Precision Worldwide, Inc.

Written Case Analysis 

 

I.  Summary

 Precision Worldwide, Inc. (PWI) manufactures industrial machines and equipment for sale in numerous countries. Repair and replacement parts account for a substantial part of the company’s business. The replacement part in question, steel retaining rings, occurs in the machines manufactured only in PWI’s Frankfurt Germany plant. Henri Poulene (HP), a French firm, recently introduced a superior plastic retaining ring that replaces the steel ring. PWI’s steel ring has an average normal life of 2 months while HP’s plastic ring last four times than that. Additionally, the plastic ring is less costly to manufacture.

The PWI sales manager, Gerhard Henk, is asking when this product will be available for him to sell. Bodo Eisenbach, the PWI development Engineer, estimates the plastic rings can be produced by mid-September at a tool and equipment cost of about $7,500. PWI currently has about $390,000 worth of finished steel rings and special steel inventories. Special steel inventory cannot be sold in its current form even for scrap. Hans Throborg, general manager of PWI German plant, agreed to sell plastic rings on limited basis until the large inventory of finished rings and special steel on hand are exhausted.

Henk strongly opposed the sale of any steel rings once plastic ones become available. He argued that since production cost of plastic rings are lower, the inventory problem would be irrelevant and suggested that the inventory be sold, or if impossible, thrown away. He also said that once customers who purchased steel rings find out of plastic rings being sold elsewhere, it would harm the sale of PWI machines.

II.        Problem Statement

 When should PWI sell plastic retaining rings?

III.        Objective

  1.  To minimize losses associated with steel retaining
  2. To maintain lucrative revenue stream from retaining rings market.

IV.  Areas of Consideration

 1.   Cost of finished steel rings and unused special steel inventories

PWI currently possess large quantity of steel rings on hand and substantial inventory of special steel. After a thorough survey, Hans Thorborg had found out that the special steel could not be sold, even for scrap. He also learned that the inventory of special steel had a cost of $110,900 and represented enough material to produce approximately 34,500 rings. If sales of the steel rings continued at its current pace of 690 rings per week,  by mid-September, there are about 15,100 finished on hand at  a cost of $167,292.90. (15,100*($1,107.90/100))

2.    Selling price and manufacturing cost of steel and plastic rings

Henri Poulene is said to be selling the plastic ring at about the same price as the  PWI steel ring which is at $1,350.00 for 100 rings. The plastic ring’s manufacturing cost is only $279.65 per 100 rings. PWI’s total manufacturing cost of 100 steel rings is $1,107.90. This is almost 300% more than the cost of plastic rings currently being produced and sold by Henri Poulene.

Current special steel inventory could be manufactured by PWI during slack period at only 70% of direct labor. Total manufacturing cost during slack period is $569.49.

100 Plastic Rings 100 Steel Rings No labor saving 100 Steel Rings

With labor saving

Selling Price $1,350.00 $1,350.00 $1,350.00
Materials $17.65 $321.90 $321.90
Direct Labor 65.50 196.50 137.55
Direct Overhead 52.40 157.20 110.04
Variable Cost $135.55 $675.60 $569.49
Contribution Margin 1,214.45 $674.40 $780.51

3.    Differential cost of plastic and steel rings

The differential cost between plastic and steel rings is $540.05. It is relatively more expensive to produce steel rings compared to the new plastic rings currently offered by Henri Poulene.

100 Plastic

Rings

100 Steel

Rings

Differential

Cost

Materials $17.65 $321.90 $304.25
Direct Labor 65.50 196.50 131.00
Direct Overhead 52.40 157.20 104.80
Variable Cost $135.55 $675.60 $540.05

4.    Lifespan of steel and plastic rings

The steel ring being manufactured by PWI has a normal life of about two months, depending upon the extent to which the machine was used. The plastic rings are said to be four times the wearing properties of the steel ring. The implication of this is that it will destroy demand for steel rings.

5.    Effect on customers’ loyalty (upon learning of new superior plastic rings) but was not made aware of it

PWI decided that if it had to sell the plastic rings, it will be limited to those markets where competitors like Henri Poulene have presence. It was because PWI expects that the plastic rings would not be produced by other companies except Henri Poulene for some time, therefore no more than 10% of PWI market would be affected.

However, the decision to sell the plastic rings on limited areas raises concern on the effect to customer loyalty once they find out that a more superior product is out in other markets at a relatively comparable price of steel rings currently being used on their machines.

6.    The effect of failing to respond to direct market competition

Henri’s Poulene’s plastic ring is the best alternative to PWI’s steel ring. Although reportedly even on selling price, tests indicated that it’s four times the wearing properties of steel rings, potentially destroying demand for PWI’s steel ring.

 

V.        Alternative Courses of Actions

 1.    Continue selling steel rings until inventories are exhausted. Thereafter introduce    plastic rings to the market

PWI should first sell all inventories of steel rings and convert special steel into finished products before selling the plastic rings. This will ensure that manufacturing costs associated with existing inventories are recovered.

