Situational Analysis

SITUATION ANALYSIS The Situation Analysis is a team exercise designed to help your group understand the current market conditions and how the industry will evolve over the next eight years. There are five parts to the analysis: • • • • • Perceptual Map Demand Analysis Capacity Analysis Margin Analysis Consumer Report The analysis can be done as a group, or you can assign the parts to individuals and then report your findings to the rest of the team. At the end of this exercise you will understand: • How technology will reshape customer expectations over the next eight years. This will drive your overall strategic vision; • How demand will increase, and how that will affect your investments in capacity; • How much money you can make. That is, determine the profit potential in a best-case scenario; • How customers perceive you and your competitors today. Is there room for improvement? PERCEPTUAL MAP This task examines how technology will shape your industry in the future. In the CAPSTONE® sensor industry, the most basic customer concerns are: How big is the sensor? How well does it perform? Think of the sensors in your car. They measure things like pressure, speed, and temperature. In general, smaller sizes are preferable to bigger sizes and higher performance levels (sensitivity, speed, etc.) are better than lower performance levels. Figure 1 shows the Perceptual Map from the Round 0 (Starting Conditions) CAPSTONE® COURIER. Imagine the Perceptual Map as a pan of water. If you dropped a pebble in the upper-left corner, you would see a wave advance across the map towards the lower-right. Three customer 1 SITUATION ANALYSIS FIGURE 1 Perceptual Maps allow teams to assess the merits of competing products relative to customer needs. groups ride this wave of technology, Performance, High End and Size. Behind the wave are the two low technology segments, Traditional and Low End. The dark inner circles have a radius of 2.5 units. They represent the heart of the segments. You want to know: • Where the segments will be in each future round. That is, how fast are the segments moving and in what direction? • Where the highest customer concentration or Ideal Spot is located within each segment. The dashed outer circles have a radius of 4.0 units. They represent the absolute outer fringe of the segment. There are no customers beyond the dashed circles. PLOT THE SEGMENT LOCATIONS FOR EACH ROUND The map axes are numbered from 0 to 20. These numbers are used to plot product and segment locations. Inside each segment there is also an Ideal Spot where customers are most concentrated. 2 Table 1 lists the segment center points at the conclusion of each round. Plot this information on Figure 1 (or page 11 of the Capstone® COURIER). Some students plot only the segment center points. Others prefer to draw a circle with a radius of 2.5 units around each segment center. PERCEPTUAL MAP TABLE 1 Segment center positions at the conclusion of each round Round Segment Traditional Low End High End Performance Size Coordinates 0 Performance Size 8 9.2 9.9 10.6 15.0 14.3 13.6 12.9 12.2 11.5 10.8 10.1 9.4 2.5 3.0 3.5 4.0 4.5 5.0 5.5 6.0 6.5 17.5 17.0 16.5 16.0 15.5 15.0 14.5 14.0 13.5 14.7 7.5 8.4 9.3 10.2 11.1 12.0 12.9 13.8 12.5 11.6 10.7 9.8 8.9 8.0 7.1 6.2 5.3 8.0 9.0 10.0 11.0 12.0 13.0 14.0 15.0 16.0 17.0 16.3 15.6 14.9 14.2 13.5 12.8 12.1 11.4 3.0 3.7 4.4 5.1 5.8 6.5 7.2 7.9 8.6 12.0 11.0 10.0 9.0 8.0 7.0 6.0 5.0 4.0 center of the segment. That is, as a segment drifts, the Ideal Spot drifts with it. Use Form 1 to determine each segment’s Ideal Spot for the next eight years. For example, using Table 1, find the High End segment centers for each round. Next, add 1.4 to performance and subtract 1.4 from size. Enter the results in the High End performance and size rows. TABLE 2 Ideal Spot locations relative to segment POINTS TO CONSIDER FOR YOUR STRATEGY Here are a few points to draw from the Perceptual Map: 1. If you never move your products (by repositioning them in R&D), segments will drift past them. A product could easily wind up outside of all segment circles centers Performance Low End 7 8.5 An Ideal Spot is the area of highest buyer concentration within a segment. Table 2 identifies the Ideal Spot locations relative to the segment centers. The segment Ideal Spot is always in the same position relative to the Traditional 6 7.8 FIND THE IDEAL SPOT LOCATIONS FOR EACH SEGMENT Segment 5 7.1 Performance Size 4 6.4 Performance Size 3 5.7 Performance Size 2 5.0 Performance Size 1 Size 0.0 0.0 -0.8 0.8 High End 1.4 -1.4 Performance 1.4 -1.0 Size 1.0 -1.4 Form 1 Round Segment Traditional Low End High End Performance Size Coordinates 0 1 2 3 4 5 6 7 8 Performance Size Performance Size Performance Size Performance Size Performance Size 3 SITUATION ANALYSIS Form 2 Segment Round 0 Growth Rate Traditional 9.2% Low End 11.7% High End 16.2% Pfmn 19.8% Size 18.3% Round 1 Round 2 where there are no customers. On the other hand, if you never repositioned a product that began in the High End, it would eventually become a Traditional product and then a Low End product. Customer segments move with or without you, and they advance a little every month. 