Cameron Auto Parts was founded in 1965 in Canada by the Cameron family to seize opportunities created by the Auto Pact (APTA) of 1965 between the United States and Canada. The APTA allowed for tariff-free trade between the Big Three American automakers and parts suppliers and factories in both countries. The one caveat in the APTA to qualify for the zero-tariff trade was that companies must maintain assembly facilities on both sides of the border. Cameron Auto Parts specifically manufactured original equipment parts (OEM) such as small engine parts and accessories based upon design specs created by the Auto manufacturers and then sold these parts to the auto makers.
Alex Cameron took the reins in 2001 and was immediately faced with a financial crisis. Sales in 2000 had dropped to $48 million and were only $18 million for the first six months of 2001. Cameron lost $2.5 million in 2000 and the same amount in the first six months of 2001. This decline was primarily due to declining auto sales of American cars and trucks and the increased presence of Japanese automakers. Market forces were driving the American firms to find ways to cut costs and modernize plants. Cameron used $10 million of its $12 million credit line to reinvest back into the firm by modernizing equipment and computer-assisted design and manufacturing systems.
However, Cameron did not have its own design engineering team and relied on specs from the Big Three automakers for its products. This left Alex Cameron with an uneasy feeling that expansion into product design was essential for the long-term survival of the firm. In mid-2001, Cameron took the steps necessary to design and develop its own parts line. Cameron hired four design engineers and, by 2003, came up with a flexible coupling idea that would entice international buyers and not just the Big Three automakers.
Cameron was then faced with the dilemma of how to market and sell the product. Projected sales of the new product in 2004 were between $35 and $40 million which was terrific but they weren’t sure they had the capacity to handle the production. They needed to decide if it was better to expand current facilities, buy/ build a new facility, or license the fabrication of the product to outside companies. While on a vacation trip to Scotland, Alex went to check in on a local customer, McTaggart Supplies, Ltd, who convinced him that the flexible coupling product was in high demand in the U.K. and that more production was necessary to keep up with the demand. Alex decided at that meeting that Cameron would exclusively license the production of the flexible coupling to McTaggart in order to gain a stronger foothold in the U.K. for relatively little up-front investment.
1. Should Cameron have licensed McTaggart or continued to export? Cameron Auto Parts should license to McTaggart in the UK. It was one of Cameron’s key goals to penetrate foreign markets and the licensing agreement with McTaggart would be a swift way to begin executing this business strategy. McTaggart was in a superior position to penetrate the U.K. market due to a good cultural understanding and close proximity to potential clients. Once this business arrangement was proven successful, Cameron Auto Parts would be able to form similar agreements with other companies and expand to other foreign markets. McTaggart is an excellent licensee, as they are a reputable company in the U.K. with excellent credit, cost saving manufacturing practices, good market contacts, and 130 years of service in the business. They are also assuming most of the financial risk by paying Cameron Auto Parts the startup costs as well as a percentage of sales.
Embarking on a licensing strategy would also eliminate the prohibitive cost of developing and maintaining a sales force in a foreign country that likely wouldn’t perform as well as a local company like McTaggart since customers had cultural ties and existing relationships with them. Additionally, orders can be filled more quickly as the product would be made locally reducing shipping costs and travel time. It was also a good decision for administrative and economic distance reasons. Since the product would be produced in the UK, it would not be subjected to excess cost of import duty, freight, insurance, or the value added tax.
This would allow for the product to be sold at a more attractive price. Lastly, the value of the dollar fell during the original five year contract and the percentage of sales in pounds produced a higher dollar income for Cameron without changing the price of the products sold. The disadvantages of continuing to export are loss of profits due to shipping costs, currency values, taxes and tariffs. The five year contract allows Cameron to evaluate the effectiveness of the licensing strategy and determine whether this is a profitable venture for the company.
2. Was Mc Taggart a good choice for licensee?
Yes, McTaggart was a good choice as a licensee. They have all the tools necessary to successfully produce and sell the flexible couplings. • McTaggart was already familiar with the product and had bought over U.S. $4,000 in the first four months in 2004. They had been able to sell the product as fast as it could be shipped and built a solid working relationship with Cameron as well as good credit. • McTaggart has production experience that Cameron may benefit from and substantial room to increase production capacity. • They have a solid reputation with great financial standing, excellent credit, and a capable sales staff to market and sell the product. • They have manufacturing capacity and are willing to invest and develop the manufacturing capability to efficiently produce the flexible couplings. In addition, they have established a client base.
3. Was the royalty rate reasonable?
A royalty rate is the money that must be paid to the owner of products (“the licensor”) from a buyer (“the licensee”). The amount of royalty fee is considered the fee for acquiring a patent or a copyright. In most businesses, a royalty fee applies when two or more companies have licensing agreements or sell the products in foreign countries. [i] In U.K., the normal rate of the royalty for licensing is around one and a half cent on each sale. However, Cameron Auto Parts was asking three per cent of sales from McTaggart. Although it was dropped down to 2 percent with a 5 year contract after negotiations, it is still higher than the normal rate. This seems reasonable as Mc Taggart will save a considerable amount of importation expense and will be able to sell the products at a lower rate than they can by importing. Cameron will have established an ongoing royalty income without incurring the overhead cost of production and sales expense.
Cameron Auto Parts asks a higher royalty rate than normal rate because the company helps McTaggart choose equipment and provides training of operation and production. Although McTaggart would like to pay these services separately, Cameron Auto Parts points out the benefits of getting services to keep higher royalty rate. With this five-year agreement, the royalty rate of two per cent is ensured in the first five years, but it will be down to one and a half per cent when the techniques of choosing equipment and operation have been acquired by McTaggart after five years.
