Situation analysisAmerican Box Company (ABC) was a low-medium quality Cardboard manufacturing company.
23rd largest competitor in US box market, the company concentrated its 60% sales in Boston. With Bob Hamilton as its current chairman and president, ABC was established by Bob’s grandfather. The small manufacturers in the US box industry were either bought out by the major competitors, Morgan Box and Chase Box, or exited the market altogether because of economies of scale in production. The large companies brought down their cost of various components of cost of production (Exhibit 1) because of multi-plant, multimarket scope of operations.
The industry concentration hence increased and Morgan Box was successfully increased its market share from 8% in 1983 to 21% in 1991. On the other hand, in ABC Bob was concerned about falling net income of the company. He wished to increase the revenue in the next year.
Since the product couldn’t be differentiated in the market in terms of quality and features, ABC could play on the basis of profit margin. Price couldn’t be increased since it was a Buyer’s market. Either the cost of production and distribution could be decreased or the amount of production could be increased.ABC had cut down its costs to an extent.
Its business was concentrated mostly in Boston so as to decrease its shipping cost. Also, it had stopped its advertising to the trade via trade publications whereas Morgan Box had escalated its advertising and was even enjoying economies of scale in trade advertising. ABC distributed its products using 2 channels- direct and reps (Exhibit 3). The channels distributed both products to different customers. The sales figures in year 1988 and 1992 are given in Exhibit 4. What is realized is that in case of direct sales, number of boxes sold had actually increased by 92% whereas in the case of independent representatives, sales of boards had more than doubled in 4 years.
However at the same time, the sales of boxes via reps and the sales of board via direct sales had been decreasing. This means that one channel would not have been an effective distribution for every product. This could also be the case due to increase in demand of boxes in larger accounts and increase in demand of boards by smaller or distant accounts. The point to be noted was that while price of board had decreased, the price of boxes had increased from 1988 to 1992 (Exhibit 5). Hence the production cost could be further brought down by managing the distribution more precisely.
Apart from the revenue decrement, the market share of the product produced by ABC was also decreasing. ABC’s products were low to medium corrugated cardboard and cardboard boxes. Another product in market was a high quality cardboard known as pressboard, whose market share was increasing continuously (Exhibit 2). ABC’s sales were more in industrial rather than consumer product market.
And in the time when pressboard was increasingly being used by industrial manufacturers, ABC was still manufacturing corrugated cardboard only. Not just this, the capacity utilization also stood at 55%. If increase in production was to be considered, there was a lot of scope, but first the market absorption capacity was to be analyzed. As Exhibit 6 shows, even though the market share of corrugated cardboard in the cardboard industry had dropped, the market share of ABC in the corrugated cardboard market had increased from7.
28% to 8%. Hence there was a lot of scope of increasing production for ABC. Problem statementShort term problem- Underutilization of production capacity by ABC even when market had a scope of absorptionLong term problem- ABC producing only corrugated cardboard while there was continuous increment in market share of pressboardObjectives1.
No further decline in revenue 2. Decrease cost of production 3. Adapt and evolve keeping in mind the developments taking place in the industryOptions1.
Make use of the 45% underutilized capacity and produce more, making sure that the cost of production per unit didn’t increase further2. Make direct sales force focus more on selling boxes. At the same time, make direct representatives focus more on selling boards while giving independent representatives commissions proportionate to the volume of boxes/board they sold3. Gradually move towards manufacturing pressboard by setting up a new plantEvaluation of options1.
Make use of the underutilized capacity of production. The underutilized capacity was 45% and as discussed the share of ABC in the market of corrugated cardboard was 8%. Hence the market had the capacity to absorb more if ABC increases its production.