2. Since you must reposition your products anyway, you could concentrate them in segments that interest you. You do not have to be in every segment. 3. In the high technology segments (High End, Performance and Size), proximity to the Ideal Spot is important. In the low technology segments (Traditional and Low End), proximity is not very important. In all segments, being inside the Fine Cut circle is extremely important, and being inside the Rough Cut circle is critically important. DEMAND ANALYSIS This task examines industry growth. Is the industry growing or shrinking? Are the segments growing at the same rate? An accurate estimate of future demand is critical to your strategy. Fortunately, the publishers of the CAPSTONE® COURIER have developed precise estimates of current demand and segment growth rates. For this exercise you need the Segment Analysis pages (pages 5 - 9) of the CAPSTONE® COURIER. To analyze the demand for each segment, find base demand at the 4 Round 3 Round 4 Round 5 Round 6 Round 7 Round 8 start of the game (Round 0), then calculate demand for Rounds 1 through 8 of the game. 1. At the top of each Segment Analysis page you will find a box called Statistics. Copy the Total Industry Unit Demand number into the Round 0 column of Form 2. 2. Given the growth rates in Form 2, calculate demand for Rounds 1 through 8. Market segments grow at a constant yearly rate. The growth rates are also found in the Statistics box on the Segment Analysis pages. POINTS TO CONSIDER FOR YOUR STRATEGY Here are two points to consider for your strategy: 1. Overall, the market is growing at about 14% per year. Last year your company did roughly $100 million in sales. By implication in Round 1 the average company will do about, $114 million, in Round 2, about $130 million, etc. The average company should double in size in six years. 2. It is easy to confuse unit market size with dollar market size. Although unit volume is higher in the low technology segments (Traditional and Low End), customers are price sensitive and prices are likely to fall over time. High technology customers (High End, Performance, and Size) are less price sensitive, and although prices will decay somewhat, they are more likely to stay high. CAPACITY ANALYSIS Form 3 Segment Product Name First Shift Capacity(000) Firm Traditional 1,800 Industry Second Shift Capacity(000) Firm 3,600 Automation Level Cost to Double Capacity Cost to Raise Automation to 10.0 4.0 $39.6M $43.2M Industry Low End High End Pfmn Size CAPACITY ANALYSIS This task examines industry capacity. Does the industry have adequate capacity to serve the market? Are some segments under capacity or over capacity? If we double the size of our company, how much will we need to invest in plant and equipment? For this exercise you need the Production Analysis (page 4) of the CAPSTONE® COURIER. We need three pieces of information from the Production Analysis. Product Names: Copy the name of your company's product for each segment into Form 3. Capacity: Copy the value for “Capacity Next Round” into the column under “First Shift Capacity, Firm.” Automation Level: Copy the value for “Automation Next Round” into the “Automation Level” column. We need to find the Industry Capacity so that we can compare it with the unit demand. Multiply your “First Shift Capacity” by the number of teams and place the result in the “First Shift Capacity, Industry” column. You can produce up to twice the rated capacity by running a Second Shift. Double your “First Shift Capacity, Firm” and place the result in the “Second Shift Capacity, Firm” column. Double the “First Shift Capacity, Industry” and place the result in the “Second Shift Capacity, Industry” column. Tip: Second Shift incurs a time-and-a-half labor charge as well as Recruiting and Training costs. This could significantly affect the margins for your products. From the Demand Analysis we know that the market will double in size within six years. We can address this issue in two ways: We can double our capacity or we can increase our automation levels and make ourselves less sensitive to Second Shift wages. WHAT WOULD IT COST TO DOUBLE OUR CAPACITY? Adding one additional unit of capacity costs: $6 + ($4 x Automation Level) Think of it this way. It costs you $6 per unit to prepare the floor space. On the floor you place an assembly line with automation level of 1.0 to 10.0. Each point of automation costs $4. For example, the floor space for an assembly line that makes 1,000 units per year costs $6,000. If it is a simple line with an automation level of 1.0, it costs another $4,000 to buy the line (total $10,000). With an automation level of 10.0, the line costs $40,000 (total $46,000 with floor space). The simple assembly line takes many workers to operate. The expensive line takes few workers. We can summarize this with the formula: Capacity x [ $6 + ($4 x Automation) ] = Investment 5 SITUATION ANALYSIS Tip: This investment is automatically calculated by the Production screen. Currently