Executive Summary Precision Worldwide,Inc (PWI) is a manufacturing company of industrial machines and equipment for almost 90 years. One of their plants located in Frankfurt, Germany, produces a particular model at a price ranging from $ 18,900 to $ 28,900. Moreover, the plant has another department that manufactures steel retaining rings. These rings are considered as an integrate parts of the machines they are actually manufactured.
This department can sell their rings either internally or externally because they are a large market and demand. The general manager of the German plant, Hans Thorborg has been considering the introduction of plastic rings as a substitute for the steel rings. His idea comes from one of his competitor, Henri Poulenc who has already implemented this new product in the market. There is a lot of potential for this product in this market because there is a lower manufacturing cost and a greater durability compare to steel rings.
The company is thinking if it is worth to shift from steel rings to plastic rings. But there are a lot of facts that they need to consider. There has been conflicting views concerning the future of the steel rings departments if they should change to plastic rings in order to acquire competitive advantage in this market and what will they do with the special steel after they have implemented the new product.
This report contains our analysis of the situation of Precision Worldwide, what are the alternatives dealing with the special steel and plastic rings and finally our recommendation. SWOT analysis | |Beneficial |Harmful | |Internal |Strengths |Weaknesses | | |Have a strong connection with the parent company in Ohio |The special steel has not salvage value | | |Accessible to rapid change of technology |They have to buy the special steel in high quantity in order for| | |Plants have a lot of freedom on decision-making.
|the supplier accept their demand | | | |Have an excess labor | |External |Opportunities |Threats | | |Acquire a competitive advantage as a first-mover with Henri |Japanese manufacturers- with low-priced spare parts | | |Poulenc in producing plastic rings |Can destroy customer relationship | | |Low manufacturing cost and a higher contribution margin |Unpredictable market | Financial Analysis In order to know how long it will take to recover the cost of changes to make plastic rings only, we have calculated the payback period in Appendix 1.
It just takes a little bit more than a week to recover the costs of changing from manufacturing steel rings to only manufacturing plastic rings. Since the cost of the special steel is already a sunk cost, it would not affect our decision of making plastic rings. As we can see in Appendix 2, by manufacturing only plastic rings, the contribution margin increases from 674. 40 to 1,214. 45, which is an increase of 80%. By keeping the same selling price, it explains the big difference of 61% of Return on Sales between the two products in Appendix 3.
In Appendix 4, we have the production costs and revenue of the steel rings when using the excess capacity during the next 2-3 months, which includes only variable costs. In appendix 5, the three alternatives discussed later are assessed in terms of financial results. By producing only plastic rings, it yields a profit of 738,500$; by producing 10% plastic rings and 90% steel rings, the profit is 761,900$; and by producing 70% plastic rings and 30% plastic rings, the profit generated is 580,600$.
As shown in appendix 6, by producing the steel rings from end of May to mid September, assuming that the sales volume stays at 690 per week, there will still be 15,100 rings left on inventory and it would require an additional 22 weeks to sell them. Furthermore, the raw material inventory will still have some steel available, which would require another 14 weeks to produce and sell. Strategic Alternatives Alternative 1 Discontinuing the steel ring production and start producing the plastic ring will allow Precision to enjoy immediately the huge contribution margin of 1,214. 45$.
This is possible because the sales price will remain relatively the same as the production cost decreases significantly. By comparing the old and the new contribution margin, there is an increase of 80%, which is a huge benefit for the company. Besides, even though Precision company is trying to base its strategy on the current steel inventory of over 390,000$, it should not affect the decision since it is a sunk cost. By introducing the plastic rings, it can solve the issue of the lost contribution margin by not producing and selling the steel rings. In fact, it can cover the lost contribution margin in a relatively short period.
It is estimated that it would yield a profit of 738,500$. Also, by not finishing selling the steel rings and start selling the plastic ones instead, the company will not be held guilty for having cheated on its customers. Furthermore, Precision’s client can enjoy a better quality and longer useful life offered by the new product. Consequently, since the customer satisfaction will increase, the customer loyalty will also increase. The most important factor by introducing the plastic rings is that Precision will not lose its market against its competitors.
