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BB 1

Baldwin Bicycle Company


Objectives of Session
1. Practice in applying a comprehensive financial analysis framework to a new business opportunity. 2. Blending strategic marketing analysis and financial analysis. 3. Blending corporate strategy with marketing strategy This case is an excellent one for contrasting the conventional framework (Relevant Cost Analysis) with the Superior (?) framework (SCM)

BB 2

197315 million bikes sold bicycle boom (Baldwin 135,000) 198210 million bikes sold (Baldwin 99,000) Baldwin: 1982 Structural Financial Model Capacity used now Total Capacity (one shift) Cost Structure Fixed Mfg. (14% sales) S&A (22% sales) Fixed 98,791 units 131,721 units Per Unit $110 $66 $44

$1470 $2354 $3824

Selling Price Variable Cost Contribution Variable

BB 3

Du Pont Model
Profit/Sales x Sales/Assets x Assets/Equity = Profit/Equity Margins Asset Intensity 10,872/8,092 (1.3x) Leverage = Shareholder Return 255/3102 (8%)

255/10,872 (2+%)

8,092/3,102 = (2.6x)

USA Average?

BB 4

1. The Relevant Cost Analysis6 Steps 2. The SCM Analysis


a. b. c. d. Basic EconomicsTwo ways Balance Sheet ReviewWhy relevant? Market Segmentation Product Positioning

3. A Strategic Assessment of the Decision 4. What would you recommend?!?!

BB 5

Analysis of the Hi-Valu Proposal


1. Incremental Contribution Revenue Less Variable Costs Material Labor Variable Overhead (40% of $24.50) Total Incremental Contribution (25,000 units @ $23.09) = $580,000 2. One-time Design Costs $5,000; too small; ignore it! QUESTION: Can we ignore a share of fixed manufacturing and selling & administrative expenses? Conventional framework says Yes, ignore it. Per Unit $92.29 $39.80 $19.60 $9.80

$69.20 $23.09

BB 6

3. Investment (no fixed assets; only working capital)


OR, Per At Baldwin
Units ~4,200 (~2,100) ~1,000 ~500 ~4,200 ~2,100 Per Unit $39.80 $39.80 $54.50a $69.20 $69.20 $92.29 Total $170,000 ($85,000) $55,000 $40,000 $290,000 $190,000 $660,000

OR, Per Commentary


(000) $ 160 $(120) $ 55 $ 35 $ 280 $ 185 $ 595

Raw Material (2 months) Accounts Payable Offset (1 month assumed) Work in Process Finished Goods At Hi-Valu Warehouse (2 months) Accounts Receivable (1 month)

a Cost of a unit 1/2 complete (39.80 +1/2 [19.60 + 9.80] )

BB 7

4. Carrying Costs
23.5% on Raw Material + WIP + Finished Goods (23.5% on $470,000) 19.0% on Accounts Receivable (19.0% on $190,000) = $110,000

40,000

$150,000
$150,000 = $6 per unit

a. What rate to use? Debt rate vs. weighted average cost of capital Finance Cost + Non-financial Cost (tax, insurance, obsolescence, ...) b. The charge = rate x Investment

BB 8

5. Erosion (3,000 units)


Contribution on a regular bike: Sales per unit [~$11M 99,000] = = = ~$110 ~$66 ~$44

Variable cost per unit Per Unit Incremental Erosion costs (3,000 units @ $44)

~$130,000

If RelevantA Big If! Type A / Type B

BB 9

6. Pulling the Relevant Cost Analysis Together


A. ROI = Profit/Investment = (580a - 130b)/660 = 450/660 = 67%!!! Good if P/I > K = hurdle rate OR
B. Residual Income = 580a - 130b - 150c = ~300

Good if RI > 0

a. Contribution Margin

25,000 x $23.+ = ~$580,000

b. Erosion ~ 3,000 x ~ $44 = ~ $130,000 c . The Finance Charge (per item 4 above = $150,000)

BB 10

Profit Model
PAT/Sales Margins CURRENT: 1982 255 10,872 x 10,872 8,092 x 8,092 3,102 = 8% x Sales/Assets Asset Intensity x Assets/SE Leverage = ROE

WITH CHALLENGER 4351 12,872 x 12,8722 8,837 x 8,8373 3,282 = 13%

1) PC of $580 - Carry Cost of $150 - Erosion CM of $130 = $300 x ~60% = $180 2) +$2.3M ($92 x 25,000) - .3M ($110 x 3,000) = $2M 3) +745 Working Capital Assets

BB 11

Conventional Pro
Incremental profit and incremental ROI excellent (even with erosion). The existing business covers the fixed costs (i.e. we are showing profits in 1982). The Incremental business need only show positive marginal contribution. We have excess capacity and volume isnt growing. Opens up a new (for Baldwin) and more stable distribution channel (Hi Value). Opens up a new market segment for growth for Baldwin (The Discount Retail segment). Risk seems low (or does it?!).

