Case of Make Profit - Berkley 2006 5.13. Bicycle Manufacturer

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Problem

  • Your client is a manufacturer of bicycles
  • They have been in business for 25 years
  • They manufacturer and sell three categories of bicycles:
    1. Racing bikes: High end, high performance bikes for sophisticated cyclists
    2. Mainstream bikes: Durable, but not overly complicated bikes for everyday riders
    3. Children’s bikes: Smaller, simpler versions of their mainstream bikes for children
  • Profits at your client have decreased over the past five years

Question

  • What is driving the decline in overall profits? -n What recommendations might correct the situation?

Analysis & More Background Data

Determine what has caused overall profits to decrease. To accomplish this, the candidate must first understand what has transpired in each of the three product categories over the past five years during which profitability has slipped.

The following are questions and answers that would be provided in an interview scenario.

  • What are the client’s margins for a bicycle in each of the three segments?
  • Racing: Cost = $600/unit, Profit=$300/unit
  • Mainstream: Cost = $250/unit, Profit = $75/unit
  • Children’s: Cost = $ 200/unit, Profit = $50/unit

Market Size means total PROFIT of WHOLE market

  • What has happened to the market size of each of the three segments over the past five years?

  • Racing: Has remained constant at its present size of $300MM

  • Mainstream: Has increased at 2% growth rate per year to its present size of $1.0B
  • Children’s: Has increased at 3% growth rate per year to its present size of $400MM

  • What has happened to our client’s market share in each of these segments?

  • Racing: Market share has decreased from 60% to 30%

  • Mainstream: Market share has increased from 0% to 5%
  • Children’s: Market share has increased from 0% to 3%

  • Who are the client’s major competitor’s in each market segment? What has happened to their market share in each segment over the past five years?

  • Racing: There is one main competitor and a host of small firms. Your main competitor has increased market share from 30% to 50% Haas Consulting Club Case Book 42

  • Mainstream: There exist many, large competitors, none of which holds more than 10% of the market
  • Children’s: As in the mainstream segment, there are many competitors, none with more than 10% of the market

Ask for More Information

The above information provides enough information to put together a picture of why profits have decreased over the past five years : Your client, with a commanding position in a flat market segment (racing), expanded into new segments (mainstream and children’s).

As this occurred, market share decreased dramatically in the most lucrative segment (racing), creating an unfavorable mix.

The extent to which profits have decreased can be deduced from some quick math : profits have slipped from $60MM five years ago (=60% x $300MM x 33% racing margin) to $44MM today ( = (30% x $300MM x 33% racing margin) + (5% x $1B x 23% mainstream margin) + (3% x $400MM x 20% children’s margin))

Target ONLY the no-sense part - why? Anything change in product/company/competitor? ASK QUESTION!

The dramatic decrease in market share in the racing segment is at this point still unexplained. Questions that would help formulate an explanation include:

  • Have there been any major changes in product quality in your client’s racing product? Or in its main competitor’s racing product? No

  • Have there been any major price changes in your client’s racing product? Or in its main competitor’s racing product? No

  • Have there been any major changes in distribution outlets for your client’s racing product? Or for its main competitor’s racing product? Yes. Previously your client and its main competitor in the racing segment sold exclusively through small, specialty dealers. This remains unchanged for the competition. Your client, however, began to sell its racing bikes through mass distributors and discount stores (the distribution outlets for mainstream and children’s bikes) as it entered the mainstream and children’s segment.

  • How do the mass distributors and discount stores price the racing bikes relative to the specialty stores? Prices at these stores tend to be 15 to 20% less.

  • What percent of your client’s racing sales occur in mass distributors and discount stores? Effectively none. This attempt to sell through these distributors has failed

  • How has the decision to sell through mass distributor’s and discount stores affected the image of the client’s racing product? No studies have been done.

  • How has the decision to sell through mass distributor’s and discount stores affected your client’s relationship with the specialty outlets? Again, no formal analysis has been performed.

