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BALDWIN BICYCLE COMPANY

BALDWIN BICYCLE COMPANY


WHO?
Ms. Suzanne Leister (SL), BALDWIN BICYCLE COMPANY (BBC) Karl Knott (KK), HI-VALUE STORES INC. (HVS)

WHEN?
May 1983

WHERE?
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CASE FACTS
Baldwin Bicycles Company (BBC): 40 years in bicycle business. In 1983 made 10 models - beginners to 12 speed adult. $10 million in annual sales. Most sales through independently owned toy stores and bicycle shops. Never before distributed through department stores. Image - above average in price and quality but not top of the line.

HI-VALU Chain of discount department stores in the northwest. Adding house brands. Approached Baldwin about having Baldwin produce bicycles. Would bear the name challenger.
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HI-VALU PROPOSAL
1. Need ready access to large inventory, (HVS has difficulty in predicting sales) 2. HVS would store inventory in regional warehouses. 3. Title would not pass until shipped to a particular store. 4. Upon shipment, payment will be due in 30 days.
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HI-VALU PROPOSAL (contd.)


5. Title passes automatically when bicycle has been in warehouse 120 days. 6. HVS pays in 30 days. 7. HVS estimated an average bicycle would remain in the warehouse 2 months. 8. HVS desired to sell Challenger bicycles at lower prices than their name-brand bicycles. Did not want to take sales away from their name brands.
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HI-VALU PROPOSAL (contd.)


9. Wanted BBC to sell them at prices lower than the wholesale prices sold through normal channels. 10.Wanted the Challenger to be different from other BBC bicycles. 11.Wanted different fenders, seats, and handlebars. 12.Wanted the Challenger name on the bicycle. 13.The packing boxes would have the HVS and Challenger names
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HI-VALU PROPOSAL (contd.) 14.Ms. SL (Baldwins Mktg. VP) thought those requirements would increase purchasing, inventory, and production costs over and above costs of a similar increase in BBC volume. 15.Bicycle boom has flattened.
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THE CURRENT STATUS


BBC Plant at 75% capacity. Added volume is attractive. HVS will agree to buy house brand bicycles exclusively from BBC for 3year period, with automatic extension unless either party gives notice.
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QUESTIONS FOR BBC


1. What is the expected added profit from the Challenger line for BBC? 2. What is the expected impact of cannibalization of existing sales? 3. What costs will be incurred on a one-time basis only? 4. What are the additional assets and related carrying costs?
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QUESTIONS (contd.)
5. What is the overall impact of the company in terms of profit, return on sales, return on assets, and return on equity? 6. What are the strategic risks and rewards? 7. WHAT SHOULD BBC DO? 8. WHY?
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BBC BALANCE SHEET


ASSETS CASH $ 342 ACCOUNTS RECEIVABLE 1,359 INVENTORIES 2,756 PLANT & EQUIPMENT (NET) 3,635 TOTAL $ 8,092

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BBC BALANCE SHEET


LIABILITIES AND OWNERS EQUITY CURRENT LIABILITIES $ 3,478 NONCURRENT LIABILITIES 1,512 OWNERS EQUITY 3,102 TOTAL $ 8,092

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BBC INCOME STATEMENT


SALES $ 10,872 COST OF SALES 8,045 GROSS MARGIN $ 2,827 OTHER EXPENSES 2.345 INCOME BEFORE TAXES $ 473 INCOME TAXES 218 NET INCOME $ 255

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PERTINENT DATA (EX-3-2)


(1) ESTIMATED FIRST YEAR COSTS OF PRODUCING CHALLENGER BICYCLES. MATERIALS $ 39.80 * LABOUR 19.60 OVERHEAD (125% OF LABOR) 24.50 TOTAL $ 83.90 !

* Includes items specific to hvs models. ! Accountant estimate 40% of overhead is variable ($18) and that the 125% of the direct labor rate is based on a volume of 10,000 per year.
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PERTINENT DATA (contd.)


(2) ONE TIME ADDED COSTS of preparing drawings, and/or arranging for fenders, seats, handlebars, tires, and shipping boxed that differ from those used in standard models is estimated at $5,000 (2-months @ 2,500). (2) UNIT PRICE AND ANNUAL VOLUME: 25,000 bicycles per year. Will pay average of $92.29 per bicycle. Will be adjusted for inflation. HVS appears firm on price.
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PERTINENT DATA (contd.)


(4) ASSET RELATED COSTS
Pretax funds for rec and inv 18.0%. Recordeeping costs - rec and inventory 1.0% Inventory insurance 0.3% State property taxes 0.7% Inventory handling, etc. 3.0% Pilferage, etc. 0.5%
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PERTINENT DATA (contd.)


(5) AVERAGE ADDED INVENTORY Materials - two months Work in process - 1,000 half complete as to labor and overhead, fully complete as to materials. Finished goods - 500 bicycles awaiting shipment to HVS warehouse.
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PERTINENT DATA (contd.)


(6) IMPACT ON REGULAR SALES
In 1982 BBC sold 98,971. Comparison shopers will see HVS as a good buy. Estimate sales of 100,000 per year without HVS.

