Broad Cost Leader

Practice Rounds Business Plan

 

This practice exercise supplements the principles outlined in the General Strategy lecture (Web site "Tutorials" section). It will help you understand the relationships between business strategy, tactics, functional alignment, and the Capstone simulation. We will use the Chester team for this example.

 

During the practice rounds, each team is assigned a different business plan. You will execute your plan by inputting the decisions described below. At the same time, your competitors will execute their assigned plans. The practice exercise may run for up to four rounds (at your professor’s discretion). As each round is processed, you will evaluate the results and then input the next round’s assigned decisions.

 

Upon completion of the practice rounds, the simulation will be reset to the beginning. Your team will then create and implement your own strategic plan for the actual competition. The practice rounds offer six distinct strategies, but like the real world there are infinite variations.

 

PREWORK AND SUPPORTING DOCUMENTS

·         The Capstone™ Team Member Guide

·         Lessons 1 and 2 on the Web site

·         Documents created during the Situation Analysis, Chapter Four of the Team Member Guide (Perceptual Map, Demand/Capacity analysis, etc.)

·         Capstone Courier (the 11 page industry newsletter)

·         Company Annual Report (Cash Flow, P & L, Income Statement, Market Share)

 

EXECUTIVE SUMMARY

 

The Chester team will adopt a Broad Cost Leader strategy, maintaining a presence in both segments. We will gain a competitive advantage by keeping R&D costs, production costs, and raw materials costs to a minimum, enabling us to compete on the basis of price. Our Cost Leader orientation will allow us gain a competitive advantage based upon low prices. We will increase automation levels to improve our margins and to make it acceptable to run overtime (which we can also view as a second shift).

   

VISION STATEMENT

 

Low priced products for the industry: Chester brands offer solid value. Our primary stakeholders are bondholders, customers, stockholders and management.

 

RESEARCH AND DEVELOPMENT

We will keep our existing product line and launch one new product in order to maintain a presence in both the Low Tech and High Tech segments. We will work to keep our products up to date (i.e. Size and Performance) in each segment despite high automation levels.

 

MARKETING

The Chester team will spend modestly on promoting and selling products in our industry. Our prices will be lower than average. After we establish our cost leadership position, we will revisit our situation to explore options to improve awareness and accessibility.

 

PRODUCTION

We will significantly increase automation levels on all products. However, because automation sets limits upon our ability to reposition products with R&D, we automate more in the slower moving Low Tech segment than in the fast moving High Tech segment. We will prefer overtime to capacity expansions.

 

FINANCE

We will finance our investments primarily through long-term bond issues, supplementing with stock offerings on an as needed basis. When our cash position allows, we will establish a dividend policy and begin to retire stock. We are not adverse to leverage, and expect to keep debt/equity between 2.0 and 3.0. We measure performance in terms of market share, stock price, ROE, and profits.

 

 

PRACTICE ROUND 1

Decision Guidelines

 

Follow the decision guidelines below unless directed otherwise by your professor. After the practice rounds, you are free to pursue any strategy you wish, and can abandon the Broad Cost Leader strategy entirely.

 

R & D

1)       Cake – improve cost structure to support our position as price leaders. Reduce reliability to 18000 MTBF - reducing material cost.

2)       Launch a new product -Cedar – New Pfmn 9.0, New Size 11.0, MTBF 20000.

 

Make certain that the projects FOR EXISTING PRODUCTS complete during this year before December 31st. Under the rules, a new project can only begin on January 1st. If these projects do not complete before the end of this year, we cannot begin follow-up projects next year.

 

 

MARKETING

1)       Cake – make modest cuts in price to $33.50, promotion to $800, and sales to $800. Forecast sales of 1300 units.

2)       Cedar   marketing decisions will be made next year when the new product is ready to begin production..

 

NOTE: Sales forecasts are purposely conservative. They reflect a pessimistic point of view.

 

PRODUCTION

Production schedules should reflect a rule of thumb – plan for 6 weeks of inventory. That is, have enough inventory on hand to meet demand for 6 weeks beyond the sales forecast. This gives you a 12% inventory cushion. For example, the Marketing forecast predicts demand for Cake at 1300, and you have 87 units already on hand in the warehouse. You want 1300 x 112% = 1456 available for sale. Since you have 87 on hand, you would schedule 1369 for production.

 

Since your Marketing forecast was conservative, it is unlikely that you will sell less than your forecast, but there is a good chance that you will stock out. Capstone does not take backorders. If you cannot meet demand, sales go to competitors. Therefore, you want to plan for the upside as well as the downside. Your Proforma Balance Sheet will forecast about 6 weeks of inventory. You hope that your actual sales will fall between your sales forecast and your inventory levels.

 

1)       For Cake schedule 1369 for production, increase automation level to 5.0.

2)       For Cedar, purchase 500 units of capacity at an automation rating of 4.0. There is a one year lag between purchase and use of new plant. So in order to produce Cedar next year, we need to order the factory this year.

 

FINANCE

Your fiscal policies should maintain adequate working capital reserves to avoid a liquidity crisis. Put another way, keep enough cash on hand to avoid Capstone’s™ loan shark, Big Al, if your competitors clobber you, resulting in large unexpected inventories in your warehouse. Inventories are paid for when you build the product. Too much unexpected inventory leads to zero cash with bills still outstanding. At that moment, Big Al arrives with a smile, pays your bills, and leaves you with a loan and a stiff interest payment. (In the United States, this event is also known as Chapter 11 bankruptcy.)

