Foundation Broad Cost Leader

FOUNDATION BROAD COST LEADER This practice exercise will help you understand the relationships between business strategy, tactics, functional alignment, and the Foundation simulation. We will use the Chester Company for this example. (During the practice rounds, each company is assigned a different strategy.) You will execute your plan by inputting the decisions described below. At the same time, your competitors will execute their assigned plans. The practice exercise will take three rounds As each round is processed, you will evaluate the results and then input the next round’s assigned decisions. Upon completion of the practice rounds, the simulation will be reset to the beginning. You can then create and implement your own strategic plan for the actual competition. Executive Summary The Chester team will adopt a Broad Cost Leader strategy, maintaining a presence in both segments. We will gain a competitive advantage by keeping R&D costs, production costs, and raw material costs to a minimum, enabling us to compete on the basis of price. Our Cost Leader orientation will allow us gain a competitive advantage based upon low prices. We will increase automation levels to improve our margins and to make it acceptable to run overtime (which we can also view as a second shift). Vision Statement Low priced products for the industry: Chester brands offer solid value. Our primary stakeholders are bondholders, customers, stockholders and management. Research and Development (R&D) We will keep our existing product line and launch one new product in order to maintain a presence in both the Low Tech and High Tech segments. We will work to keep our products up to date (i.e. Size and Performance) in each segment despite high automation levels. Marketing We will maintain awareness and accessibility. After we establish our cost leadership position we will revisit our situation to decide whether sales and promotion budgets should be reduced or if we should keep pace with our competitors. Our prices will be lower than average. Production We will significantly increase automation levels on all products. However, because automation sets limits upon our ability to reposition products with R&D, we automate more in the slower moving Low Tech segment than in the fast moving High Tech segment. We will prefer overtime to capacity expansions. Finance We will finance our investments primarily through long-term bond issues, supplementing with stock offerings on an as needed basis. When our cash position allows, we will establish a dividend policy and begin to retire stock. We are not adverse to leverage, and expect to keep debt/equity between 2.0 and 3.0. PRACTICE ROUND 1 Follow the decisions below. After the practice rounds are complete and the competition rounds begin, you are free to choose a different strategy; you are not obligated to continue as a Broad Cost Leader. R & D Round 1 Cake – Reduce reliability (MTBF) to reduce material cost. Example: Reduce MTBF from 21000 to 18000. Do not reduce MTBF below 17000 hours, because that is the lower limit of acceptable reliability (MTBF) for High Tech customers. New Product – Launch a new High Tech product, with a project length less than 2 years (no later than December of next year). Example: Name: Cedar (replace the first NA in the list), performance 9.0, size 11.0 and a reliability (MTBF) 20000. Important: Under the rules of the simulation, the names of all new products must have the same first letter as the name of the company. Important: With the exception of the new product, make certain that the projects complete during this year before December 31st. Under the rules, a new project can only begin on January 1st. If these projects do not complete before the end of this year, you cannot begin follow-up projects next year. Perceptual Map from the Research & Development Spreadsheet: Product names in black indicate the product’s current location, names in magenta indicate the product’s revised position (with slight revisions, the names will overlap). Names of newly invented products appear in magenta. Marketing Round 1 Cake – Make moderate price cuts and decrease promotion and sales budgets. Forecast unit sales near last year’s level. Example: Price $33.50, promotion budget $800, sales budget $800. Forecast sales of 1300 units. New Product – Marketing decisions will be made next year when the new product is ready to begin production. Production Round 1 Production schedules will plan for eight weeks of inventory. That is, have enough inventory on hand to meet demand eight weeks beyond the sales forecast. This requires a 15% inventory cushion (8/52 = 0.15). For example, suppose Marketing forecasts demand at 1000, and you have 100 units in inventory. You want 1000 x 115% = 1150 available for sale. Since you have 100 on hand, you would schedule 1050 for production. If you cannot meet demand, sales go to competitors. Therefore, you want to plan for the upside as well as the downside. Your proforma balance sheet will forecast about eight weeks of inventory. You hope that your actual sales will fall between your sales forecast and the number of units available for sale. Schedule production for your existing product using this formula: (Unit Sales Forecast X 1.15) - Inventory On Hand. New Product – Buy 300,000 units of capacity by entering 300 in the Buy Sell Capacity cell. Set an automation level of 3.0. Important: There is a one year lag between purchase and use of new capacity and automation for both new and existing products. Important: Make certain the Cake project completes during this year, before December 31st. Under the rules, a new project can only begin on January 1st. If a project does not complete before the end of this year, you cannot begin follow-up project next year. Finance Round 1 Your fiscal policies should maintain adequate working capital reserves to avoid a liquidity crisis. Working capital can be thought of as the money that you need to operate day-to-day. In Foundation