Berkshire Threaded FastenersBerkshire Threaded Fasteners Company has recently lost their president, John Magers. The resulting appointment of his inexperienced son Joe Magers has lead to the company’s loss of confidence. Brandon Cook is the recently appointed general manger who was hired to turn the company around after a loss of $70,000 in a good business year. As a member of an outside consulting firm I have been called in to give advice on the problems the company is facing. The time period has been updated to the present times.
Manufacturing ProcessSee Appendix A for the detailed manufacturing process. In short, fasteners begin as wires, rods and bars which are then cut to length, headed and finally threaded. What should be noted is that this particular manufacturing process called cold forming is high-speed, high-volume, economical and has low wastage. Such economies of scale will allow Berkshire to offset the very high costs of cold-forming equipment.
Business StrategyA careful analysis is needed in order to determine Berkshire’s business strategy. At first one would think it was product differentiation because of the inelastic demand in the short run. But one thing that should also be noted is the fact that for most goods, demand is much more price elastic in the long run than in the short run. This combined with the fact that Berkshire is convinced that it could not individually raise prices without suffering substantial volume declines, and that all the products of the different manufacturers in the industry are very similar, prove that their business strategy is in fact cost leadership. Another piece of evidence that also supports this strategy is the fact that the major focus of their accounting system seems to be on cost reduction.
Place in the EconomyThe industrial fastener industry has been experiencing modest growth since the 1990s with an average per annum revenue growth rate of 3.6% ; though the number of employees have remained relatively the same. The North American fastener industry is still expected to grow by around 4% annually despite the competition from foreign countries. However this number represents a decline from the 9% growth spurt which occurred in 1998.
The North American fastener production is strongly tied to the production of automobiles, aircraft, appliances, agricultural machinery and equipment, and the construction of commercial buildings and infrastructure. The more these industries prosper, the greater the demand and prospects for the fastener will there be. There has been as ever expanding market for fasteners in the 21st century in the aerospace industry. In fact a 9% annual growth in fasteners for this industry can be expected. Motor vehicle sales have also increased by 9.6% from 2005 to 2006. Unfortunately housing starts have only increased by 0.7% from 2005.
In the future analysts expect metal fasteners to face competition from the adhesives industry as more products are being made with plastic, a product best joined together by adhesives. Also buyers have now been demanding innovative and diverse fasteners which are also more environmentally friendly- fasteners that maintain lubricity without the use of cadmium, a suspected carcinogen. So the industry is slowly shifting its focus to more highly engineered, technologically advanced fasteners.
SWOTStrengths:1) Newly appointed Brandon Cook has wide executive experience in manufacturing products similar to that of Berkshire.
2) Berkshire operates in a capital intensive industry. But as a percentage of total sales, Berkshire’s labour costs are 24.69%. This suggests that they either still retain their employees even when they could have done without them or that they pay very high salaries to a few workers. This shows that Berkshire has either very loyal employees or very skilled employees- both being assets. Weaknesses:1) Joe Magers is not very experienced and the company is facing losses in the production of the 200 and 300 series’.
2) As a percentage of total sales, Berkshire’s fixed costs are 47.37%. This is much higher than what a price competitive manufacturer like Berkshire should have had.
3) Berkshire pays 49% of all its wages and salaries to administrative and sales employee, when the industry average is 27% . This shows poor decision
making processes of the firm.
Opportunities:1) If product lines are discontinued, with the excess capacity and skilled labour force they can branch out into the production of more diverse fasteners. This ties in with the fact mentioned previously that buyers are now demanding more specialized products. Threats:1) Berkshire operates in an industry where a few of its competitors are much larger.
2) The industry is dominated by Bosworth who dictates the prices that are charged for fasteners.
3) Buyers are slowly demanding more specialized fasteners.
ProblemWhat is very evident is that the company is losing money on its products. In the previous time period they had incurred a loss of $70,000. Berkshire is unsure if it is the result of the production of the 300 series or the pricing decisions of the 100 series. These alternatives need a careful analysis in order to make informed decisions that will help turn the company around.