Pros- Increase in revenue generation since ultimately more products would be sold.Economies of scale due to more utilization of the capacity would further bring down per unit cost of productionThe decrease in cost of production would also give ABC a margin to expand its practice outside of BostonCons-Per unit cost could even increase if the requirement of the corrugated cardboard industry was outside of Boston (transportation cost is high)Cost of production could even increase on selling more due to increase in cost of storage and increase in commission paid to the independent reps2. Make direct sales focus more on selling boxes. The direct sales called on larger accounts and they could demand boxes more. Similarly, 111% increase in sales of board by reps could mean more demand of boards by smaller or distant accounts. Hence the demand of the products by different kind of customers be evaluated first, and the commissions to the reps would be paid accordingly.Pros-This will bring down the per unit cost of a product and hence increase profit marginEffective utilization of distribution channels would even reduce time of selling Cons-Making the channels focus on selling one product more would lead to further decrease in sales of the other product.
This could surpass the increase in sales of first productThe value of boxes decreased from 1988 to1992. Hence direct sales targeting more and selling more boxes might have not led to a significant increase in revenue3. Gradually move towards manufacturing Pressboard and adapt to the changing environment in the industry. This would require setting up a new plant.
Being a long term goal, it needed to be put in action only when the short term problems were taken care of.Pros-ABC would be able to fulfill the demand of the industrial as well as the individual market more effectively. Hence its market share will increaseMore production will lead to large scale of economiesCons-Setting up a new plant would require a huge investment. Also, ABC would have to be ready for incurring initial losses since breakeven time could be large.Short term problems were to be solved first. DecisionUtilize the 45% capacity of the plant already in function. The corrugated market has a lot of scope of absorption and the objective of revenue increment could be surely increased by selling more.
The further benefit from economies of scale would lower the cost of production also. Even if the commissions of reps are not decreased, the company would still profit more by just utilizing its capacity. The result of experimenting on the commissions of sales reps could be uncertain since the reps could even get demoralized if they would be paid less than before. Also, this option would not require huge investment as in case of option 2, since no new machines/plant would be required. Adding to this, the rate of decrease of market share of corrugated market had slowed down relatively (Exhibit 2).
This could mean that merely playing in the corrugated cardboard market, ABC could increase its profit by many folds. Whereas shifting to a new product would require not just capital investment, but training of labor for the new set of skills.Action plan1.
Company buys more raw materials (Paper)2. Manufacture ; Assembly ; Packing ; Marketing (sales)3. Keeping in mind the huge fixed cost, per unit cost would come down.
Production cost will further increased by economies of scale achieved due to utilization of capacity. Hence expansion of business to distant areas could be done.4. The distribution channels to be trained accordingly or hired in more number to be able to sell the surplus finished product. Contingency planDrawing inference from the increase/decrease in sales of the 2 products by the 2 distribution channels, the direct sales would target selling more boxes whereas the reps would target selling more boards.
This would decrease per unit cost of product, thereby making sure that the revenue doesn’t decline further.Exhibit 1Major components of cost of productionManufacturing Paper processed into cardboard Assembly Cutting and folding of cardboard sheets into boxesPacking Packing of unfinished cardboard into containersMarketing (Selling and Distribution) Commissions for independent reps as well as salaries of direct sales force. Fixed Overhead Costs General, Administration and overhead expense of Business as a wholeExhibit 2Market Share of Cardboard sales (% of $ volume)Year Corrugated Pressboard1988 72% 38%1989 66% 34%1990 60% 40%1991 51% 49%1992 48% 52%Exhibit 3Distribution of products by ABC Exhibit 4Sales of 2 products of ABC by distribution channels 1992 sales 1988 sales Product line Volume (tons,000) Revenue ($000) Volume Revenue % change in volume soldDirect sales Boxes 62 2085 32.3 1086 91.9% increase Board 41 955 120.2 2800 65.
8% decreaseIndependent reps Boxes 66 1947 106.5 3139 38% decrease Board 34 391 16.1 185 111.8% increase Exhibit 5Change in value (price) of each product from 1988-1992Product Value ($) 1988 1992Board 21.
9 17.9Boxes 30.44 31.5Exhibit 6Industry sales vs. ABC salesYear Cardboard Industry sales (total) Corrugated cardboard sales ABC sales % market share of ABC1988 5,247,321 3778071.12 275100 7.28%1992 5,168,210 2480740.8 203000 8%