Info

$281.2

Note-. E = Estimated Exhibit 2: Westfield, Inc.: Packaging Alternatives— Balance Sheet (dollars in millions)

grew steadily through the early 1950s, and advances in technology spurred additional applications including use for cleansers, caulk, frozen fruit juices, and refrigerated dough. During the 1950s, three significant manufacturing advances laid the groundwork for future growth of traditional containers:

• the development of higher speed winding and cut-off equipment;

• improved lining materials such as aluminum foil for greater product protection; and

• specially designed metal ends for improved seaming techniques.

Use of the traditional container for frozen concentrate juices, or FC| (FC| refers to all types of frozen concentrate juices), in 6- and 12-ounce sizes increased significantly during the 1960s. During this same period, the motor oil container gradually became the largest product segment within this industry.

While a limited number of major new markets were on the horizon, technical innovations and imaginative new applications offered good opportunities to convert several of these major segments. Such innovations included aseptic packaging, hot-filled cans, improved liner technology, and new advancements in end-seaming technologies. Potential applications for the future included coffees, peanuts and other snack foods, meat products, and institutional foods.

Competition

Traditional-container manufacturers had steadily been nibbling away at the metal can and glass markets by offering definite cost advantages. Still, the threat of substitutes remained very high. Since no proprietary technology was used in manufacturing, traditional containers were commodities. Companies competed on quality, service, and packaging innovation. Prices were already low—less than one-half cent per can so there was little room for price wars. Packaging innovation was either developed internally or at the insistence of a customer. Providing a new innovative package that solved a problem, offered a cost advantage, or differentiated the customer's product gave the manufacturer a competitive advantage. Companies were committed to research and development, and most were testing the potential of new technologies for their container lines.

Customer

Packaging provided a key marketing tool for customers. Customers tried to differentiate their products from competitors' products with eye-catching, attractive, informative labels or with a new, unique container. The outside package was usually the first thing the end user saw of the product, and many believed that packaging influenced buying behavior. Even though the container represented but a small portion of the total cost of the product, it needed to be appealing, functional, easy-to-fill, and long-lasting.

Westfield's product line satisfied these requirements. These traditional holders were strong, lightweight alternatives to metal and glass containers that could take advantage of high-speed filling equipment with minimal changeover costs. Additionally, the manufacturing process for these containers eliminated the side seam, giving the customer an unimpaired 360-degree billboard for graphics. Graphic quality was sharp and eye-catching for easy identification. Finally, the containers satisfied end users' demand for convenient resealable packaging.

Customers were large and extremely powerful, and few exhibited loyalty to a particular container manufacturer. Price was the key attribute in the decision-making process, followed by quality of both the service provided and the product, as well as the previous experience with a particular manufacturer. Customers often looked to container manufacturers that were innovators.

A revolutionary new container material on the market was receiving much attention. Until very recently, for example, motor oil had been packaged in the traditional containers supplied by Westfield and its competitors. But in late 1986, motor oil packaging was converted to this new container material. The switch was not cost driven; but rather the new material, molded with a spout, made pouring the oil easier and neater. Westfield feared further conversions from traditional containers to these new ones in other key market segments such as frozen concentrate juices.

Consumer Packaging Group

In 1986, the container unit was renamed the "Consumer Packaging Group" to emphasize, primarily internally, Westfield's desire to think beyond traditional containers to additional product lines that it might market to some of its existing customers. The Consumer Packaging Group had 16 plants strategically located near customers in order to be responsive to their needs and to save shipping costs. (See Exhibit 3 for a map of the plant locations.)

When the motor oil container market—the largest user of all segments—switched from the traditional material to the new material, the Consumer Packaging Group's sales declined because some of its customers switched to container manufacturers capable of producing the new material. Westfield reacted

Exhibit 3: Westfleld, Inc.: Packaging Alternatives—Consumer Packaging Group Plant Locations by moving into production of these new containers. But because the conversion to the new material was capital intensive and because the company wanted to iron out any production problems before attempting large volume production, Westfield agreed to produce these new containers for only one of its major oil packer accounts. But the seriousness of the substitution threat hit home when the loss of sales was so extensive that one of the production lines for traditional motor oil containers was cut below a full shift.

Situation

Realizing that the decline of traditional containers to the motor oil market was likely the precursor to similar declines in other markets, Westfield sought to be proactive in its conversion of other key segments to the new containers. Bill McRay focused his attention on the frozen concentrate juices (FC|) segment because it represented 19 percent of the division's sales and currently used only traditional containers. Westfield's reaction to this situation would likely influence the direction, and perhaps even the fate, of the firm.

Adding to the threat of substitution were the following factors: commodity product, basic technology, low price, low switching costs for customers, little brand loyalty, high bargaining leverage of customers. Mitigating the threat was the capital intensiveness of the industry.

The size of the FCJ market was an estimated 2.4 billion units, representing approximately $105 million in sales (see Exhibit 4 for a list of the major FCI customers). Wesfield had a 23 percent unit market share of the 2.4 billion unit market. Sales had been flat over recent years because of a consumer trend to drink chilled ready-to-serve juices, packed in cartons, instead of FCI. Annual market growth was projected to be 3 percent for the next few years.