Alternative #1 Status QuoQuantitative Analysis:In order to determine if the company should “do nothing,” is to predict the future cash flows and net income (loss) for the second half of the year. See Appendix B for this calculation. The predicted net income is in fact a loss of 1134. Yet, net income may not be a faithful representation, so cash flows have also been calculated. The predicted cash flow is a negative amount of 388. These amounts while better than alternative #3 (drop the 300 series) is not as good as the cash flow and net income amounts for alternative #2 (reduce price levels of the 100 series).
One very important thing that needs to be noted is the fact that variable costs are indeed relevant. Fixed costs remain constant even after the production is stopped, but variable costs increase and decrease with production. Therefore the total contribution margin for this alternative was calculated to be 1504 which does show this alternative in a better light especially when in comparison to its net loss and cash flow figures.
Qualitative Analysis:The reduced production of the 100 series as a result of the price level remaining the same will have a significant impact on Berkshire. The reduced production may lead to employees worrying about the fact that they may be laid off to such an extent that their productivity is significantly lowered. Berkshire could also develop a reputation of charging higher prices than the industry standard and they could end up loosing more and more buyers to competitors.
Alternative #2 Change price level to $2.25 for the 100 seriesQuantitative Analysis:In order to determine if the price level needs to be dropped a few calculations are needed. First a prediction of its impact on the net income and cash flows for the second half of the year is needed. These calculations are shown in Appendix C. The predicted net income figure is a loss of 1035. The predicted cash flow is a negative amount of 289. While these figures do seem abysmal, what should be noted is that in comparison to the other alternatives, these figures are much better. Both the net loss and negative cash flow amounts in this alternative is 99 lower than the “status quo” alternative and 338.58 lower than the “drop 300 series” alternative. This hints to the fact that maybe the price should in fact be dropped.
Another fact that backs this assertion up is in the calculation of the Contribution Margin (CM) for both price levels, based on data from the first half of the year. Table 2 in Appendix A shows this calculation. While the CM of the new price level is lower than that of the original level (0.96 vs. 1.16), the fact that they will sell 250,000 units more (and hence a higher total CM for the new price) clearly makes up for this difference. The success of the new prices level will be contingent on the number of units sold. What is very dangerous about this alternative is that if in the future the demand in the market for this product line slumps, only a very small amount of money will be available to be used to pay off the fixed costs.
Qualitative Analysis:The change in price level will not have much of an effect on the employees of Berkshire because they would still be producing around the same amount of units (1000000 vs. 996859). They would not have to worry about being laid off. What will be affected is Berkshire’s reputation. If they had not changed they would have developed a reputation of charging high prices. The reduction of the price would put them at par with Bosworth.
Alternative #3 Drop 300 seriesQuantitative Analysis:In order to determine if the 300 series needs to be dropped a few calculations are needed. First a prediction of the impact of its removal on the net income and cash flows for the second half of the year is needed. The predicted net income figure is a loss of 1373.58 and the predicted cash flow is calculated to be a negative amount of 627.70. The net loss figure calculated is the highest loss of all three alternatives and the negative cash flow amount is also much higher than the alternatives as well. This hints to the fact that maybe the 300 series line should not be dropped. Also, if the 300 series had been dropped at the beginning of the year it can be seen that there would have been a loss of -183. See the calculations for these numbers in Appendix D.
Another aspect that backs up this assertion is the calculation of the Contribution Margins for all three product lines based on first half information. Even though Berkshire incurred a loss of .22/unit in the first half for series 300, when you calculate the CM it is a whole new story- the CM of 300 is a positive number- 1.15/unit, this means that Berkshire would in fact incur an even greater loss if they chose to halt production. The 1.15 per unit would no longer be available to cover some of the fixed costs. What is also surprising is the fact that the 300 series Contribution Margin is not far behind from that of the 100 series (the most profitable product line) and equal to that of the 200 series.