the Traditional product has 1.8 million units of capacity (this is shown in thousands, as 1,800) and an automation of 4.0. If we buy an additional 1.8 million units of capacity, we will invest: 1,800,000 x [ $6 + ($4 x 4.0) ] = $39,600,000 This investment is already entered in Form 3. Calculate the investments for the remaining products and place the results in the “Cost to Double Capacity” column. Tip: Changes in capacity affect labor, recruitment, training and separation costs. WHAT WOULD IT COST TO MAXIMIZE AUTOMATION? What if we took a different approach? We could hire a Second Shift, but then we must pay our Second Shift workers rates of 150% of the normal wage. If we maximize automation by bringing each line to 10.0, we would have fewer workers and would become indifferent to running a Second Shift. To get the Traditional product to an automation of 10.0, we need to increase automation 6.0 points. We do not need additional floor space because we are upgrading our existing machines. Our formula produces the following investment: 1,800,000 x [ $0 + ($4 x 6.0) ] = $43,200,000 This investment is already entered in Form 3. Using this formula, substitute the capacity and automation levels for the remaining lines. Enter the results in the “Cost to Raise Automation to 10.0” column. We must also consider the impact automation has when products are repositioned on the Perceptual Map. In general, we can classify repositioning into two types of projects, short moves and long moves. Short moves are used to keep up with the segment drift rates. Segments move 6 at speeds between 0.7 units per year and 1.3 units per year. If we want to keep up with the segment, we need to move a short distance each round. Short moves also keep the product's age down. Short moves depend upon a flexible workforce that can make incremental improvements instead of big leaps, and that implies relatively low automation levels. The higher the automation level, the longer it takes to do a short move. Tip: As a rule of thumb, you can automate to 5.0 or 6.0 in any segment and keep up with the drift rate with short moves every round. Long moves are used to reposition products to different segments, or to move from the trailing edge of a segment to the leading edge. The move takes place in one big leap. During the R&D project, the product sits at its original location getting older. Long moves are comparable to retooling, and they are indifferent to automation levels. A big move (say 4 units on the map) can be accomplished in 2.5 to 3 years. Tip: Changes in automation affect labor, recruitment, training and separation costs. POINTS TO CONSIDER FOR YOUR STRATEGY Here are five points to consider for your strategy: 1. The average company will invest between $100 and $200 million in plant and equipment during the next eight years to keep up with market growth and improve efficiencies. 2. Capacity in a segment can vary greatly from one round to the next. Old products can exit a segment. New products and repositioned products can enter. As they enter and exit, their production capacity moves with them. 3. Segments that are short of capacity are quite different than segments with too much capacity. Capacity shortages often lead to product shortages and a Seller’s MARGIN ANALYSIS Form 4 Segment Product Name Price Material Cost Labor Cost Second Shift (Y/N) Traditional Contribution Margin $ % N Low End Y High End N Performance N Size N Margin Potential Traditional $30.00 $8.00 $3.36 Low End N $18.64 62% N High End N Performance N Size N Market. Capacity excesses lead to overproduction and a Buyer’s Market. segments offer the same opportunity? What drives our margins? 4. These two states do not gradually shift from one to the other. They are more like ice and water. A little under capacity and you can price high and sell everything. A little over capacity and the power shifts to the customer. Then you must compete on the merits of your product. 5. Check Plant Utilization every round (Production Analysis, page 4 of the CAPSTONE® COURIER). Plant utilization of 100% means that you are running one complete first shift. At two full shifts, utilization is 200%. If a plant is utilizing below 100%, consider liquidating capacity. Conversely, if a plant is close to 200% utilization, consider adding capacity to meet demand. Fast moving, high tech segments tend to favor additional capacity over increased automation because they can make short moves more easily. Slow moving low tech segments favor automation over capacity because customers are willing to tolerate higher ages and poorer positioning. For this exercise you need the Production Analysis (page 4) of the CAPSTONE® COURIER and the five Segment Analysis pages (5 through 9). MARGIN ANALYSIS This task examines profit potential. How much money could we make? Do all We need four pieces of information from the Production Analysis: • • • • Product Name Price Material Cost Labor Cost Copy this information to the top section of Form 4. We will use it to explore our current situation. Calculate the current Contribution Margin Per Unit for