Question

Case 11–3 Carmichael Corporation

Amanda Tellford, purchasing manager for Carmichael Corporation, became increasingly concerned about the purchase of MS-7, a special ingredient used in Stimgro, one of her company’s new products. It appeared that a major cost increase might threaten the product’s profit- ability, and Amanda was anxious to explore any alternatives that promised at least some cost relief.

CARMICHAEL CORPORATION

Carmichael Corporation was the U.S. subsidiary of Carmichael International, a UK-based producer of veterinary products and feed additives. Total U.S. sales were expected to be about $20 million with profits before taxes of about $1.2 million. Carmichael occupied a special niche in the market, offering small-volume specialty products that the bigger producers considered uneconomical. However, if sales of these products grew, the possibility existed that a larger producer might become interested. Carmichael had an exclusive distribution agreement with three distributors who covered all parts of the United States. Each distributor sold Carmichael products to feed stores, cooperatives,

and farm supply stores, which, in turn, sold to the farmer. For Stimgro the pricing structure through the distribution chain was approximately as follows:

(Stimgro) Carmichael ->$360 -> Distributor -> $520 -> Feed Store - >$780 - > Farmer

The Carmichael plant located in Chicago employed about 70 hourly rated people. The premises were leased and primary activities involved the mixing of ingredients and the bottling and packing of finished products. About half of the $8 million worth of ingredients was imported from the UK parent; the remainder and all packaging were purchased in the United States. The executive team consisted of Tim Paterson, president and treasurer; Charles Godfrey, sales manager; Amanda Tellford, manager of accounting and purchasing; and Andrew Hartwick, plant manager.

Carmichael Corporation concentrated on poultry medicines and feed additives. Three years earlier, Carmichael had introduced Stimgro, a feed additive for young turkeys, which had shown unusual promise in promoting rapid, healthy development in birds less than one month old. Shortly there

after, a competitor, Brisson, introduced a similar product. Because Brisson, like Carmichael, had its own exclusive distributors, Brisson’s entry into the market did not result in lower Stimgro sales for Carmichael. Small specialty producers like Carmichael and Brisson did not compete on price or manufacturing cost. Their big concern was finding new products to sell and making sufficient profit before the prod- uct was taken over by a larger company or lost its market appeal. Carmichael and Brisson had about equal shares in the Stimgro market with annual sales of about $1.4 million each.

Carmichael imported the two primary ingredients for Stimgro from its UK parent and mixed and packaged them in the Chicago plant. The manufacturing cost for Stimgro is shown in Exhibit 1. Carmichael’s selling price of Stimgro was $360 per kilogram. Amanda Tellford had tried to find a North American source for MS-7 over the past few years but had found that all potential sources, pharmaceutical, and specialty chemical firms had declined serious interest. They claimed the volume was far too low, and the price would have to be at least $800 per kilogram before they could be persuaded to manufacture MS-7.

Exhibit 1

(cost/kg)

MS-7 (500 grams) - $100

Other ingrediants (500 grams) - $48

Packaging – 4

Labor – 8

Overhead – 20

Total - $180

BRISSON

Brisson Corporation was a U.S.-owned manufacturer of products similar to those marketed by Carmichael. Brisson’s range of products was greater than Carmichael’s, and its annual sales volume was about $24 million. Brisson had originally obtained its MS-7 from a UK competitor of Carmichael International, but in the spring of the current year it had placed orders for equipment to manufacture its own MS-7. This action had surprised Amanda Tellford because, like Carmichael, Brisson had been relatively poorly prepared to take this step. For example, the North American market demand for MS-7 was limited to its use by Carmichael and Brisson. Although future growth might show a healthy increase, total current market demand certainly did not warrant the $1 million investment Brisson had to make.

Moreover, MS-7 was tricky to produce, requiring very careful temperature, pressure, and timing control. The main equipment item was a large glass-lined autoclave ingeniously instrumented and constructed to deal with the unusual demands of MS-7 production. The autoclave was normally a fairly general-purpose type of equipment in the chemical industry. However, the special conditions required for the manufacture of MS-7 made this reactor a special-purpose tool, certainly overdesigned and overengineered for the other uses to which Brisson might apply it. MS-7 manufacture was a batch production process, and the expected capacity of the equipment was about 40,000 kilograms per year based on two-shift operation.

