Fence Company MBA Case Study

8/8/2019 Fence Company MBA Case Study

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Fence Company Ltd.


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Fence Company Ltd.

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Established in 19x5, Fence Company Ltd. is the brain-child of two brothers, Robert and MorrisWood. Catering to the residential housing market, FC is a low-cost provider of wooden fences.After a financially distressing year, FC requires an overhaul to its cost and pricing structure, itsmarketing, human resources, and its operationsindeed, it has yet to establish an overallstrategy congruent with its competencies and resources.

The current financial and

strategic position of FC wasevaluated using various formalsystematic models, such asNadler and Tushmans (1997)Congruency model, Porters(1985) Five Forces, and companyanalysis (SWOT). These modelspoint to a best-cost providerstrategy supported withexpanded marketing and seasonalwork teams. Fence CompanyLtd. must no longer competesolely on price but also on qualityand brand, which can allowpricing at a premium.

Fence Company must first reduceits fixed costs. The secretary awarehouse expenses should be eliminated and replaced with cellular telephone and deliv

costs. Better controls are required for the tools and machinery to avoid additional expensesfollowing years.

Sales commissions should be changed to encourage more sales, but of smaller one-houseprojects rather than large groups. The volume discount to group sales should be eliminated, asit resulted in negative earnings.

As a benchmark, FC should aim to return 8% on investmenta reasonable target given thecurrent economic climate.


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Fence Company Ltd.

BBBackground

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Equally owned by two brothers, Robert and Morris Wodd,Fence Company Ltd. (FC) Was incorporated in March, 19x5.Catering to the residential fence market, it offers volumediscounts for group purchases, guarantees to repair defectivefences at no cost, and has a capacity of 36,000 metres peryear.

Industry AnalysisIInndduussttrryy AAnnaallyyssiiss

The Canadian fencing industry, along with all residentialconstruction industries, has been hit hard since the beginning of the 19x0 recession. In fact,Industry Canada cites this period as being the most prolonged period of stagnationsince theGreat Depression. This stagnation has been mainly attributable to cyclical, demographic, andstructural factors. Owing to excess capacity generated during the previous decade and theconcurrent slow growth in the overall Canadian economy, Fence Company faces a particularly

difficult challenge in the next few years.

See Appendix 1 for a comprehensive industry analysis.

The ProblemTThhee PPrroobblleemm

Fiscal year 19x5 was a difficult one for Fence Company.It is now late March, 19x6, and the Woods must make

some modifications to their current business model inorder to remain viable. The 50,000 metres projectedfor 19x6 is unreasonable, since this projected volumeexceeds capacity by 39%.

Company AnalysissCCoommppaannyy AAnnaallyyssiis

See Appendix 2 for complete Congruency and SWOT analyses.

The use of formal models facilitates systematic development of feasible alternatives. In orderto propose alternative courses of action that fit FCs specific context, its current internal andexternal situation, its competitive environment, its strategic objectives, and its competenciesand resources must be considered. General recommendations made at the generic levelwithout regard for specific company context are therefore avoided since all recommendationstake FCs specific context into account


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Fence Company Ltd.

Practical As umptionsPPrraaccttiiccaall AAss

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A number of assumptions were integrated into this financial model:

Variable Costs are LinearThis model assumes that variable costs, such as materials and labour, are linear over therelevant range; that is, there are no volume discounts on material, and no additional costs tohiring supplementary teams.

100-metre Average Fence Length

The model assumes an average house to require 100metres of fence. Obviously, many houses will requiremore or less fencing; however, all orders were ato comprise 100 linear metres.

Constant Selling PriceThe model assumes a non-negotiable pricing of $12 permetre for base scenario. This conservative assumptionassumes that sales closes each sale at the minimum

expected $12 per metre price point. Each sale is assumed to close for the same price.Similarly, in each proposed scenario, all orders are presumed to be closed for the same sellingprice per metre.

Non-adjacent Multiple OrdersIn the case of one-, two-, and four-house multiple orders, the $120 machine transportation feeis assumed to apply to each order. Further, multiple orders are presumed to be non-adjacentfor the purposes of calculating length of fencing. Adjacent orders would result in reducedmachine transportation costs and reduced materials cost for the shared portions of the fences.

Non-Unionized LabourLabour is presumed to be non-unionized. Although management is legally prohibited frominterfering in the formation of unions, labour force is presumed to be non-unionized. Thisresults in lower wage costs, easier lay-offs, and higher productivity.

Minimum Salaries FixedThe required $12,000 salary for secretarial staff and $15,000 per owner are assumed to befixed and constant. Although including the $15,000 per owner is controversial given the

business is a limited partnership, this is presumed to be an absolutely necessary minimumrequired return for the purposes of analysis. Return on investment (ROI) is therefore assumedto be over and above the required salaries.