each product. Contribution Margin is simply price minus material cost minus labor cost. As an example, if a product’s price were $20, its material $8 and its labor $7, the Contribution Margin Per Unit would be: $20 - $8 - $7 = $5 Next, calculate the current Contribution Margin Percentage for each product. This is simply Contribution Margin Per Unit divided by the Price. Continuing with the example above, if the Contribution Margin Per Unit were $5 and the Price $20, then the Contribution Margin Percentage would be: 7 SITUATION ANALYSIS MTBF drives material costs at the rate of $0.30 per 1,000 hours of reliability. $5 / $20 = 25% MARGIN POTENTIAL In the bottom of Form 4 we will explore the upper limits of profitability. The highest Contribution Margin would be the highest price less the lowest possible material and labor costs. We will need the upper price limits for each segment. These are found on the Segment Analysis pages in the boxes called Customer Buying Criteria. Enter the upper price limit for each product in the bottom part of Form 4 ($30.00 for the Traditional segment is already entered). RELIABILITY AND POSITIONING COMPONENT COSTS Material costs are driven by two components: • The MTBF specification (the Reliability Component Cost); and • The positioning on the Perceptual Map (the Positioning Component Cost). Higher reliability, higher performance and smaller size, result in higher material costs. It follows that the lowest possible material costs are produced by lower reliability, bigger size, and poorer performance. TABLE 3 Material Positioning Component Costs for Fine Cut Circle (Approximate) Trailing Edge Leading Edge Traditional $3.80 $7.80 Low End $1.00 $5.00 High End $6.00 $10.00 Performance $4.50 $8.50 Size $4.50 $8.50 TABLE 4 Minimum Material costs for the Traditional segment Trailing Edge Positioning Component Cost Minimum Reliability Component Cost Total 8 $3.80 $0.30/1,000 x 14,000 = $4.20 $8.00 The Reliability Component Cost of a product with a 17,000 hour MTBF rating is: $0.30 / 1,000 x 17,000 = $5.10 Each segment expects a minimum MTBF found in the Customer Buying Criteria box on the Market Segment Analysis pages. For example, the minimum acceptable reliability in the Traditional segment is 14,000 hours, which produces a Reliability Component Cost of: $0.30 / 1,000 x 14,000 = $4.20 To understand the Positioning Component Cost, recall the analogy used to describe the Perceptual Map earlier in this chapter. If the map were a pan of water, and you drop a pebble in the upper-left corner, a wave front of technology would roll across the map towards the lower-right corner. Material costs are highest at the wave front, and fall steadily with distance behind the wave. They are highest at the leading edge of the High End segment, and lowest at the trailing edge of the Low End segment. Similarly, Positioning Component Costs are higher at the leading edge of a segment than at the trailing edge. The Fine Cut Circle costs are listed in Table 3. Last year, at the leading edge of the Traditional segment, Positioning Component Costs were approximately $7.80. At the trailing edge of the Traditional segment Positioning Component Costs were approximately $3.80. ADDING THE COMPONENT COSTS In the Margin Potential portion of Form 4, estimate the minimum combined material cost. To do this, add the trailing edge Material Component Cost in Table 3 to the minimum Reliability Component Cost for each segment (see the example in Table 4). MARGIN ANALYSIS LABOR COSTS To illustrate labor costs, we will assume last year that the base labor cost was $11.20 per unit (this is not the actual labor cost). The base labor cost is defined as the cost to produce a unit using First Shift labor on a production line with the lowest possible automation. In CAPSTONE®, all production lines must have an automation rating of at least 1.0. Tip: Remember, unit costs increase when a Second Shift is deployed, and as Wage and Benefit escalators take effect. To estimate the lowest possible labor costs, we must assume a high automation level, no Second Shift, and a favorable labor contract. Using $11.20 as the base labor cost per unit (when automation is at 1.0), labor costs fall $1.12 (10%) for every point increase of automation. When 9.0 points are added to the automation level (bringing it to 10.0), labor costs fall to $1.12 per unit. In the Margin Potential section of Form 4, enter an estimate for per unit labor costs using the following assumptions: • • • • Base labor cost of $11.20 per unit No Second Shift No annual wage increase Automation levels as follows: Traditional 8.0 Low End 10.0 High End 5.0 Performance 6.0 Size 6.0 Tip: In the high technology segments (High End, Performance and Size) the automation levels should be lower than the low technology segments (Low End and Traditional) because R&D projects become increasingly difficult with higher automation. “BEST CASE” MARGIN POTENTIAL We now have all the information we need to determine a “Best Case” margin potential and complete the Contribution Margin columns in the Margin Potential section of