In Amanda Tellford’s eyes, Brisson’s action affected her own purchases of MS-7, which up to this point had been at an advantageous transfer price from the UK parent. Although the exact impact was still not entirely clear, she expected at least a 40 percent increase in her laid-down cost. Amanda had no doubt that Brisson would aggressively seek customs protection from undervalued MS-7 imports and that at least a 20 percent duty would be applied on the American selling price.

Amanda Tellford, therefore, requested information from the parent company concerning manufacturing costs of MS-7. She added several other data from her own knowledge and prepared the following summary:

Summary of MS-7 cost and price data :

Minimum equipment outlay installed; $1 million

Delivery on equipment : 9–12 months

UK normal market price : $224/kg

Our laid-down current cost from Carmichael, UK : $200/kg

Carmichael (UK) out-of-pocket cost (material, labor, and variable overhead) : $160/kg

Estimated minimum laid-down cost in Chicago after Brisson starts production : $280/kg

Amanda Tellford went to see Charles Godfrey, Carmichael’s sales manager, to discuss possible sales requirements for the future. Charles said, “It’s really anybody’s guess. First, it depends on the popularity of turkeys. We are banking on continued growth there. Second, as soon as the feed compa- nies can develop a suitable substitute for our product, they will go for it. We appear to be very expensive on a weight basis, although research and actual results show we represent excellent value. It takes such tiny quantities of Stimgro to improve the overall quality of a mix that it is difficult to believe it could have any impact. More competition can enter this market any day. We are just not large enough in the U.S. market to have any strong promotional impact. Each of our product lines is specialized, of relatively small volume, in an area where the big firms choose not to operate. Should a larger firm enter this market, they could flat- ten us. Now you tell me how to turn this into a reasonable forecast.”

Amanda Tellford replied, “I’m glad that’s your problem and not mine, Charles. Anytime you feel you’re ready to put some figures down, please let me know, because it may become very important for us in the near future.”

In looking over past figures, Amanda estimated that the second half of this year’s requirements would total about 1,000 kilograms of MS-7. Amanda decided that she had better think out the effect that Brisson’s decision to make MS-7 might have on her future purchasing strategy.

Case 11-3: Carmichael Corporation

Discussion Questions:

1. What impact will Brisson’s decision to manufacture MS-7 have on the cost structure of Stimgro for Carmichael?
2. Should Amanda Tellford do anything at this stage?
3. What alternatives are open to Amanda Tellford?
4. What are the advantages and disadvantages of each alternative?
5. What is the cost structure for Stimgro and the margin?
6. Since Stimgro is very profitable, with a good margin, why does it matter if the cost of MS-7 increases?

Main Question:

7. As Amanda Tellford, what alternatives would you consider regarding MS-7? Which alternative would you pursue and how would you go about it?

Answer 1

Answer:

Answer 1:

The choice of Brisson for creating MS-7 will extraordinarily affect Carmichael as far as the manufacturing cost of Stimgro as Brisson is nearly producing MS-7 within its own office by buying its own equipment and as it has its own distribution network, it will also be an added advantage for Brisson in decreasing the distribution cost. Accessibility of MS-7 from the North American source for Carmichael would be in danger since North American source would not get the economies of scale for MS-7 creation if Brisson would deliver MS-7 in its own facility. If this condition arises, then North American source would supply the MS-7 at the cost of 800$ per kilogram (as compared with the current rate of $ 100 per kilogram) which would expand the manufacturing cost of stimgro for Carmichael and thus the selling cost of stimgro would need to be expanded via Carmichael for making profits. In any case, it would positively reduce the piece of the overall industry of Carmichael in stimgro product offering when contrasted with Brisson which would be manufacturing MS-7 at its own facility.

Answer 2:

At this stage, Amanda Telford should analyze the complete cost required for the in house creation of MS-7. In the event that it comes out to be greater than acquirement cost than Amanda Tellford should communicate the same to the management of Brisson and should cause them to comprehend the advantages of redistributing the manufacturing of MS-7 toward the North American source which would help in the accessibility of MS-7 at a moderate cost. Nonetheless, if the expense of in-house creation of MS-7 is less when contrasted with the acquisition cost than Amanda Tellford should ask the administration from Carmichael to go for the in-house creation of MS-7.