Snow-Ploughing is IncrementalThe model assumes that the $500 per winter month truck rental expense and its associatedrevenues are incremental to FCs core competency of fence construction. It is therefore


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Fence Company Ltd.

All Teams Share One TruckThe model assumes that one truck is used by all teams. Once the team and materials are

delivered to the site, the truck can leave to service another team (during the multi-teamsummer months).

Cellular Telephone Costs $100 per monthIn order to evaluate the feasibility of replacing the full-time secretary with cellular telephonesfor the two owners, the cellular telephone was assumed to cost $50 per person per month, or$100 per month.

Financial AAnalysisFFiinnaanncciiaall Annaallyyssiiss

FCs current proposed 19x6 budget is detailed in Appendix 3. According to their plannedallotment of work teams (outlined in Appendix 3), assuming an average fence order-size of 100metres, maximum capacity is estimated at 360 houses (orders) per year.

Base Scenario Not ViableGiven its current cost and pricing structure, FC is far from able to break even with its most

conservative offer, the one-house, 100-metre order. This order gains FC an estimatedcontribution margin of $118 per house. In order to break even relying entirely on 100-metreorders, FC would have to build 78,814 metres of fencing, or over 788 house orders. With amaximum capacity of 36,000 metres (360 houses) per year, FC is not able to remain viable withits current 100-metre pricing structure.

Its most generous offer, a four-house, 400-metre order offers increased sales commission and avolume discount. This pricing structure results in a negative contribution margin; every four-house, 400-metre order loses FC approximately $152.

The Solution: Cut CostsFence Company must align its cost and price structure more closely with its capabilities. Givenits estimated production ceiling of 36,000 metres in 19x6,

AlternattivesAAlltteerrnnaatiivveess

Differentiate the ProductThe Woods have undertaken Porters low-cost providerstrategy by default. The focus is on volume, attractingclients on the basis of price. Although the Woods brothersguarantee quality, they have not delivered it. This morphsthe guarantee from an asset to a liability. FC must segmentits market and position itself to target it most effectively. In

k i h l b i i i i bl


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Fence Company Ltd.

rom pre-manufactured

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be applying fencing to porches and verandas in fashionable ways. This would particularlyappeal to the luxury homeowner who is less price-sensitive.

Develop new ProductsFC could erect barriers to entry by specializing in a particular type offence. Intellectual property laws would protect product innovationsprovided their technologies have not been presented to the public in adisclosing nature. The cost to protect a technology with a patent,however, would be estimated in the tens of thousands; however, withFCs estimated 19x6 revenues of $436,000, establishing a research anddevelopment division and acquiring and prosecuting patents is far out

of reach. The companys core competencies lie in assembling fences fparts, not developing new ones.

Realign Business as Best-Cost ProviderRather than try to serve all segments of a heterogeneous market and compete solely on thebasis of price, Fence Company should identify its target segments and pursue a best-costprovider strategy, emphasizing delivering its previously-stated value proposition of quality

workmanship while striving to optimize cost structure to maintaincompetitiveness with new entrants.

Cash out or Sell the BusinessThe Woods brothers have made little capital investment and have nfirm commitments, such as collective agreements or long-termleases. Potential new entrants also recognize the relative ease ofexiting the industry, increasing competitiveness. If FC wants tobecome competitive, it must make a new value proposition thatresults in increased benefits and presents potential new entrantswith a barrier to exit.

Increase AdvertisingLittle (1970) describes a sigmoidal mathematical relationship between advertising expenditureand short-run sales response. No advertising efforts were under way in 19x5 and none wereplanned for 19x6. FCs sales would, therefore, increase exponentially with sufficientadvertising expenditures. This level would be determined by Littles ADBUDG (1970) functioncalibrated with inexpensive marketing research information.

Increase Teams to meet Demand

Although FC currently has a capacity of 36,000 metres, the Wood brothers estimated themarket to be 50,000 metres. Because FC is not bound by a collective agreement barring hiringseasonal short-term workers, FC could easily hire seasonal or student workers as required.

Cut CostsFC currently has a high proportion of fixed costs that cannot be justified by expected revenues.A full-time secretary at $12,000 per year can be replaced by a cellular telephone for each of


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Fence Company Ltd.

veranda specialist (horizontal). This strategy would allow FC to exploit economies of scale andadditional resources; however, the brothers would lose a significant amount of control and

identity.

Recom endationsRReeccoommmmmeennddaattiioonnss

Fence Company should establish a best-cost provider strategy and support it with adequatemarketing and human resources. The Woods estimated the total 19x6 market size to be 50,000metres (500 houses). Although their current team configuration cannot support this demand,FC could supplement its workforce during the summer months and access additional low-coststudent work.

