Individual Case Summary forCrafton Industries, Inc.

The Problem. Crafton Industries, Inc. faces the following problem with regards to deciding what their target distribution channel is:  Should Crafton industries modify its distribution channel in light of intensifying price competition and increasingly costly demands from its current wholesalers? Recommendation. Based on the analysis below of the costs associated with a wholesaler versus direct distribution channel, Crafton Industries should not modify its current distribution process. Crafton Industries should consider the following decision factors as proof that direct distribution would be the wrong transition. Profit Potential and Market Share. Presently, Crafton Industries is operating with a net profit of $3 million dollars despite not being in the top five of U.S Carpet and Rug Manufacturers. The top five manufacturers account for 75% of the market sales. Crafton is a not a dominant force and could be risking the small market share that it has been acquired through the years. Crafton Industries conversion could be a very risky move because present wholesalers have threatened a mass exodus. The exodus would affect the profit potential for the coming year of the company and negatively affect consumers until the new direct distribution centers were built. Due to the 2007 recession much of the floorcovering industry had to deal with significant losses in sales. The number of manufacturers decreased significantly and yet Crafton Industries managed to survive. Making a drastic change to a new form of distribution could further impact Crafton’s potential to obtain more market share, which was limited already. Working Capital. Presently, Crafton Industries has working capital of $16,625,000 million which technically would sufÏce to cover the estimated direct distribution costs. However, it is important to note that Crafton could possibly not be accounting for all the costs associated with the new distribution channel since it is an estimate. Adopting direct distribution would require Crafton to assume all new costs. Some direct distribution costs Crafton would assume would be inventory losses, sale losses during transition, fixed costs, as well as any development and training challenges with the sales team. The wholesaler distribution costs, on the other hand, are more predictable and discussed with wholesalers prior to service beginning. The unplanned costs could lead Crafton to have a working capital deficit where liabilities exceed the assets of the firm. Competition. In prior years, the largest manufacturer of carpets and rugs, Shaw Industries, attempted to engage in direct distribution by purchasing some retail chains. Many wholesalers and other retailers boycotted and switched to other manufacturers in response. Shaw Industries sold the acquired retail chains after only three years due to a significant loss of sales. Crafton Industries should use Shaw Industries as a primary example of why direct distribution is not a preferred method to reduce costs. Crafton should see the same expected response engaging in direct distribution from present retailers. 1 Buying Groups. Many retailers formed buying groups in pursuit of lower prices based on purchasing larger quantities directly from the manufacturer. Although buying groups serve as an incentive to focus on direct distribution for Crafton Industries because of the larger quantities increasing sales. Retail groups could become increase Crafton Industries delivery and transportation costs because of the many retailers in one buying group. Buying groups could make delivery costs significantly variable which could require Crafton to seek financing to cover product costs. 2 Table 1: Wholesaler vs. Direct Distribution Costs - Side by Side Margins Provided Service Cost Accounts Receivable Carrying Cost Total Estimated Costs Wholesaler Distribution Costs1 $ 13,500,000 $ 3,240,000 $ 1,330,049 Warehouse Expenses Sales Representatives Sales Managers Direct Distribution Costs2 $ 4,900,000 $ 2,240,000 $ 320,000 $18,070,049 Sales Administration $ 1,024,000 Inventory Carrying Cost Accounts Receivable Carrying Cost Delivery/Transportation $ 1,013,000 $ 1,664,000 Total Estimated Costs $ 13,681,000 $ 2,700,000 ______________________________________________________________________________ Wholesaler vs. Direct Distribution Costs Computations 1 All relevant computations are located on Table 2. 2 All relevant computations are located on Table 3. 3 Table 2: Costs Associated with Wholesaler Distribution Wholesaler Distribution Costs Margins Provided1 Service Cost2 Accounts Receivable Carrying Cost 3 Total Estimated Costs4 Average Accounts Receivable5 Total Accounts Receivable6 $ 13,500,000 $ 3,240,000 $ 1,330,049 $18,070,049 $ 133,004,923 $ 54,000,000 ______________________________________________________________________________ Wholesaler Distribution Costs Computations 1 Margins Provided = $54,000,000*0.25 = $13,500,000 2 Service Cost = $54,000,000 * 0.06 = $3,240,000 3 Accounts Receivable Carrying Cost = 133,004,923*.10 = $1,330,049 4 Total Estimated Costs = Margins Provided + Service Cost + AR Carrying Cost 5 Average Accounts Receivable = 54,000,000/4.06 = $133,004,923 6 Total Accounts Receivable = 75,000,000*.72 = $54,000,000 4 Table 3: Costs Associated with Direct Distribution Direct Distribution Costs Warehouse Expenses1 Sales Representatives2 Sales Managers3 Sales Administration4 Inventory Carrying Cost5 Accounts Receivable Carrying Cost 6 Delivery/Transportation7 Total Estimated Costs8 Total Accounts Receivable9 $ 4,900,000 $ 2,240,000 $ 320,000 $ 1,024,000 $ 1,013,000 $ 1,664,000 $ 2,700,000 $ 13,681,000 $ 67,500,000 ______________________________________________________________________________ Direct Distribution Costs Computations 1 Warehouse Expenses = Fixed Cost $700,000*7 warehouses = $4,900,000 2 Sales Representatives = 32 reps. *$70,000 = $2,240,000 3 Sales Managers = 4 managers * $80,000 = $320,000 4 Sales Administration = $(2,240,000+320,000) *0.40 = $1,024,000 5 Costs of Residential Sales =(COGS*0.72) = $56,250,000*0.72=$40,500,000 Average Inventory = $40,500,000/4 = $10,125,000 Inventory Carrying Cost = $10,125,000*.10 =$1,012,500 ≈ $ 1,013,000 6 Accounts Receivable Carrying Cost = $67,500,000*(90/365 days) = $16,643,835.62 ≈ 16,644,000*0.10 =$1,664,000 7 Delivery/Transportation Cost= $67,500,000*0.04=$2,700,000 8 Total Estimated Costs = Costs #1 through #7 added =$13,681,000 9 Total Accounts Receivable = $54,000,000 * 1.25 = $67,500,000 5 Table 4: Working Capital Available Fiscal Year Ending June 30, 20101 Current Assets $ 26,937,500 - (Current Liabilities) $ (10,312,500) = Working Capital Available2 $ 16,625,000 ______________________________________________________________________________ Working Capital Computations 1 Figures obtained from Exhibit 3 in case, Pg. 434 2 Working Capital = Current Assets - Current Liabilities 6