Answer 3:

There are two choices open to Amanda Tellford. One being that the Carmichael should deliver MS-7 inside its own office if its manufacturing cost is less than the procurement or redistributing cost. Another alternative to Amanda Tellford is that Carmichael should to acquire MS-7 from North American source if its manufacturing cost is more than the procurement or re-appropriating cost.

Answer 4:

Advantage of first alternative (Answer 3):

It will reduce the procurement and transportation cost. It will also reduce the stock expense and the danger of coming up short on stock of MS-7 and lead time will be decreased.

Disadvantage of first alternative (Answer 3) :

The investment is higher for buying the equipment and later on course of time it might greatly affect the assembling cost of stimgro however in the current situation, its effect on the manufacturing cost will be less. Additionally, the manufacturing of MS-7 is troublesome as it requires cautious temperature, pressure and timing control.

Advantage of second alternative (Answer 3):

It will lessen the expense of buying the gear, labor cost and the expense for the arrangement of the extra facility for manufacturing MS-7.

Disadvanatge of second alternative (Answer 3):

The different organizations requesting MS-7 will be required to work in a joint effort with one another and any dispute will result into the market share of Carmichael as its business is dependent on a single product of stimgro.

Answer Main Question:

As Amanda Tellford, I would go for the first alternative of manufacturing the MS-7 inside the facility of Carmichael. I would initially plan the facility required for the manufacturing the MS-7. I would then make the financial analysis for the equipment buying, labor requirement and the requirement for different sources and would pursue after the sellers for the equivalent. For works, I would either hire them or would get the key duties to the agency.

For economies of scale, I would go after the large scale manufacturing of stimgro, arrive at more clients for deals and would increase the product offering or go for the separation technique.

(or)

Stimgro has a sound edge, in view of a selling cost of $360 and all out costs, including overhead, of $180.. Based on annual deals of $1.4 million, Carmichael was as of now selling around 4,000 kilograms of Stimgro. Based on formula of 0.5 kilograms of MS-7 (case Exhibit 1), acquisition of MS-7 are at present around 2,000 kilograms.

A meeting to generate new ideas in class with the students can be utilized to build up a not insignificant rundown of potential choices for Amanda Tellford. There are five choices that should be covered in the discussion . The legitimate request in spread the options in class are:

● buy from parent (no change)

● stockpile

● make own

● sell to Brisson (this is an inventive choice and might need to be presented by the instructor )

● purchase from Brisson

1. Purchase from parent – no change

What will occur with the expense of MS-7 after Brisson begins production and obligations are forced?

● market cost: $224.00

● duty @ 20%: $44.80

● estimated least set down cost : $280.00

●difference : $11.20 → likely for freight How noteworthy is the cost increment and what is the impact?

● The difference in the set down cost and expected cost is $280 - $200 = $80/kg.

● 2,000 kilos × $80 = $160,000 yearly premium expense.

● With yearly benefit a year ago of $1.2 million, this speaks to about a 13% drop in Carmichael benefits.

2. Inventory/Stockpile MS-7

Cost to reserve one year's stock:

● 2,000 kg bought every year, subsequently average inventory = 1,000 kg

● Savings/cost avoidance= $80 × 2,000 kg/year = $160,000/year

● Average stock investment at @ $200 per kilo = $200,000

● carrying costs @ 25% = $50,000

● Therefore $110,000 happier than purchasing from parent

Cost to reserve multi year's inventory:

● 4,000 kg more than two years speaks to a normal stock of 2,000 kilos

● Average inventory investment for first year: 3,000 kilos @ $200 per kilo = $600,000

● Average inventory investment for second year: 1,000 kilos @ $200 per kilo = $200,000

● carrying costs @ 25% = $150,000 + $50,000 = $200,000

● Savings: 2 × $160,000 = $320,000 more than multi year time span

● Net investment funds: $320,000 - $200,000 = $120,000.

In this way $120,000 happier than purchasing from parent over two year period.

It appears to be somewhat unsafe to hold for a long time to just spare an extra $10,000 (contrasted with storing for one year). There is additionally some missing data: Is there distribution center space accessible? Would we be able to store MS-7 for one year? Is there supply of MS-7 accessible to assemble a stockpilr?