working capital is current assets (cash + accounts receivable + inventory) - current liabilities (accounts payable + current debt). If you run out of cash because your sales are unexpectedly weak, an Emergency Loan will be issued. Here are some guidelines to help you avoid an Emergency Loan. Your proforma balance sheet predicts your financial condition at the end of this year. Make conservative sales forecasts. Do not rely on the benchmark prediction. Override it with a forecast of your own. If you are conservative, it is unlikely that your worst expectations will be exceeded. Next, build additional inventory beyond your conservative expectations. This forces your proforma balance sheet to predict a future where your sales forecast comes true and you are left with inventory. (If you sell the inventory, that’s wonderful.) On the Finance spreadsheet, issue stock, bonds or current debt until the December 31 Cash Position for the upcoming year equals at least five percent of your assets, as displayed on the proforma balance sheet. This creates an additional reserve for those times when your worst expectations are exceeded and disaster strikes. As you gain experience with managing your working capital, you will observe that the guidelines above make you somewhat “liquid,” and you may wish to tighten your policy by reducing cash and inventory projections. That is fine. The better your marketing forecasts, the less working capital you will require. Match your plant investment with a long-term bond. If you do not have sufficient new bond debt capacity, issue stock to cover the shortfall. Do not pay a dividend. Save decisions by selecting “Update Official Decisions.” PRACTICE ROUND 2 R & D Round 2 Cake – Improve positioning and reduce age. Reduce reliability (MTBF) to reduce material cost. Example: Increase Cake’s performance to 6.7, reduce size to 13.0, and reduce MTBF to 17000. New Product – Note that the new product’s row is yellow instead of green, and that you cannot change these cells. This is because your product will not emerge from R&D until its current project completes. Under the rules of the simulation, new R&D projects cannot begin until the old one completes. Marketing Round 2 Cake – Offer a price cut to $32.50. Hold promotion and sales budgets at $800. Cake will still sell to both Low Tech and High Tech customers. Enter a forecast of 1100. New Product – Price at $44.00, Promotion at $1000, Sales at $1000. Since Cedar won’t be ready to enter production until well into this year, so enter 200 for sales forecast. Production Round 2 Schedule production using the formula: (Unit Sales Forecast X 1.15) - Inventory On Hand Important: As your new product is coming out sometime during the year, you might not be able to use the above formula – new products cannot begin production prior to their revision (release) date. Should the number you enter into the production schedule turn red, reduce the schedule until the red number turns black. Cake – Increase automation by 1.0 points. New Product – Increase automation level, but only by 1.0 points. We will want to begin repositioning it next year in order to keep it fresh for High Tech customers. The higher the automation rating, the more difficult it is to reposition. We must strike a balance between our cost pressure requirements vs. our need to reposition often. FINANCE ROUND 2 Match your plant investment with a long term debt (bond). If you do not have sufficient new bond debt capacity, issue stock to cover the shortfall. For this round, look at the proforma balance sheet and apply the following rule of thumb. Keep your cash account in between 6% and 10% of your projected sales for the following round. To do this, look at your proformas income statement to see your projected Total Sales. Take the listed Total Sales and make sure that your Cash account on your proformas balance sheet is 6%-10% of that number (Ex: Proformas Cash/Proformas Total Sales = Number between .06 & .10). Adjust your cash position to meet the above guidelines. If you are cash rich, pay dividends and buy back stock. Do not issue current debt. Save decisions by selecting “Update Official Decisions.” PRACTICE ROUND 3 R & D Round 3 Cake – Reduce reliability (MTBF) to reduce material cost. Example: Reduce Cake’s MTBF to 14000. New Product – Slightly improve the product to reduce its age. Reduce Reliability to 19000 MTBF. Marketing Round 3 Cake – Offer a price cut. Slightly reduce promotion and sales budgets. Cake will now be a Low Tech product, therefore the sales forecast should adjust for the loss of High Tech sales. Example: Price $32.00, promotion budget $750, sales budget $750, and sales forecast 1100. New Product – Offer a price cut to $43.00. Keep promotion and sales budgets steady. Enter a sales forecast of 500. Production Round 3 For each product, schedule production using the formula: (Unit Sales Forecast X 1.15) - Inventory On Hand New Product – Buy 200,000 units of capacity by entering 200 in the Buy Sell Capacity cell. Finance Round 3 Match your plant investment with a long term bond. If you do not have sufficient new bond debt capacity, issue stock to cover the shortfall. Follow the guidelines from last round to manage your cash position. If you are cash poor, issue stock. If you are cash rich, pay dividends and buy back stock. Do not issue current debt. Save decisions by selecting “Update Official Decisions.” SUMMARY CONSIDERATIONS Your instructor may want you to play another practice round. If so, continue the Broad Cost Leader vision. Having executed the plan for two or three rounds, you are now in a position to analyze it. Consider the following questions: What are this plan’s strengths? Weaknesses? How will competitors respond to your actions? How can you influence competitors to avoid competing with you directly? Which performance measures support this plan? What is the long range potential of this plan? Its future sales volume? Its future profitability? How can you best coordinate this plan as a team?