Cost Leader with a Product Life Cycle Focus

Practice Rounds Business Plan

 

This practice exercise supplements the principles outlined in the Strategy lecture (Web site "Tutorials" section). It will help you understand the relationships between business strategy, tactics, functional alignment, and the Foundation simulation.  We will use the Andrews 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 Andrews team will adopt a Cost Leader with a Product Life Cycle Focus strategy, concentrating on the High Tech and Low Tech 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 “product life cycle” focus will allow us to reap sales for many years on each new product we introduce into the High Tech segment. Products will begin their lives in the High Tech market and mature into Low Tech products before they are retired and their assets harvested.

   

 

VISION STATEMENT

 

Reliable products for mainstream customers: Andrews brands offer value. Our primary stakeholders are bondholders, stockholders, customers, and management.

 

RESEARCH AND DEVELOPMENT

 

We will introduce a new High Tech product every 2 years and retire our Low Tech product when it becomes obsolete (falls outside the Low Tech segment circle). We will ultimately have a steady stream of products lined up along the leading edge of the High Tech segment, trailing edge of the High Tech segment, and trailing edge of the Low Tech segment.

 

MARKETING

 

The Andrews team will spend modestly on promotion and sales budgets  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 products we intend to keep for more than three years and spend the money necessary to set-up highly automated plants for our new products as they are launched. We will sell off the plants for products that become obsolete as opposed to re-positioning.

 

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 stock price, ROE, and ROS.

 

 

 

 

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 Cost Leader Product Lifecycle strategy entirely.

 

R & D

 

1)       Reduce MTBF on the Able product from 21000 to 17000

2)       Launch a new product: Name it Adam, enter 10.2 for New Performance, 9.9 for New Size, and 24000 for MTBF

 

MARKETING

 

Reduce Able’s price from $34 to $32. Reduce the Promotion and Sales budgets from $1000 (one milion) each to $800 (eight hundred thousand) each (actual numbers are counted in 000’s). Enter 1400 for “Your Sales Forecast” (one million four hundred thousand).

 

NOTE: We will price and market Adam during the year we begin production (2004).

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, your Marketing forecasts demand at 1400, and you have 87 units already on hand in the warehouse. You want 1400 x 112% = 1568 available for sale. Since you have 87 on hand, you would schedule 1481 units for production of Able product.

 

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.

 

For your new product Adam, you need to purchase a factory in 2003 (next year) in order to schedule production in 2004. NOTE: There is a one year lag between purchase and use of new production capabilities for both new and existing products..

 

 

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 (which you will make for new product Adam in 2003) with a long-term bond. If you do not have sufficient new bond debt capacity, issue stock to cover the shortfall.

2)       Pay a dividend between $0.50 and $1.00.

3)       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 2

Decision Guidelines

 

R & D

1)       Able – tweak positioning to reduce age. Decrease Able’s Size by 0.1 to 13.5 Note that Able is leaving the High Tech segment. Next year (2004) we will reduce the MTBF to 14000.

2)       New product Adam is still in the R&D pipeline. The only decisions for Adam this year revolve around Production – purchasing a factory

 

 

MARKETING

 

Reduce Able’s price from $32 to $31.50. Reduce the Promo and Sales budgets to $700 each. Enter 1600 for Your Sales Forecast

 

Adam’s price will be established next year (2004).

 

PRODUCTION

 

For Able, schedule production at 1600 (sales forecast) X 112% = ______ - inventory on hand.

 

For Adam, buy 700 (seven hundred thousand) units of capacity with a new automation rating of 7.0 (will cost about twenty three million eight hundred thousand)

 

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

 

Lower Able’s MTBF from 17000 to 14000

 

MARKETING

 

Offer a small price reduction on Able. Hold Promo and Sales budgets steady. Enter 1600 for Your Sales Forecast.

 

Price Adam at $45. Set Promo and Sales budgets at $1200 each. Enter 650 for Your Sales Forecast.

 

PRODUCTION

 

 

1)       For Able, schedule 1600 units for production (max overtime allowable)

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

In Round 4, you’ll begin phasing out your Able product by selling off your production capacity. You will also launch a new product to the High Tech segment as Adam transitions into a Low Tech product.

 

 

FINANCE

 

1)       Follow the guidelines from last round to manage your cash position.

2)       Do not retire long-term debt. Use excess cash to buy back stock and pay dividends.

 

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 Product Life-cycle 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?