3. Make MS-7

Carmichael can make MS-7, with the target of offering to Brisson or going alone (e.g., for Stimgro). There is information for the situation that can be utilized to assess the expense of delivering MS-7:

● Equipment $1 million introduced, which speaks to $333,333 every year dependent on a multi year compensation

● Interest costs: utilizing $500,000 average equalization @ 10% expense of capital = $50,000/year for 3 years

● There is no data for the situation about overhead cost distribution, so these should be researched. For the reasons for the investigation, overhead expenses are assigned as "X".

-. Utilizing these presumptions and the information for the situation, the expense of creation is given underneath. Two situations are "separated from everyone else" (Carmichael just) and "together" (Carmichael and Brisson at twofold the volume).

Alone                 Together

variable expense    $160

capital      $167 ($333,333/2,000 kilos) $83.5 ($167/2)

interest $25 ($50,000/2,000) $12.50 ($25/2)

overhead $X/2

Total -$352.00 + X $256.00 + X/2

No doubt even by consolidating the necessities of Carmichael and Brisson, the expenses of creation in-house is restrictively costly. For what reason is Brisson making in-house? A few prospects are:

● Brisson has different utilizations for the equipment .

● Their MS-7 volume expanding.

● MS-7 costs are expanding.

● They might need to sell abundance limit.

● Brisson has supply issues.

● They committed an error.

Despite our cost investigation, Brisson was some way or another ready to legitimize the speculation. Moreover, the main alternative for which we don't have an expense is for purchasing MS-7 from Brisson.

At this point the instructor can ask what Amanda Tellford ought to do straightaway. For what reason don't we send Brisson a letter/RFQ for MS-7? They would probably get back a cost for $280.00.

A consistent subsequent stage is to haggle with Brisson. Amanda realized that she could generally buy MS-7 from the parent organization, so supply was guaranteed. Investigating the choice of purchasing from Brisson might decrease MS-7 expenses after the obligations were forced. Arrangement bodes well, versus different techniques for value assurance, since Carmichael is managing a contender and we need to stray from advertise cost (e.g., $160 - $280). Contrasted with different techniques for value assurance, arrangement is tedious and costly, yet right now potential recompense makes it worth the venture.

Amanda was prepared to examine the suggestion with different individuals from the Carmichael supervisory crew. The gathering met every week for an administration meeting in Tim Paterson's office. It was normal information among all individuals from the supervisory group that there was no adoration lost between Charles Godfrey and Brisson. Amanda didn't know why Charles had a solid hated of Brisson, yet she anticipated that his job as team lead and a solid serious soul likely affected his assessment of Brisson. Amanda was certain that Tim Paterson and Andrew Hartwick would be delicate to how Charles would respond to an arrangement with Brisson. Therefore, Amanda concluded she should converse with Charles first on the premise that in the event that he vetoed a way to deal with Brisson there would not be a lot of point in pressing together the issue further.

Amanda went to Charles' office to perceive what he may achieve. Their discussion is sketched out in Appendix An of this showing note and can be put on an overhead to be followed pass up pass up line. Understudies can be solicited to play the job from Amanda Tellford and how they would react to every one of remark by Charles Godfrey. This speaks to the inner selling step in the exchange procedure.

Educators can run a fake exchange in class with the understudies before demonstrating the arrangement among Tellford and Godfrey. This activity includes parting the class into sets and takes around 15 minutes. The task for the fake exchange is:

Right now one arrangement, if it's not too much trouble flip a coin to decide if your job will be that of Amanda Tellford or Charles Godfrey. Whoever surmises the coin cost accurately may pick first. On the off chance that your job is that of Charles Godfrey, it would be ideal if you attempt to be a genuine hater of Brisson. Most definitely, you have no earlier information on the reasoning Amanda has experienced so far as for MS-7.

On the off chance that your job happens to be that of Amanda Tellford, it would be ideal if you set yourself what you accept to be a sensible target for this inward selling exchange. Attempt your best to convince Charles Godfrey that the choice you wish to pursue makes sense.

Following the mock exchange the instructor can do a fast question of the results of the gatherings. I normally get a vote and start with remarks from the understudies that had the job of Charles Godfrey. I at that point survey the genuine exchange among Tellford and Godfrey in the informative supplement, going line-by-line, asking the students to take the role of Amanda Tellford and how they would react to every one of remark by Charles Godfrey.