Answer - Revenue

There has been no appreciable change in either quality or price (or any other tangible factor) of your client’s racing product relative to its competition. It is not the product that is the problem, but rather its image.

As your client came out with lower end, mainstream, and children’s products and began to push their racing segment through mass distributors and discount outlets, their reputation was compromised.

Additionally, the presence of the racing products in the discount outlets has put your historic racing distributor (the specialty shops) in a precarious position. The specialty shops must now lower price to compete, thereby cutting their own profits. Instead, they are likely to push the competition’s product.

Answer - Cost

After checking with Revenue, DO NOT FORGET COST!

  • How does the client account for its costs? The client has a single manufacturing and assembly plant. They have separate lines in this facility to produce racing, mainstream and children’s products. They divide their costs into the following categories: labor, material and overhead. Overall costs have been increasing at a fairly hefty rate of 10% per year.

  • What is the current breakdown of costs along these categories for each product segment? Racing: Labor = 30%, Material = 40%, Overhead = 30%; Mainstream: Labor = 25%, Material = 40%, Overhead = 35%; Children’s: Labor = 25%, Material = 40%, Overhead = 35%

  • How has this mix of expenses changed over the past five years?In all segments, labor is an increasing percentage of the costs.

  • Does the basic approach to manufacturing (i.e. the mix of labor and technology) reflect that of its competition? Your client tells you that there is a continuing movement to automate and utilize technology to improve efficiency throughout the industry, but it is his/her opinion that their approach, maintaining the “human touch”, is what differentiates them from the competition. (Unfortunately, he’s right!!)

  • Is the workforce unionized? Yes

  • What is the average age of the workforce? 52 and climbing. There is very little turnover in the workforce.

  • What is the present throughput rating? How has it changed over the past five years? Presently the plant is producing at about 80% of capacity. This has been decreasing steadily over the last several years.

  • What is the typical reason for equipment shutdown?Emergency repair

  • Describe the preventive maintenance program in effect at the client’s facility? Preventive maintenance is performed informally based on the knowledge of senior technicians.

  • How often has equipment been replaced? Is this consistent with the original equipment manufacturer’s recommendations? The client feels that most OEM recommendations are very conservative. They have followed a philosophy of maximizing the life of their equipment and have generally doubled OEM recommendations.

The above information is sufficient to add some understanding to the cost side of the equation. Your client has an aging workforce and plant that is behind the times in terms of technology and innovation. This has contributed to excessive breakdowns, decreased throughput, increased labor rates (wages increase with seniority) and greater labor hours (overtime to fix broken machines).

Recommendation

Abandon the mainstream and children’s segment to recover leadership in the racing segment

Issues to consider in this approach

  • How much of the racing segment is “recoverable”?
  • What are the expected growth rates of each segment?
  • How badly damaged is the relationship with the specialty outlets?
  • Are there alternative outlets to the specialty shops such as internet sales? o How will this move affect overall utilization of the operating facilities?

Maintain the mainstream and children’s segment, but sell under a different name

Issues to consider in this approach

  • Is there demand among the mass and discount distributors for bicycles under their name?
  • What additional advertising and promotions costs might be incurred?
  • What are the expected growth rates of each segment? -What is driving the buying habits of the mainstream and children’s market?

Reduce costs through automation and innovation

Issues to be considered

  • What technological improvements are to be made?
  • What are the required investments?
  • What are the expected returns on those investments?
  • How will these investments affect throughput?
  • To which lines are these investments appropriate?
  • Are the mainstream and children’s segments potentially “over-engineered”?
  • What impact will this have on the required workforce levels?
  • If layoffs are required to achieve the benefits, what impact will this have on labor relations?

Reduce costs through establishing a formal preventive maintenance program

Issues to be considered

  • What organizational changes will be required?
  • What analysis will be performed to determine the appropriate amount of PM?
  • What training is required of the workforce?
  • What technical or system changes are required?
  • How will the unionized workforce respond?
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