BB 12

Cons
Can we really look at a deal on an incremental basis when it covers 25% of volume and runs for at least 3 years??!! On a full cost basis, not attractiveLose $16 per unit [92-69-15-24]. Lousy ROE (} 8% ) now; Even with the H/V deal, the ROE is still not good (} 13% ); Need to get higher margin on the remaining capacity. Creates a major cash crunch; Highly leveraged now; No debt capacity left; How to finance the incremental investment? Inventory at H/V may run up to average 4 months, not 2 months; Implications for ROI, cash flow, and financing? Additional sales losses, if current dealers drop Baldwin line? A very sweet deal for H/V; Can we negotiate a better deal? (probably yes; should we try?)

BB 13

BALDWIN: 1982
Balance Sheet
Cash A/R (45 days) Fixed Assets $342 $1,359 $3,635 $8,092 2,678 + 1,512 3,102 A/P (45 days) + Accruals $852 Bank Borrowing $2,626 LTD SE $1,512 $3,102 $8,092

Inventory (123 days)* $2,756

D/E Ratio =

= 135% 1983 mfg. plan?!

*~ 30,000 bikes in inventory = 30% of 1982 sales

BB 14

The Positioning Issue


Selling 2 similar(?) products at different prices through different channels to the same (?) customers Is this H/V deal good business? I. Normal Channel: Delivered cost $110 + $10 (transportation) plus retail markup @ 40% on selling price Selling Price = $200 II. H/V: Delivered cost $92 + $8 (transportation) plus retail markup @ 25% on selling price Selling Price = $133 Is the $67 difference in price ($133 vs. $200) reflective of a difference in value to the customer? Brand Image Dealer Image Point of Sale Merchandising Free Assembly Service

BB 15

Baldwin: Background
Currently profitable, but only modestly so (ROE }8%) Heavily leveraged Their old strategic niche is eroding away, slowly but surely, from above and below Sales volume decreasing during last 2 years A solution presents itself in the H/V offer Is it a good solution?

BB 16

Impact of the H/V Deal on the Current Business Strategy?


MINOR+ ? MAJOR+

How much flexibility does Baldwin have to experiment? How much urgency is there to do something? Does the H/V deal make sense strategically?

Reassessment of Baldwins current position


BB 17

Current contribution margin: $44 (40% of sales) Break even point: 89k units ($3.9M / 44) or 2/3 of cap. Profit (before tax) at around 450K Profit (before tax) at cap. Would be at 1.9M => Excellent! Inventory: 120 days (long); Receivables 45 days (avg.) Gross margin: 26% of sales (low in manufacturing) Selling and admin costs: 22% of sales (high, given GM) These results suggests that Baldwin is geared for much higher level of sales so, what about H/V offer?

BB 18

What is Baldwins strategic niche currently? Does it matter if they stray from that? Can we be a significant supplier simultaneously in two price segments with a substantially identical product? How to implement diverse strategies (low cost and differentiation) within the same firm? Avoid stuck-in-the-middle

BB 19

Is the H/V deal a good one?


Financially? Strategically? Ethically?

Post Mortem The Message?

BB 20

Framework for Strategic Cost Analysis


Any Decision Must Take An Integrated View Of

Financial Analysis
Sorting out the relevant costs Contribution or full cost profit as the metric How to best treat fixed or common costs

Strategic Mission Analysis


Mission Positioning Framework Build Hold Harvest Divest

Competitive Strategy Analysis


How to compete successfully to accomplish the chosen mission Low cost Differentiation ANALYZE Suppliers Customers Substitutes New entrants Competitors

There are no Free Lunches, Good Cheap Cigars, or Short-Run Business Decisions

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