Best-Cost Provider StrategyThe best-cost provider strategy aims to provide the best possible product at the best possibleprice. While this seems to be a contradiction, it really represents a balance. The Woodsshould ensure appropriate product quality by ensuring better controls. This can beaccomplished through establishment of more rigorous and formal standards. This wouldrepresent an additional fixed cost; however, once a standard has been developed, variablecosts are required to implement it. Alternatively, the Woods could consider pursuing a nichestrategy. They could cater to upscale luxury homeowners, who would be willing to pay apremium for attractive quality fences or to agricultural clients who would require large orderson the same site and regular maintenance contracts.

Cut CostsRegardless of the strategy FC chooses, however, it must reduce its costs. The current coststructure requires production of 78,800 metres of fence to break-even. This not only exceedscurrent capacity, but it also exceeds estimated market demand. Wage rate is assumed to beminimum wage and therefore cannot be reduced legally. Materials costs are assumed to be attheir minimum assuming that FC receives volume discounts already and stockpiles material inthe warehouse.

The warehouse expense, however, could be removed. This would reduce the need for a truckto transport materials. It is estimated that FC would then be required to pay a 5% premium forJust-in-Time delivery of materials and for ordering in smaller quantities.

The secretary can be replaced by two cellular telephonesone for each owner. Although thesecretary may be able to accommodate more callers, the current market size of 500 housesdistributed evenly over the nine-month work term would translate into less than three calls per

day. Assuming the owners are not actually involved in the unskilled labour, three calls per daycan easily be handled by the two owners. This represents a net savings of $10,800 per yeara90% reduction in the relevant costs.

Because all tools from the previous years must be replaced, this expense isincluded in all estimates; however, the new tools must be controlledbetter. This could be accomplished by issuing each worker with a


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Fence Company Ltd.

Supplement Workforce to Meet DemandDuring the peak summer seasons, FC can supplement its workforce by hiring student workers.Student workers have a lower legislated minimum wage and are less career-oriented than theregular workers. Not constrained by a collective agreement, FC is free to adjust its workforceto meet demand. Its current planned work team distribution accommodates 36,000 metres peryear (assuming 20 work-days per month):

Month Work Teams Capacity (metrres)

April 1 2,000

May 3 6,000June 3 6,000July 3 6,000

August 3 6,000September 3 6,000

October 1 2,000November 1 2,000

Total 36,000

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The brothers estimated the market size to be 50,000 metres. This can be accomplished bythe addition of student workers as follows:

Month Work Teams Capacity (metrres)April 1 2,000May 4 8,000

June 5 10,000July 5 10,000

August 4 8,000September 4 8,000

October 1 2,000November 1 2,000

Total 50,000

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University and college students can begin work earlier than high school students; thus, thecombined school students can accommodate more work teams during June and July.

Increase Marketing EffortsIn order to tap into this expanded market, or to expand the market greater than 50,000 metresper year, FC can increase marketing efforts. Littles ADBUDG model (Little, 1970) outlines theexponential growth of sales due to increased advertising andpromotion. Cluster analysis and factor analysis can be applied toprevious customers (pre-existing data that are readily availablewithin FCs own files) to identify customer segments which can


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Fence Company Ltd.

of erecting fences; however, because the business is essentially dormant during this period, thebrothers can evaluate this option. This should be viewed as an incremental cost, however, and

the costs of renting the truck during the winter were not included in calculations pertaining tothe fence business; further, revenues resulting from ploughing snow are irrelevant to FCsoperations, since FCs competencies do not include ploughing snowperhaps the Woods do.

Eliminate Volume Discounts and Reduce CommissionsSince the volume discount increases variable costs so significantly that no profit is possible, itshould be eliminated; further, the $13 price should be enforced and supported with adifferentiated product of higher quality or singular construction. Vinyl fencing is a newalternative that provides better ruggedness at comparable cost to wood. The overall budget

assumes that fences will be sold at $13 per metre, and assumes group sales are sold at $12 permetre. Even with this structure, however, group sales are unprofitable and should not beimplemented.

Commissions should be structured to encourage the more profitable single-house orders. Forthis reason, a constant 5% commission is suggested for single or group sales; however,calculations estimated the commission at 6%. This supports a high performing salesperson byincreasing commissions based on volume of single-house sales while not encouraging groupsales.


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Fence Company Ltd.

References

Nadler DA and Tushman ML. 1997. A congruence model for organization problem solving. InManaging Strategic Innovation and Change: A collection of readings. Oxford UniversityPress. New York.


