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CAPSTONE® Business Simulation Detailed STUDENT Notes

The CAPSTONE® Business Simulation is a very sophisticated game that quite accurately emulates
the real world so business students can get a small taste of what it is like to run a manufacturing and
sales organization. Since it is a game, you need to understand the rules of the game and how your
team performance is measured. The student guide books provide the rules on how to play the game,
and the separate document How the Computer Grades Your Team gives you insight on how the
score for the game is kept. It is a bit complicated, but compared to the real world it is a piece of
cake. I suggest you read the following and make sure you are managing for a maximum score
before each game year is rolled over.

The Great Rules of Thumb on page 2 should help you achieve a much higher score.

To Avoid an Emergency Loan on page 4 is the formula you should use as the last thing before you
upload your final decisions. It is not foolproof—wildly bad decisions you make could fool it—but
it is a strong indicator of a potential problem.

If you are having problems, go to page 5 to see if you can diagnose and fix and your problem.

Page 7 gives one way to start your sales forecast. It is a little different from the book approach and
it (like the technique in the book) only a start—there is no perfect way to forecast because no one,
not even the computer knows what the competitors are going to do. THINK!

You don’t have to read and follow all of these tips, but the
teams that follow them will probably have the best chance of
winning the simulation and getting the best grade!

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Great Rules of Thumb for the CAPSTONE® Business Simulation

Give customers the top two things they want—in the Good category. Just be in the Fair
category with their other desires. Age and Reliability criteria stay the same every year. Price drops
$0.50 each year. Positioning changes per the perception chart.

1. To maximize the value of Price to the customer, be in the bottom third of the expected rice
range. (Middle 1/3 fair, bottom 1/3 is poor.)
2. To maximize the value of Reliability to the customer, be within top third of MTBF
specification. (Middle 1/3 fair, bottom 1/3 is poor.)
3. To maximize the value of Age to the customer, be within 0.5 of the ideal age on December 31.
(0.6-1 year is fair, >1 year is poor.)
4. To maximize the value of Positioning to the customer, be within 0.5 of the segment’s ideal spot.
(0.6-1.5 is Fair, >1.5 away is Poor.)
5. To maximize the value of Awareness to the customer, be above 80.5%. (50-80% is Fair, <50%
is Poor.)
6. To maximize the value of Accessibility to the customer, be above 80.5%. (50-80% is Fair,
<50% is Poor.)
7. Keep bonds at BB or better.
8. Leverage = Total Assets/Total Equity. Ideal is 1.81-2.80 from shareholder’s perspective
9. Customer Survey scores above 50% are Good.
10. To drive stock price up, increase profitability and return excess profits to the stockholders.
11. Ideal inventory is 1. Inventory levels should not exceed 60 days (two months) of Sales.
12. Inventory should be about 4-6 weeks of sales (about 10% of sales). Stocks outs are very bad
since they represent loss of pure profit (all SG&A already recovered).
13. Most successful firms run 50-80% overtime. Much cheaper than adding capacity.
14. Plant utilization should be 150-180%. At 180% add plant capacity. Don’t ever exceed 200%,
but always run at a minimum of 100%.
15. Automation increases are good, but be careful of lengthy R&D times and total costs.
16. Products that straddle the fence are neither fish nor fowl.
17. Trailing edge products have substantially lower material costs.
18. Even great products must have good marketing to keep awareness up.
19. Don’t set prices more than $4.90 over the customer’s expected range.
20. Don’t let cash get over 5% of Sales.
21. Keep employee rolls at what is needed for production—no more. If extra money is spent on
recruiting and training, you can reduce total number of personnel due to productivity increase
22. Production rule of thumb: Marketing forecast minus inventory on hand times 12%.
23. Keep 60 days of working capital on hand
a. Go to Income Statement and look at Total Variable Costs
b. Divide Total Variable Costs by 1/6 (60days/365daysin a year) to figure 2 months of
working capital
c. Use excess capital for R&D, plant, special marketing, paying down debt
d. Cash position on balance sheet should be 8% or so of total assets

2
More Rules of Thumb

The best philosophy is to satisfy your intended customers. Your job is to create the demand, then
fill it.