Form 4. For example, in the Traditional market, the top price in the segment is $30. The minimum Cost of Goods Sold is: $8.00 + $3.36 = $11.36 Therefore, the highest Contribution Margin is: $30 - $11.36 = $18.64 The Contribution Margin Percentage is: $18.64 / $30 = 62% How realistic is this Contribution Margin? Not very, yet margins above 50% do occur regularly within CAPSTONE®. Much depends on the competitive environment. It is important to know, however, where the upper limits lie. POINTS TO CONSIDER FOR YOUR STRATEGY It is unlikely that you could do much better than the Contribution Margins in Form 4, but not impossible. For example, supUse the formula below to calculate per pose that you have the only product in the unit labor costs for each segment: High End segment. In this happy monopolis[ $11.20 - (Automation x $1.12) ] + $1.12 = Unit Cost tic environment, you could automate to 10.0, drop MTBF to the bottom of the range, and For example, labor costs for Traditional raise your price $4.99 above the posted price products made on a line with an automation range. Of course, the opportunity was created level of 8.0 are: when your competitors exited the segment. [ $11.20 - (8.0 x $1.12) ] + $1.12 = $3.36 It follows that you must keep an eye on competitors to “keep them honest.” 9 SITUATION ANALYSIS Form 5 Traditional Price Low End Price High End Price Performance Price Size Price Reliability Reliability Reliability Reliability Reliability Age Age Age Age Age Positioning Positioning Positioning Positioning Positioning Awareness Awareness Awareness Awareness Awareness Accessibility Accessibility Accessibility Accessibility Accessibility Overall Overall Overall Overall Overall CONSUMER REPORT Awareness: Award a Good if your product’s awareness exceeds 80%, Fair if it is 50% to 80% and Poor if it is below 50%. This task examines what our product offers to customers. Is there room for improvement? If our competitors increase the rivalry, how can we respond? For this exercise you need the Production Analysis (page 4) of the CAPSTONE® COURIER and the five Segment Analysis pages (5 through 9). The Customer Buying Criteria box on each Segment Analysis page lists what customers want and how important each product characteristic is to them. In Form 5, evaluate each of the products in relation to these criteria. Rate each product as follows: Accessibility: Award a Good if your product's accessibility exceeds 80%, Fair if it is 50% to 80% and Poor if it is below 50%. Your Overall assessment should consider the relative importance of the Buying Criteria listed on the Segment Analysis pages. For example, in the Traditional segment, age is the most important criteria, accounting for 47% of the purchase decision. Reliability is least important criteria, accounting for only 9% of the purchase decision. In the Overall row, give your products a Good only if the top two attributes rate Good, and if the awareness and accessibility ratings are at least Fair. G = Good F = Fair P = Poor Price: Award a Good if your product's price is in the bottom third of the expected price range, Fair if it is in the middle third and Poor if it is in the top third. Reliability: Award a Good if the MTBF specification is in the top third of the range, Fair if it is in the middle third and Poor if it is in the bottom third. Age: Award a Good if the age on December 31 is within 0.5 years of the ideal age, Fair if the age is 0.6 to 1 year and Poor if the age is beyond 1 year. Positioning: Award a Good if your product is within 0.5 units of the segment's Ideal Spot, Fair if it is 0.6 to 1.5 units away and Poor if it is beyond 1.5 units. 10 When you finish, compare your results with the December Customer Surveys on the Segment Analysis pages. The scale is 0 to 100. If 0, it means that customers refused to purchase the product in December, although they did buy it sometime earlier in the year (perhaps it was repositioned). A score below 25 can be considered Poor, 26 to 50 Fair, and above 50 Good. A solid product line is fundamental to all Differentiation Strategies, which offer superior products to generate high demand, then increase price to trade off some of that demand for higher margins. POINTS TO CONSIDER FOR YOUR STRATEGY Here are five points to consider: 1. Strive to give your customers the top two Buying Criteria. Sacrifice what customers do not care about to give them what they want. 2. There is a tendency to focus on the Perceptual Map. Keep in mind that the Perceptual Map is more important as a Rough Cut consideration than a Fine Cut distinction. 3. It takes time and maintenance to build a solid product offering. Try to get the maximum benefit from R&D. Invest routinely in awareness and accessibility. 4. If all competing products are equal, they split the market equally, regardless of their merits. To achieve substantially higher demand than a competing product, you must have a substantially better offer. 5. It does not matter how good your product is if you stock out. A good product must be backed by adequate production capacity to supply the demand it generates. 11