A few other very important observations also need to be taken into account. First, since many products do cover all their variable costs, no product line would ever be dropped if only a contribution margin analysis were conducted. Second, even though the 300 series covers its variable costs and part of its fixed costs, it proves to be below par when considering full costs. Finally, in the long run all costs are variable, so the 300 series in this time frame is in fact a poor product line.
Qualitative Analysis:If the 300 series was dropped it would have a significant qualitative impact on Berkshire and its employees. All the employees who were involved in the production of this line would either have to be laid off (which would have a negative impact on the reputation of the firm), or they could still be retained (which would lead to them obtaining a deep sense of respect and loyalty to the firm). Also the employees who would be shifted around would gain a greater skill set and hence become very valuable assets to the company.
Evaluation of the alternativesComparison Table1) Profitability2) Timeliness3) Consistency with Strategy.
Alternative #1-$11347 daysNot as muchAlternative #2-$10354-7 daysYesAlternative #3-$137410-14 daysNot as much1) Profitability:The primary objective of all businesses, no matter how big or small, is profit. That is why as a criterion, Profitability was given the number one rank. The three alternatives can easily be evaluated on this criterion by comparing the net income figures. Alternative #2 easily wins in this criterion. Despite the fact that it does have a net loss, the loss was not as great as that of Alternative #1 and #3. One important thing that should be noted is the fact that perhaps the second half of the season is always a slow period and that is why the net income figures are so low.
2) Timeliness:Berkshire operates in a business environment where if firms that lag behind in decision making, implementation of policies etc, they will be left behind with no profits. That is why Timeliness was given the rank of two.
Surprisingly Status Quo would have an implementation time of around 7 days. Since keeping the price level of the 100 series the same at 2.45/unit would result in them producing 385332 less number of units (See Appendix E for the calculation), time would be need to shift employees around to new jobs in the firm, possibly close down a warehouse or even convert the machines used to produce the 100 series to now produce a different product line.
Alternative #2, “reduce price level” would probably only take 4-7 days to implement. The only thing Berkshire would need to do would be to inform their current buyers of their new price level and perhaps also to advertise the lower price in a specialized fastener industry journal.
Alternative #3, “drop the 300 series” would probably take around 10-14 days. Not only would Berkshire need to shift employees around, close down a warehouse etc, as a result of producing a lower number of 100 series units, but they would also have to announce the dropping of the 300 series line to its buyers, move even more employees around (or possibly lay them off), close even more warehouses down, move machinery around the manufacturing space etc. This would be a very time consuming process.
Overall Alternative #2 would win in this criterion as it would have a less time consuming implementation time and process.
3) Consistency with Strategy:This criterion was given a rank of three because while necessary in the evaluation, Profitability and Timeliness do have a greater importance. In the short run Alternative #2 had the greatest consistency with strategy. Berkshire is a cost leader, and reducing the prices of the 100 series ties in very well with this strategy. Alternative #1 and #3 chose not to reduce the price and this decision conflicts with their cost leadership strategy.
ConclusionOverall I would recommend that Berkshire implement Alternative #2- reduce the price level of the 100 series, as it did win in all three criteria. But one important thing needs a re-mention. The CM per unit of the reduced price level was lower than that of the higher price level. It was only because of the higher volume of sales did it manage to have a higher total contribution margin. In the future if sales volumes drop, despite the price change Berkshire would incur heavy losses. At this present time Alternative #1 and #3 are both very unprofitable and will still be in the future. At least Alternative #1 is not as unprofitable at this present time but what happens in the future will all depend on sales.
Recommendations for Specific Action1) Chose a date when the price change will come in to effect and make sure all current buyers are aware of this well ahead of time.
2) Advertise in newspapers, journals etc to get the message across to new buyers that Berkshire has reduced its prices.
3) All forms, documentation, accounting systems etc should be changed to take into account the new price level.
4) Make sure that there are people at hand to research the market and evaluate whether demand is going to decline for the 100 series.
5) Make sure that there are researches available to study the market for new trends and new types of fasteners that could be produced in the future.