In conclusion, the royalty rate is reasonable for both parties involved. Cameron Auto Parts was able to enter the U.K. market expeditiously through McTaggart’s sales force, cut down on lead-times, save on duties, freight, and insurance and not be subject to currency fluctuations. McTaggart was able to sell a product already in demand, obtain training, focus on increasing sales and gain valuable insight into Cameron’s manufacturing process. Both companies would benefit from the shared knowledge they could provide each other, thus make the licensing agreement valuable for everyone involved.
4. What about the alternatives to licensing?
The alternative to licensing would be to continue production and sell directly to McTaggart and other customers. This would involve dedicating a certain amount of production floor space to a market that is culturally and geographically distant and unpredictable. There is risk involved as the production space ties up cash flow and is not certain to produce profit. Travel expense would be incurred as company representatives would have to travel often to the U.K. in order to resolve issues or sell products. The sales side expense would be higher as well.
More sales people would have to be employed to serve that region. They would either have to travel often or be based there and paid in pounds, which are currently stronger than the dollar. Instead of receiving a check from one contact that represents all sales for the whole area, Cameron would have to maintain relationships with various customers, which requires personalized attention to each and exposes him to having to perform collections and write off bad debt.
Since unit production costs were estimated to decline 20% as annual sales climbed from $20 million to $100 million and Andy felt that the $20 million mark was easily obtainable in the coming year, the continued value of exporting to Europe would have grown along with the European market. Looking at the pricing index, we can see that importing to Europe results in a cost of 113 to the importer. Since Cameron Auto Parts sell the flexible couplings at the same price to domestic and foreign distributors, licensing is an effective strategy to penetrate the European market while eliminating import and other logistical costs.
Cameron Auto Parts would benefit most from a licensing agreement with McTaggart Supplies Ltd. Other options exist besides exporting or licensing such as a joint venture / wholly-owned subsidiary, selling through an agent, or selling through a distributor. Benefits to these strategies include reduced manufacturing cost, higher sales volume, and better market penetration and in some cases shared risk. The drawbacks to these methods include loss of price control, unpredictable sales volume, and loss of profits. [ii]
Cameron Auto Parts enjoyed rapid growth during the 2004-2005. In 2004, the company undertook a major plant expansion for $10 million, adding 200,000 square feet to the company’s production capacity. Royalties from McTaggart during the first year of the licensing agreement were £20,000; this grew to and £100,000 the following year. High overall profitability left Cameron in a strong financial position in 2006.
In 2006, Cameron was presented with an opportunity to purchase a 40 percent interest in Michelard & Cie., a family-owned distributor organization in France, which would allow Cameron to break into the continental European countries. Cameron agreed to the deal for $4 million and a royalty of 4 percent on sales of all flexible couplings.
The deal enraged McTaggart, who had been selling flexible couplings in Europe and would now be competing with Michelard. Partly to appease McTaggart, Cameron agreed to a proposed joint venture in Australia. McTaggart would own 60 percent of the plant and be responsible for managing the venture. According to McTaggart, local assembly in Australia could triple volume of current sales to around £10 million. An investment of £2 million could make around £400,000 a year after Australian taxes while avoiding tariffs imposed on shipping finished products. This agreement would also position the firms to benefit from Australia’s free trade agreement with New Zealand. [iii]
Cameron Auto Parts is very likely a pseudonym for Fernco, Inc., a flexible coupling manufacturer based outside of Detroit with a very similar history to that of Cameron Auto Parts. Fernco, Inc. is lead by Chris Cooper who, like Alex Cameron, took over the company from his father after graduating from Michigan business school. In addition to manufacturing facilities in Canada, the U.K., Australia and Germany, Fernco has expanded distribution to the E.U, New Zealand, Mexico, Puerto Rico, and China. [iv]
[i] “Valuation Resource”Royalty Rates and License Fees.” Retrieved June 29, 2011 from < http://www.crucial-systems.com/dmbr/Mechanical_Royalties> “Mechanical Royalties.” Time. 05 December 2004. Retrieved June 29, 2011 from < http://www.crucial-systems.com/dmbr/Mechanical_Royalties> [ii] “Use These Top Five Strategies for Selling in International Markets.” Retrieved July 1, 2011 from [iii] Beamish, Paul and Crookell, Harold. “Cameron Auto Parts (B) – Revised.” Richard Ivey School of Business. University of Western Ontario. Jan 10, 2006. [iv] Ferno Company Website. Retrieved July 1, 2011 from .
It is best NOT to start with a recommendation. I would first discuss the pros and cons of the issue on hand
Cameron can simply do what it has been doing: Exporting. It is important that you should show licensing would be superior to exporting in order to advocate licensing
These are good points. You realize the resources and capabilities of Cameron are limited.
That is also a good point but that point supports the “exporting” option.
There are other options as well: Joint Venture (JV) and foreign direct investment (FDI) are others to be considered.
Take a look at the posted answers, especially, slide # 5 where a table lists pros and cons of each option in terms of various resource based factors. I must indicate my preference for such tabular presentations. They are simple, neat and to the point.
All of your points are good. But they are one-sided. I am ALWAYS interested in a “balanced” analysis detailing not only points that support your perspective but also counter perspective. Please see the posted answers for such a perspective
There is NO precise way of determining the royalty rate. Please see the posted answers for some guidance
Not sure I understand this last point. Cameron is an Exporter. Why would they worry about import costs?
Please take a look at the posted slides for this question.
There are 2 things I suggest to improve your analysis: 1. Provide a balanced perspective. Nothing in this class is a clear pro or con. Every issue has both pros and cons. Both need to be studied carefully. 2. Incorporate other assigned readings into your analysis to provide evidence of learning. Some of the assigned readings could have easily been cited to support your viewpoint.