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AAAp eendix 1: Industry Analysispppppennddiixx 11:: IInndduussttrryy AAnnaallyyssiiss

Porters Five Forces

RIVALRY AMONGCOMPETING SELLERS

Low marginscut-throatcompetition in low-costprovider segments

Many are members ofCanadian Fence IndustryAssociation (CFIA)havemore credibility

POTENTIAL NEW ENTRANTS

Relatively easy to enter market

Niche and best-cost provider strategies yieldbetter returns than Fence Companys low-cost provider strategy

BUYERS

Significant power

Residential contractors

Residential homeowners

Reduced discretionaryincome due to recession

SUP LIERS

Reliable supplies crucialto on-time delivery wheusing Just-in-Time

delivery Short-term profitability

crucial to maintainingsupplier relationships andcredit

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SUBSTITUTES

Vinyl fencingcomparable cost, greaterreliability

Increased trust among neighbours mayreduce demand for fences


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Fence Company Ltd.

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Nadler and Tushman (1997) developed a congruency model that facilitates systematicgeneration of feasible alternatives given an organizations environment, history, and corecompetencies given its selected strategy. This model has been used to develop alternativecourses of action for FC based on its specific situation.

Without taking strategy, competencies, and organizational structure and background intoaccount, recommendations are not defensible.


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Fence Company Ltd.

CCCompetenciiies

Mediocre fence-building capability

Small capacity Low reliability

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Organizational Culture

Family-owned Informal, loose

controlsInformal perform

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management

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Devise and implementinternal controls

Optimize coststructures

Reconsider overallstrategic position

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Informal organization

structure Project-based teams Flexible work teams Not constrained by

collective agreements

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SSStrategy- Establish better internal controls- Consider alternatives to Porters low-cost provider strategy- Increase customer base (most customers are one-time clients)

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EEEnviiironment///RRResources///HHHiiistory- Customer-centric - Limited financial resources

- Low barriers to entry - Young (1-year-old) company

- Low product diversity - Low product reliability

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Fence Company Ltd.

STRENGTHS WEAKNESSES Flexible staffing

Can lay off as required

Low wage rates

Rent equipment as required

Non-unionized workforce

Student summer breaks closely match peak times

Operating Leverage relatively low

Lack of adequate quality controls

Guarantee work without actual quality

Lack of formal business judgment

Discount structure hurts margins rather thanimproves

Commission structure hurts margins

OPPORTUNITIES THRREATS Housing starts indicate growing market

Large low-cost student summer workforce

Gain credibility by becoming member of CanadianFence Industry Association (CFIA)

Low barriers to entry

Low barriers to exit

Recessionseconomic factors

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Financial Analysis


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Fence Company Ltd.

Base ScenarioHouses 1 2 4 Teams Capacity (houses)

Metres 100 200 400 April 1 20Selling Price $12 $12 $12 May 3 60

Revenues $1,200 $2,400 $4,800 June 3 60

Less Vol Disc $0 $0 July 3 60Commission 5% 6% August 3 60

Less Commission $60 $144 $384 September 3 60

Net Revenues $1,140 $2,256 $3,936 October 1 20November 1 20

Variable Costs 1 2 4 Total 360Wood 660.00$ 1,320.00$ 2,640.00$

Nails 110.00$ 220.00$ 440.00$Transportation 120.00$ 240.00$ 480.00$

Labour 132.00$ 264.00$ 528.00$

Total VC 1,022.00$ 2,044.00$ 4,088.00$

1 2 4

CM $118.00 $212.00 B/E (houses) 788.1356 877.3584906UCM $118.00 $106.00

CM% 9.83% 8.83%

Fixed Costs 1 2 4Secretary 12,000.00$ 12,000.00$ 12,000.00$

Management 30,000.00$ 30,000.00$ 30,000.00$

Warehouse 30,000.00$ 30,000.00$ 30,000.00$

Tools 3,000.00$ 3,000.00$ 3,000.00$Truck

April 500.00$ 500.00$ 500.00$May-Sept 2,500.00$ 2,500.00$ 2,500.00$

Oct/Nov 1,000.00$ 1,000.00$ 1,000.00$Machine 4,800.00$ 4,800.00$ 4,800.00$

Gas/Maintenance 8,000.00$ 8,000.00$ 8,000.00$Telephone 1,200.00$ 1,200.00$ 1,200.00$

Total FC 93,000.00$ 93,000.00$ 93,000.00$

-$4808%

-$152.00 -2447.37-$38.00

-3.17%


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Fence Company Ltd.

Scenario 1: Proposed

Houses 1 2 4 Teams Capacity (houses)


Revenues $1,300 $2,600 $4,800 June 3 60Less Vol Disc $0 $0 $0 July 3 60Commission 5% 6% 5% August 3 60



Variable Costs 1 2 4 Total 360

Wood 693.00$ 1,386.00$ 2,772.00$


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Scenario 2: Proposed Additional Teams

Houses 1 2 4 Teams Capacity (houses)


Revenues $1,300 $2,600 $4,800 June 5 100Less Vol Disc $0 $0 $0 July 5 100Commission 5% 6% 5% August 4 80



Variable Costs 1 2 4 Total 500

Wood 693.00$ 1,386.00$ 2,772.00$

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