(7) ESTIMATE LOSS


3,000 units TO CHALLENGER. MAY LOSE SOME DEALERS AS WELL.
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RELEVANT COST ANALYSIS


CONTRIBUTION (per cycle):
REVENUE VARIABLE COSTS
MATERIALS $39.80 LABOUR 19.60 OVERHEAD (40% of $24.5) 9.80 *

$92.29

TOTAL VC UNIT CONTRIBUTION

$69.20 $23.09
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RELEVANT COST ANALYSIS


ANNUAL VOLUME EXPECTED 25,000 TOTAL CONTRIBUTION $ 577,250 (25000 * 23.09)

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RELEVANT COST ANALYSIS


CONTRIBUTION FROM 3000 LOST SALES
REVENUE VARIABLE COST (same) CONTRIBUTION MARGIN TOTAL ($44.18 * 3,000) $ 113.38 * 69.20 $ 44.18 $ 132,540
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RCA - Revenue
COMPUTATION OF REVENUE MARGIN % = MARGIN/SALES MARGIN = 2827/10872 = 26% Assume, SP per unit = x Sales Revenue Cost of Sales = Gross Margin @ x COS = 0.26x Assumption: @ x 0.26x = COS COS=COM @ 0.74x = COS @ 0.74x = $ 83.9 @ x = $113.38 .

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RELEVANT COST ANALYSIS

One time added costs - ignore for all practical purposes. Probably will be done with idle time.

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RELEVANT COST ANALYSIS


ADDED ASSETS AND COSTS:
MATERIALS (25,000/6) * 40 (39.20) $160,000 WORK IN PROCESS 1,000(40 + .5(30)) 55,000 FINISHED GOODS 500 * 69 (69.20) 35,000 FINISHED GOODS AT HI-VALUE (25,000/6) * 69 (69.20) 280.000 ACCOUNTS RECEIVABLE (25,000/12) * 92 (92.29) 185,000

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RELEVANT COST ANALYSIS


TOTAL ASSETS NEEDED 715,000 POSSIBLE 45 DAY CREDIT FROM SUPPLIERS -120,000 NET EXTRA INVESTMENT $ 595,000

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RELEVANT COST ANALYSIS


SUMMARY ASSUMING ONLY THE VARIABLE COSTS ARE DIFFERENTIAL. NEW CONTRIBUTION $ 577,000 LOST CONTRIBUTION -133,000 NET $ 444,000 LESS HOLDING COSTS 150,000 NET ADDED CONTRIBUTION 294,000

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FULL COST ANALYSIS


REVENUE TOTAL COSTS UNIT MARGIN TOTAL ($8.39 * 25,000) $92.29 83.90 $ 8.39 $209,750

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FULL COST ANALYSIS


CONTRIBUTION FROM 3000 LOST SALES REVENUE $ 113.80 Total COST 83.90 CONTRIBUTION MARGIN $ 29.48 TOTAL ($29.48 * 3000) $ 88,440

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FULL COST ANALYSIS


ADDED ASSETS AND COSTS:
MATERIALS (25,000/6) * 40 (39.20) $ 160,000 WORK IN PROCESS 1,000(40 + .5(44) 84,000 FINISHED GOODS 500 * 84 (83.90) 42,000 FINISHED GOODS AT HI-VALUE (25,000/6) * 84(83.90) 340,000 ACCOUNTS RECEIVABLE (25,000/12) * 92 (92.29) 185,000

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FULL COST ANALYSIS


TOTAL ASSETS NEEDED 711,000 POSSIBLE 45 DAY CREDIT FROM SUPPLIERS -120,000 NET EXTRA INVESTMENT $ 691,000 RANGE 400,000 TO 900,000 WITHOUT OFFSET HOLDING COSTS ARE $165,000. WITH IT THEY ARE $142,000.

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FULL COST ANALYSIS


SUMMARY ASSUMING FULL COSTS. NEW PROFIT $ 210,000 LOST CONTRIBUTION - 88,000 NET $ 122,000 LESS HOLDING COSTS 165,000 NET ADDED CONTRIBUTION -43,000

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Conventional Pro

Incremental profit and incremental ROI excellent (even with erosion). The existing business covers the fixed costs (i.e. we are showing profits in 1982). The Incremental business need only show positive marginal contribution. We have excess capacity and volume isnt growing.

Opens up a new (for Baldwin) and more stable distribution channel (Hi Value). Opens up a new market segment for growth for Baldwin (The Discount Retail segment). Risk seems low (or does it?!).
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Cons Can we really look at a deal on an incremental basis when it covers 25% of volume and runs for at least 3 years??!! Creates a major cash crunch; Highly leveraged now; No debt capacity left; How to finance the incremental investment? Inventory at H/V may run up to average 4 months, not 2 months; Implications for ROI, cash flow, and financing? line? A very sweet deal for H/V; Can we negotiate a better deal? (probably yes; should we try?) Additional sales losses, if current dealers drop Baldwin

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Currently profitable, but only modestly so (ROE }8%) Heavily leveraged Sales volume decreasing during last

2 years

A solution presents itself in the H/V offer Is it a good solution?

Baldwin: Background
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Impact of the H/V Deal on the Current Business Strategy?


How much flexibility does Baldwin have to experiment? How much urgency is there to do something? Does the H/V deal make sense strategically?
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What is Baldwins strategic niche currently? Does it matter if they stray from that? Can we be a significant supplier simultaneously in two price segments with a substantially identical product? How to implement diverse strategies (low cost and differentiation) within the same firm? Avoid stuck-in-the-middle

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Is the H/V deal a good one?


Financially? Strategically? Ethically?

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Framework for Strategic Cost Analysis


Any Decision Must Take An Integrated View Of

Financial Analysis
Sorting out the relevant costs Contribution or full cost profit as the metric How to best treat fixed or common costs

Strategic Mission Analysis


Mission Positioning Framework Build Hold Harvest Divest

Competitive Strategy Analysis


How to compete successfully to accomplish the chosen mission Low cost Differentiation

ANALYZE Suppliers Customers Substitutes New entrants There are no Free Lunches, Good Cheap Cigars, or Short-Run Business Decisions 39 Competitors