Never, ever have idle assets


--Become lean and mean quickly
--Make all of your assets work hard, including assets that are not obvious such as cash and
R&D engineers.

The right time to apply an "end game" mentality is in Round 1, not the last round
--Even in Round 7 it makes sense to add needed capacity and automation

The second shift is more profitable than the first


--Make every unit of capacity produce at least one unit, and preferably two units
--Capacity next round should always be equal to one half our best case scenario we expect
next round
--It never makes sense to have less capacity than you need to serve your demand next year.
A team should always add enough capacity to serve its customers.
--Since no demand forecast is perfect, a team should plan to have enough capacity to serve
its best case for demand

First cut your costs, then consider price cuts

Automation levels of 5 to 6 will allow you to keep up with drift rates using only short moves

Follow the suggested procedures for sales forecasting and demand analysis

Keep ROS >8%


Keep Turnover >1.3
Keep Leverage between 1.8 and 2.5
Your market share should be >1.5 average market share
Stock price should be >$40 + 5*Round #
You should invest $10M to $25M in plant improvement each year (add capacity, increase
automation)
Sales to current asset ratio between 3.5 and 4.0
Current Ratio (current assets divided by current liabilities) between 2.0 and 2.5
Total assets >100M
Production should be at least 1.5x capacity
Automation of Low End products >9
Automation of Traditional products >7
Automation of High Tech products >6.5
Be within 0.5 units of ideal for all products except Low End

Not always, but usually the best strategy will include adding 2-3 products to your mix.

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Evaluating Product Success

Go to each Segment page in the Capstone Courier.


1. Check for stockouts (Middle of right of page, brown and yellow bar chart)
2. Check for Revision date. (Bottom of page in Top Products in Segment)
3. Pay attention to Top 2 buying criteria for the segment. Hit or miss?
4. Check Awareness. (Bottom of page in Top Products in Segment)
5. Check Accessibility. (Top right of page.)
6. Check customer survey to see about predictions for the next year. (Bottom of page in Top
Products in Segment)

Top Ten Student Tactical Errors


1. Margins insufficient to sustain the business
2. Launching a new product in R&D, but failing to purchase plant capacity for production.
3. Setting prices more than $4.90 above the customer’s expected range (results in zero sales – even
in a “seller’s market”).
4. Creating wildly inflated sales forecasts resulting in a ton of inventory (often results in high-
interest Emergency Loan).
5. Ordering plant improvements without securing sufficient funding (results in high interest
Emergency Loan).
6. Failure to account for Customer Buying Criteria (price, age, reliability, positioning) when
creating a new product, or updating an existing product.
7. Finalizing decisions without first reviewing proforma financial statements.
8. Increasing plant capacity on an existing production line before reaching 100% plant utilization.
9. Viewing simulation loans and finances as if it were personal debt rather than business debt (using
every available resource to pay-off debt as quickly as possible).
10. Excessive cash (more than 5% of Sales) on the Balance Sheet (a wasted resource).

To Avoid an Emergency Loan

To help avoid an emergency loan, the last thing to do before uploading your final decisions is add
together your Cash and Inventory (from Proforma Balance Sheet). If that sum is less than 16% of
Total Assets (from Proforma Balance Sheet), you are in danger of having to get an Emergency
Loan!

4
Advice to Struggling Teams

Each time a round of the game is processed, compare the results of struggling teams to the criteria
listed below.

Low Contribution Margin: Contribution margin is revenue minus direct labor, raw materials—
expressed as a percentage of sales. It is reported on page 1 of the Capstone Courier as an aggregate
average of each team's product portfolio. A good minimum benchmark for Contribution
Margin is 30%. If contribution margin is below 30%, the team should consider reducing its cost of
goods, and/or raising its prices. Margins should get as high as 40% or better.
Typical Problems Causing Low Contribution Margins
1. MTBF ratings set too high. MTBF ratings directly affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on page 5-9 of the
Capstone Courier. Are they higher than they need to be? If the MTBF range is 12-
17,000, and it is the #4 buying criteria (as in the Low End Segment), there is little
benefit in having MTBF set higher than the minimum.
2. Prices too low. Check the Income Statement in the team's annual company reports (not
the Courier). Compare the price of each product with the cost. Prices must be set high
enough to allow reasonable profit within the current cost structure. If the cost structure
is too high, work on it through MTBF rating reductions, investments in automation and
capacity, and reductions in overtime.

