT COST ANALYSIS

• One time added costs - ignore for all practical purposes. Probably will be done with idle time.

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RELEVANT COST ANALYSIS

ADDED ASSETS AND COSTS:MATERIALS (25,000/6) * 40 (39.20) $160,000WORK IN PROCESS 1,000(40 + .5(30)) 55,000FINISHED GOODS 500 * 69 (69.20) 35,000FINISHED GOODS AT HI-VALUE(25,000/6) * 69 (69.20) 280.000ACCOUNTS RECEIVABLE (25,000/12) * 92 (92.29) 185,000

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RELEVANT COST ANALYSIS

TOTAL ASSETS NEEDED 715,000

POSSIBLE 45 DAY CREDIT

FROM SUPPLIERS -120,000

NET EXTRA INVESTMENT $ 595,000

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RELEVANT COST ANALYSIS

SUMMARY ASSUMING ONLY THE VARIABLE COSTS ARE DIFFERENTIAL.

NEW CONTRIBUTION $ 577,000

LOST CONTRIBUTION -133,000

NET $ 444,000

LESS HOLDING COSTS 150,000

NET ADDED CONTRIBUTION 294,000

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FULL COST ANALYSIS

REVENUE $92.29

TOTAL COSTS 83.90

UNIT MARGIN $ 8.39

TOTAL ($8.39 * 25,000) $209,750

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FULL COST ANALYSIS

CONTRIBUTION FROM 3000 LOST SALES

REVENUE $ 113.80

Total COST 83.90

CONTRIBUTION MARGIN $ 29.48

TOTAL ($29.48 * 3000) $ 88,440

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FULL COST ANALYSIS

ADDED ASSETS AND COSTS:MATERIALS (25,000/6) * 40 (39.20) $ 160,000WORK IN PROCESS 1,000(40 + .5(44) 84,000FINISHED GOODS 500 * 84 (83.90) 42,000FINISHED GOODS AT HI-VALUE(25,000/6) * 84(83.90) 340,000ACCOUNTS RECEIVABLE (25,000/12) * 92 (92.29) 185,000

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FULL COST ANALYSIS

TOTAL ASSETS NEEDED 711,000

POSSIBLE 45 DAY CREDIT

FROM SUPPLIERS -120,000

NET EXTRA INVESTMENT $ 691,000

RANGE 400,000 TO 900,000

WITHOUT OFFSET HOLDING COSTS ARE $165,000. WITH IT THEY ARE $142,000.

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FULL COST ANALYSIS

SUMMARY ASSUMING FULL COSTS.

NEW PROFIT $ 210,000

LOST CONTRIBUTION - 88,000

NET $ 122,000

LESS HOLDING COSTS 165,000

NET ADDED CONTRIBUTION -43,000

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• Conventional Pro

• • Incremental profit and incremental ROI excellent (even with erosion).

• • The existing business covers the fixed costs (i.e. we are showing profits in 1982). The “Incremental” business need only show positive marginal contribution.

• • We have excess capacity and volume isn’t growing.

• • Opens up a new (for Baldwin) and more stable distribution channel (Hi Value).

• • Opens up a new market segment for growth for Baldwin (The “Discount Retail” segment”).

• • Risk seems low (or does it?!).

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• Cons

• • Can we really look at a deal on an “incremental” basis when it covers 25% of volume and runs for at least 3 years??!!

• • Creates a major cash crunch; Highly leveraged now; No debt capacity left; How to finance the incremental investment?

• • Inventory at H/V may run up to average 4 months, not 2 months; Implications for ROI, cash flow, and financing?

• • Additional sales losses, if current dealer’s drop Baldwin

• line?

• • A very sweet deal for H/V; Can we negotiate a better deal? (probably yes; should we try?)

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• • Currently profitable, but only modestly so (ROE 8%)

• • Heavily leveraged

• • • Sales volume decreasing during last 2 years

• • A “solution” presents itself in the H/V offer

• Is it a good “solution”?

Baldwin: Background

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•

• • How much flexibility does Baldwin have to experiment?

• • How much urgency is there to “do something”?

• Does the H/V deal make sense strategically?

Impact of the H/V Deal on the “Current” Business Strategy?

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• • What is Baldwin’s strategic niche currently? Does it matter if they stray from that?

• • Can we be a significant supplier simultaneously in two price segments with a substantially “identical” product?

• • How to implement diverse strategies (low cost and differentiation) within the same firm?

• • Avoid “stuck-in-the-middle”

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• Is the H/V deal a good one?

• • Financially?

• • Strategically?

• • Ethically?

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•Any Decision Must Take An Integrated View Of

• Strategic Competitive• Financial Mission Strategy• Analysis Analysis Analysis

There are no “Free Lunches,” “Good Cheap Cigars,” or “Short-Run Business Decisions”

• Sorting out therelevant costs

• “Contribution” or“full cost profit” asthe “metric”

• How to best treatfixed or commoncosts

“Mission Positioning”Framework

• Build• Hold• Harvest• Divest

How to compete successfully to accomplish the chosen mission

• Low cost• Differentiation

ANALYZE• Suppliers• Customers• Substitutes• New entrants• Competitors

Framework for Strategic Cost Analysis