 

Here are some guidelines to help you avoid Big Al. Your proforma Balance Sheet predicts your financial condition at the end of this year. Make conservative marketing forecasts. Do not rely upon the computer’s forecast. Override it with a forecast of your own. If you are conservative, it is unlikely that your worst expectations will be exceeded. Next, build additional inventory beyond your pessimistic expectations. This forces your proforma Balance Sheet to predict a future where your conservative sales forecast comes true and you are left with inventory. (If you sell the inventory, that’s wonderful.) Now look at the proforma Balance Sheet’s Cash and Inventory accounts. Drive your Cash position until it roughly equals your Inventory position. That is, either issue stock or borrow bonds until Cash equals Inventory. This creates an additional reserve for those times when your worst expectations are exceeded and disaster strikes.

 

Working capital can be thought of as the money that you need to operate day-to-day. In Capstone™ it is equivalent to your Current Assets – Cash, Accounts Receivable, and Inventory.  As you gain experience with managing your working capital, you will observe that the guidelines above make you somewhat “liquid”, and you may wish to tighten your policy by forecasting less cash and inventory. That is fine. The better your marketing forecasts, the less working capital you will require.

 

1)       Match your plant investment (11 million dollars) with a combination long-term bond (60%) and stock issue (40%). If you do not have sufficient new bond debt capacity, issue more stock to cover the shortfall.

2)       Pay no dividend.

 

SAVE DECISIONS

 

1)       In the menu, click File | Save, or click the Save Decisions button in the toolbar.

2)       Print proformas. You will find a Print Proformas button in the toolbar.

3)       Upload your decisions to the Web site.

 

 

PRACTICE ROUND 2

Decision Guidelines

 

R & D

1)       Cake – improve positioning to 6.7 New Pfmn, 13.0 New Size. Reduce reliability to 17000 to reduce material cost.

2)       Cedar – You cannot make any R&D changes to Cedar as the project has yet to complete.

 

MARKETING

1)       Cake – offer a price cut to $32.50. Hold promotion and sales budgets near current levels. Forecast sales of 1450.

2)       Cedar   price at $44.00, Promotion at $1000, Sales at $1000. Since Cedar won’t be ready to enter production until well into this year, so enter 200 for sales forecast.

 

PRODUCTION

1)       For each product, schedule production using the formula:
(UnitSalesForecast X 112%) – InventoryOnHand.

2)       Cake –increase automation level by 1.0 or 2.0 units – whatever you feel you can afford that will help create your cost leadership position.

3)       Cedar – increase automation level, but only by 1.0 unit. We will want to begin re-positioning Cedar next year in order to keep it fresh for the High Tech customers. The higher the automation rating – the more difficult it is to re-position. We must strike a balance between our cost pressure requirements vs. our need to re-position often in the high end.

 

FINANCE

1)       Match your plant investment with a long-term bond. If you do not have sufficient new bond debt capacity, issue stock to cover the shortfall.

2)       Look at the proforma balance sheet, and add together your Cash and Inventory accounts. Apply the following rule of thumb. Keep between 15% and 20% of your balance sheet assets in Cash plus Inventory. You do not care about the mix, but you do want to have adequate reserves to cover unexpected swings in inventory.

3)       Adjust your cash position to meet the guideline from #2. If you are cash poor, issue stock. If you are cash rich, pay dividends and buy back stock.

4)       Do not issue Short Term Debt.

 

SAVE DECISIONS

1)       In the menu, click File | Save, or click the Save Decisions button in the toolbar.

2)       Print proformas. You will find a Print Proformas button in the toolbar.

3)       Upload your decisions to the Web site.

 

 

PRACTICE ROUND 3

Decision Guidelines

 

R & D

1)       Cake – Reduce reliability to 14000 MTBF in order to reduce material cost.

2)       Cedar – Reduce Reliability to 19000 MTBF. Reposition Cedar moderately towards the current leading edge of the High Tech segment with a slight decrease in Size and slight increase in Performance.

 

MARKETING

1)       Cake – Offer a price cut. to $32.00 Hold promotion and sales budgets near current levels. Forecast sales near average. Example: promotion budget $750, sales budget $750, and sales forecast 1500.

2)       Cedar – offer a price cut to $43.00, reducer promotion and sales budgets slightly. Forecast above average unit sales.

 

PRODUCTION

1)       For each product, schedule production using the formula:
(UnitSalesForecast X 112%) – InventoryOnHand.

2)       For Cedar, increase capacity to 800.

 

FINANCE

1)       Look at your modest plant investment. You should have suffucient cash on hand to pay for it. If not, borrow or issue stock.

2)       Look at the proforma balance sheet, and add together your Cash and Inventory accounts. Apply the following rule of thumb. Keep between 15% and 20% of your balance sheet assets in Cash plus Inventory. You do not care about the mix, but you do want to have adequate reserves to cover unexpected swings in inventory.

3)       Adjust your cash position to meet the guideline from #2. If you are cash poor, issue stock. If you are cash rich, pay dividends and buy back stock.

4)       Do not issue Short Term Debt.

 

SAVE DECISIONS

 

1)       In the menu, click File | Save, or click the Save Decisions button in the toolbar.

2)       Print proformas. You will find a Print Proformas button in the toolbar.

3)       Upload your decisions to the Web site.

 

 

SUMMARY CONSIDERATIONS

 

Your professor may want you to play another practice round. If so, continue the Broad Cost Leader vision.

 

Having executed the plan for two or three rounds, you are now in a position to critique it. Consider the following questions:

 

What are this plan’s strengths? Weaknesses?

 

How will competitors respond to your actions?

 

How can you influence competitors to avoid competing with you directly?

 

Which performance measures support this plan?

 

What is the long range potential of this plan? Its future sales volume? Its future profitability?

 

How can you best coordinate this plan as a team?