A second alternative would be to finish using the raw material inventory available on hand to produce the last steel rings the capture the maximum contribution margin from steel rings and in the same time, offer the plastic rings in France. The main advantage on this is that the steel inventory would have to be wasted and thrown away. Furthermore, Precision can start enjoying the contribution margin offered by the new plastic ring, while in the same time selling the steel rings. In terms of financial results, it yields a profit of 761,900$, which is more attractive than only selling only the plastic rings.
The disadvantage over this is that if a customer ever find out about the availability of the plastic rings and was sold some steel rings instead, it would greatly harm the customer-supplier relationship because they would have felt as if Precision cheated them. In the long run, it would not be beneficial at all since there would be a high possibility for customers to change to the French supplier. Alternative 3 The third alternative is to use the 30% excess capacity to produce the steel rings. It is very similar to the second alternative. However, the profit generated is much smaller as it yields only 580,600$.
There is absolutely no advantage on this alternative since the profit is much smaller than the previous two alternatives. In addition, it is not logic to offer both rings to the market at the same price. Even tough Precision is planning to sell the steel rings at discount it does not guarantee a demand because of the better quality and longer useful life of the new plastic rings. Recommendation After a thorough analysis of the possible alternatives to the current issue, introducing the plastic rings and discontinuing the steel ones would be the most beneficial for Precision.
As stated earlier, the steel inventory is a sunk cost and it should not affect decision even though the second and third alternatives are based on the possibility of using the steel inventory. The contribution margin enjoyed by introducing the plastic rings right away is 80% higher than the previous model. The total profit projected is admittedly higher in the second alternative but after weighing the pros and cons qualitatively, starting to make the plastic rings is more beneficial. Precision would gain a competitive advantage over his competitor and it would not cheat its customers.
Ultimately, it becomes competitive advantage for Precision. Appendix |Appendix 1 | | | |Cost |Income Per Week |Payback Period | |7,500 |/7385 |1. 015 week | | | | | | | | | | | | | |Appendix 2 | | | | |Plastic |Steel | |Batch Price |1,350 |1,350 | |Material cost |17. 65 |321. 90 | |Labor |65. 50 |196. 50 | |Fringe Benefit (0. 80 per Labor dollars) |52. 40 |157. 20 | |Contribution Margin |1,214. 45 |674. 40 | |Appendix 3 | | | |One Week/690 rings |Plastic |Steel | |Sales |9,315 |9,315 | |Material Costs |122 |2,221 | |Labor Costs |452 |1,356 | |Departmental |542 |1,627 | |Fringe Benefits (40% dep) |362
|1,085 | |Administrative |452 |1,356 | |Total Cost |1,930 |7,645 | |Operating Income |7,385 |1,670 | |Return On Sales |79% |18% | |Appendix 3 | | | |One Week/690 rings |Plastic |Steel | |Sales |9,315 |9,315 | |Material Costs |122 |2,221 | |Labor Costs |452 |1,356 | |Departmental |542 |1,627 | |Fringe Benefits (40% dep) |362 |1,085 | |Administrative |452 |1,356 | |Total Cost |1,930 |7,645 | |Operating Income |7,385 |1,670 | |Return On Sales |79% |18% | |Appendix 4 | | |30% Excess Capacity |Steel | |Sale |2,795 | |Material Costs |666 | |Labor Costs |407 |
|Fringe Benefit (0.80 per Labor dollars) |1,085 | |Total Cost |2,158 | |Operating Income |636 | |Return On Sales |23% | |Appendix 5 | | | | |Alternatives Profits for One Week |Plastic |Steel |Total | |10% Plastic /90% Steel |739 |6,881 |7,619 | |100% Plastic /0% Steel |7,385 |0 |7,385 | |70% Plastic /30% Steel |5,170 |636 |5,806 | |Appendix 6 | | | | |End of May-Mid Sept of Steel Rings |690 Rings |Per Week | | |14 Weeks |Rings |Costs |Weeks Needed | |Finished Steel Rings Sold |9,660 |31,096 | | |Finished Steel Rings Left |15,100 |48,471 |22 | |Raw Material |9,740 |31,353 |14 | |Total |34,500 |110,920 |36 |