Excessive Emergency Loans: Emergency loans are listed on page 1 of the Capstone Courier.
Every time a cash flow shortfall occurs — Big Al steps in to keep the team afloat: at a 7.5%
premium, of course. Modest emergency loans are no big deal. Emergency loans in excess of 10
million usually indicate serious sales forecast mistakes.
Typical Problems Causing Emergency Loans
1. Excessive inventory carry costs. Check the inventory status of each product on page 4
of the Capstone Courier. If there is excessive inventory — try and determine why.
Were sales forecasts simply too high? Or, was it a matter of having a "lousy" product (in
the minds of the customers from that segment) when compared to the competition? You
can determine this by comparing products on the Market Segment Report (page 5-9 of
the Capstone Courier).
2. Sometimes teams make big investments in plant but forget to raise the money. Check
page 3 of the Capstone Courier (financial analysis). Were there large investments in
plant & equipment? If so, how was the capital raised?
3. Operating losses

Excessive Inventory Amounts: It is very costly to carry large amounts of inventory (total unit cost
multiplied by a penalty of 12%). The ideal year-end inventory position is one unit in each product
line: one would know that every potential sale was made, and the carry cost would be so small as to
be inconsequential. Excessive inventory goes hand-in-hand with less than expected revenue from
sales — a "double-whammy." Not only did the team experienced unanticipated inventory overhead,
it also had substantially less income than planned. Inventory levels should not exceed 60 days
(two months) of Sales.
Typical Problems Causing Excess Inventory
1. Overly optimistic sales forecasts. Previous year customer demands (and segment growth
rates) are listed for each market segment on pages 5-9 of the Capstone Courier.
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Compare the team's sales forecast figures against segment demand. Were their sales
expectations unrealistic? For example, if the segment demand ceiling was 3 million
units, and there are six teams with products in the segment, a "fair share" starting point is
500 thousand sales per team. If you have a better than average product, your sales will
be a little higher. The opposite is true for less than average products. However, you
should understand that every product that tracks within the "rough-cut" parameters will
experience some sales. In other words, customers do not buy all of the "best" product
until it stocks out, then begin buying the second "best" product until it stocks out, etc.
Instead, customers evaluate each product monthly. The "best" products get more sales
than less desirable products, but it is relative. It is possible for a less desirable product to
stock out, while a better product carries inventory. For example, say the Andrews team
produces 250 thousand of a "lousy" product in the size segment, and Baldwin produces
750 thousand of a great size segment product. In this scenario, it would be feasible for
Andrews to stock out while Baldwin ended up with 150 thousand units in inventory.
2. Not understanding how the spreadsheets work. Sometimes students get confused about
the relationship between sales forecasts, production schedule, and production capacity.
a. Sales Forecasts only affect proformas. They are a tool - not a management
"decision."
b. Production Schedule (on the Production spreadsheet of the student software) is
the actual production for the year. Students must enter the number of units they
want to produce. The processing "compiler" program will divide the total
production by twelfths and produce (and sell) that amount each month.
c. Production Capacity is the size of the factory. If the Capacity is 500 thousand,
teams may produce up to one million units. But, all units produced above 500
thousand will be affected by second shift charges. Teams may choose to sell
capacity, or simply leave it idle and unused.

Excessive Stock Price Dip: Stock price is affected by performance, asset base, debt, dividend
policy, and number of shares outstanding. In a year of aggressive investment in plant expansion and
automation, you would expect that the necessary debt load would cause some uneasiness on the part
of shareholders. But, if the stock price dips more than $15.00, it may be a warning sign of too much
debt. The stock price can also suffer in profitable years. For example, liquidation of plant brings in
cash, but makes shareholders wonder about the long term competitive ramifications. Also, paying
dividends during the same year debt is accumulated has a negative affect on stock price. This is true
even if the debt was a Big Al emergency loan.