The net price of the traditional FCI container was $52.35 with variable manufacturing costs of $43.79 (figures per thousand). In investigating alternative

Total Usage (in millions)

Major Customers Units Total Cost*

Coca-Cola Company 700 $37.0

Ventura Coastal Company 96 8.0

McCain's 60 4.3

Welch Foods 96 5.3

Seneca Foods 80 4.5

Others

Procter & Gamble

Treesweet

Bodiness

•Note that unit costs vary per customer because of differences in such factors as volume, length of time as customer, degree of customization required, special delivery arrangements, etc. The $52.34 price quoted in the case is an average across all customers.

Exhibit 4: Westfield Inc.: Packaging Alternatives— Major FC) Customers technologies, Westfield ran across a new material and manufacturing process, Formatek, that could offer substantial cost savings as its variable manufacturing costs were only $38.40 per thousand.

The Alternative

In luly 1985, Westfield first uncovered this new process, Formatek, which was developed by an Australian company. Formatek introduced control in the high-speed manufacture of containers that had never before been achievable with other container materials. Uniformity of wall and base thickness, for example, was key to the manufacturing process, and Formatek's performance was excellent along those lines.

The fixed capital investment in this process (for one line) would be $2,099,000, and the annual volume output (operating 7 days a week, 3 shifts) would be 81 million units. These units would replace an equal number of traditional containers. In line with company practices, any currently operating equipment that would be replaced by the Formatek investment would be shipped to Westfield's overseas operations instead of being sold or disposed of. The terminal (book) value for the old equipment would be approximately $500,000 at the time of the installation of the new machine, and the Consumer Packaging Group would receive credit for the book value. The Formatek technology was not expected to become obsolete before 1995.

The plant's fixed costs for the Formatek machine would be $330,000, and the variable manufacturing costs would be $38.40 per thousand. Inflation was expected to average 5 percent a year over the life of the new licensed technology. (See Exhibit 5 for a summary of the costs and other assumptions for Formatek.)

An off-set printing technique was assumed in calculating the costs, but Bill wondered if the quality of the graphics would be an issue because multicolored inks were applied directly to the container and heat dried, so the quality depended on the surface and the inks. Slower printing speeds reduced blurred labels. The detail of off-set printing was not equivalent to that of paper labels used on traditional containers, but temperature extremes in filling and transporting FCJ limited labeling alternatives.

Formatek would give Westfield a proprietary technological competitive advantage and provide its customers with a container that Westfield's competitors could not offer. Westfield licensed this technology in early 1986 (agreeing to pay a royalty fee of 2.5 percent of sales) and had begun testing potential applications

Westfield's ROI Target (after tax) 15% Annual Volume Estimated for 1988°

(000s of units) 81,000

Royalty Deduction (% of sales) 2.5%

Miscellaneous Deduction (% of sales) 1.0%

Variable Mfg. Costs (per 000) $38.40

Plant Fixed Costs ($000) $330

Depreciation Life (straight line) 8 years

Marketing, Technical, & Administrative

Fixed Capital ($000) $2099 Accounts Receivable

(days of sales outstanding) 25

Inventories (days of sales outstanding) 50 Expected Inflation for Sales and Fixed Costs 5%

Expected Inflation for Variable Costs 5%

Tax Rate 34%

Note: All costs were estimates of those expected with the Formatek project.

"The 81 million units would replace an equal number of traditional containers.

Exhibit 5: Westfield, Inc.: Packaging Alternative— Summary of Formatek Machine Data.

in its pilot plant. Westfield's exclusive rights to the new technology would expire within two years if the technology were not put into operation before then.

In Bill's mind, the evaluation of the Formatek project had to be done on a stand-alone basis. Economically, the process for traditional containers was too entrenched to make an apples-to-apples comparison: the machines were fully depreciated; the workers had come quite a way down the learning curve; and the traditional containers were so profitable that Westfield would be extremely hard-pressed to find any new technology that could beat the traditional containers' margins. Even more importantly, though, the project had important strategic implications for the firm. Bill was far less interested in the incremental pennies per container that could be won or lost here than he was with the continuing viability of Westfield as a container manufacturer. For these reasons, the project needed to be evaluated as a stand-alone alternative.

To be consistent within this stand-alone analysis, Bill wanted to consider all the key factors—terminal value of old equipment; variable manufacturing costs; plant fixed costs; marketing, technical, and administrative costs (MTA); changes in working capital; and recovery of the initial capital outlay—as though this line were starting from scratch. Specifically, 25 days of accounts receivable and the 50 days of inventory would need to be built up the first year, and changes would be reflected in years thereafter. Bill also wanted to separate inflation for sales and fixed costs in his spreadsheet from inflation for variable costs to facilitate his sensitivity analysis.

Bill identified the following questions as key to his evaluation of the Formatek project:

• What would the IRR be over the life of the project if the new containers were introduced at the prevailing price of the traditional containers?

• What would the IRR be if the Formatek equipment was stretched two years past its estimated eight year life?

• What prices would Westfield have to charge to achieve the 15 percent hurdle rate required of all of Westfield's capital expenditures under both the eight-year and 10-year scenarios?

• What are the key value drivers in the analysis? Could small changes in several drivers lead to big changes in the IRR? For example, what would happen if variable costs rose only 4.5 percent per year (because of learning curve improvements), the royalty fee could be negotiated down to 2.25 percent and/or the price could be raised to $52.84?

• Assume future technology improvements allow 2 percent annual increases in output. What would be the effect?

• What strategic factors should be considered?

Bill knew he had to move quickly if Westfield was to enter 1988 with Formatek capacity on line.

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