Excessive negative profits: Profits are listed on page 1 of the Capstone Courier. Losses are
usually the result of a combination of costs being too high and prices too low. Profit can also suffer
from excessive expenditures in selling and advertising, heavy interest payments on debt, and losses
on liquidation (scrapping) of inventory when retiring a product line.

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Alternative Approach to Sales Forecasting in CAPSTONE®
All of this procedure is done on the Capstone spreadsheet

1. Go to Decisions, R&D
a. What are the top two things the customer wants in your Segment?
i. You should hit the first one dead on at least once per year, as well as the second
one if you can.
ii. Adjust product via R&D—Pfmn, Size, and MTBF
2. Go to Decisions, Marketing. Adjust price via Price, adjust promotion via Promo Budget, adjust
place via Sales Budget)
a. Decrease price
b. Increase promo budget
c. Increase sales budget
d. Don’t trust or use the resulting computer estimate of Sales Forecast on the
marketing screen. It assumes all companies offer one mediocre product in each
segment.
3. Establish your own unit sales forecast
a. Go to Last Year’s Report, then to your segment
b. See total industry unit demand in the Statistics block
c. Multiply that total industry unit demand by 1+Growth Rate % in the Statistics block
d. Calculate the number of products offered in the segment by looking at the Top Products
in Segment (scroll down)
e. Adjust the number of products by eliminating minor players, reducing any products
apparently moving out of the segment (could be in ½ product increments), add for
potential newcomers (could be in ½ product increments)
f. Divide the demand by number of products to get average units per product (if all else
were equal)
g. Go to Top Products in Segment
i. Add up all of the recent Customer Survey numbers
ii. Divide our Survey # by the total to get our % demand
iii. Multiply our % demand by total unit demand to get a most likely forecast for us.
We will apply Kentucky windage in a moment
h. Check our product vs the competitors on the Top 2 customer preferences for that
segment
i. Check our Awareness relative to the competitors
j. Check our Accessibility relative to the competitors
k. Adjust promo budget and sales budget to improve our Awareness and Accessibility
relative to competitors (being in the top 2-3 is best)
l. On the Market Share bar chart, find the spread between the potential demand across the
competitors.
i. Calculate the number of units that represent the low side of demand and the high
side of demand to give us the spread in units if the market was to stay about the
same
m. Calculate our worst case and best case Sales Forecast keeping them inside the spread of
demand and adjusted for what we think the Kentucky windage should be based on what
we think our percent of the market will be based on the above calculations
4. Go to Decisions, Marketing

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a. Enter the Worst Sales Forecast
5. Go to Decisions, Production
a. On the Production Schedule enter the Best Case Sales Forecast (less any inventory on
hand)
6. Go to Proformas, Income Statement
a. Check Sales and Net Margins. Write down both numbers
b. Go back to Marketing and change the Sales Forecast to Best case
c. Return to Proformas, Income Statement
i. Recheck Sales and Net Margins. Write down both numbers.
d. Go back to Marketing and change the Sales Forecast to Worst case
e. Go to Proformas, Balance Sheet
i. Check Current Assets “Cash” and “Inventory”
1. Cash must be positive in worst case.

This process gives you upside potential if the Best Case happens, but makes sure you don’t have to
get an Emergency Loan if the worst happens. It also allows you to potentially pick up some sales if
competitors stock out.

Note on Inventory: If an R&D revision does not finish until August, what is built between January
and July? The old product design is produced and sold until the revision date. Production then
switches to the new design. Furthermore, all of your old inventory is reworked to match the new
product specifications. This will not affect the historical costs of the old inventory. Also, you do
not have to worry about having both the old and new designs on the market.
Note on Selling Plant Capacity: Sales are for $0.65 on the dollar and occur at the beginning of the
year. Selling for less than the depreciated value loses money, and selling for more than depreciated
value makes money.