By mid-September, there will be 15,100 finished rings left on hand and another 34,500 that can be produced from existing inventory of special steel. This can be manufactured during slack periods wherein only 70% of labor is employed. At the current pace of 690 rings sold per week, it will take 18 months to dispose all inventories of steel rings.

Rings Var. Cost Months of

Inventory

Previously Finished Rings 1/ 15,100 $102,015.60 5.5
Special Steel (Raw) 2/ 34,500 196,474.05 12.5
Total 49,600 $298,489.65 18.0
1/ (15,000/100) * $675.60

2/ (34,500/100) * $569.49

Steel Rings
Volume 49,600
Revenues (49,600/100) * $1,350.00 $669,600.00
Variable Cost 298,489.65
Contribution Margin $371,110.35

 

On the same 18-month period, PWI could have sold 12,400 plastic rings (49,600/4). This is based on test results which indicated that plastic rings wearing properties are four times that of steel rings. The equivalent contribution margin from selling plastic rings is $150.591.80.

Plastic

Rings

Volume 12,400
Revenues $167,400.00
Variable Cost 16,808.20
Contribution Margin $150,591.80

 

Advantages:

  1.  PWI will be able to recover the costs of previously finished steel rings amounting to $102,015.60.
  2. PWI will recover cost of special steel raw material amounting to $110,900.00.
  3. PWI’s contribution margin will increase by $371,110.35.

 

Disadvantage:

  1. PWI may lose market share with prolonged inaction over Henri Poulene’s entry into the retaining rings
  2. Lost opportunity to increase profit margin from plastic rings sales amounting to $150,591.80.
  3. Continued sale of steel rings may harm sales of PWI machines as customers find suitable alternatives to replacement

 

2.    Continue selling steel rings until plastic rings are ready for the market. Thereafter, scrap all unsold steel rings and special steel

PWI will sell plastic rings in all markets and scrap all unsold steel rings and special steel inventories once plastic rings are available for sale.

Plastic Rings Steel Rings
Volume 12,400 15,100
Revenues $167,400.00 $203,850.00
Variable Cost 16,808.20 102,015.60
Contribution Margin $150,591.80 $101,834.40
Sunk Cost (Special Steel) 0.00 $110,900.00

 

Advantages:

  1.  Net positive contribution margin of $48,757.80 despite scrapping 15,100 steel rings
  2. PWI will maintain its dominance in the retaining rings market by canceling out whatever advances HP has already
  3. Sales of PWI machines will not be
  4. PWI will not be affected from dip in demand of steel rings since it has already shifted to plastic rings

Disadvantages:

  1. Inventory loss from special steel of $110,900 because it’s not saleable in its current
  2. Plastic rings will undermine PWI’s long-run profitability in the retaining ring market as it will take longer for customers to replace worn-out rings and place re-orders.

3.      Continue selling steel rings until plastic rings are ready for market. Thereafter, sell both plastic and steel rings with steel sold at reduced priced until all inventories are exhausted.

PWI should make both plastic and steel rings available in the market albeit steel  rings at lower price to exhaust all steel inventories and recover its cost before phasing out the product completely. The minimum price of steel rings that PWI should take is $979.21. This is in consideration of the contribution margin of plastic rings which is $1,214.45 per 100 rings, lifespan and the corresponding replacement or reorder frequency.

Plastic Rings Steel Rings
Selling Price $1,350.00 $979.21
Variable Cost 135.55 675.60
Contribution Margin $1,214.45 $303.61
Replacement Frequency 1 4
Equivalent Contribution $1,214.45 $1,214.45

 

Plastic

Rings

Steel Rings Total
Volume 12,400 49,600
Revenues $167,400.00 $485,688.16 $653,088.16
Variable Cost 16,808.20 335,097.60 351,905.80
Contribution Margin $150,591.80 $150,590.56 $301,182.36

 

Advantages:

  1.  Total contribution margin from both steel and plastic rings is $301,182.36.
  2. PWI will maintain its dominance in the retaining rings market by canceling out whatever advances HP has already
  3. Sales of PWI machines will not be
  4. PWI will recover the cost of special steel

Disadvantages:

  1. There is a good chance customers will still prefer plastic retaining rings for its superiority and cost effectiveness relative to replacement frequency thus undermining revenues from steel
  2. Lost profit on steel rings due to reduced

4.   Continue selling steel rings until plastic rings are ready for market. Thereafter, sell plastic rings on the French market only and continue selling steel rings in all other markets.

PWI should sell plastic rings only where competitors selling plastic retaining rings are present. In this case, PWI should only concentrate on selling plastic rings on the French market, which account for 10% of the company’s total volume of rings sold. Plastic rings sales volume at 10% is 1,240 while steel rings sales volume at 90% is 44,640.

 

Rings Var. Cost
Previously Finished Rings 15,100 $102,015.60
Special Steel (Raw) 29,540 168,227.35
Total 44,640 $270,242.95
1/ (15,000/100) * $675.60

2/ (29,540/100) * $569.49

Plastic Rings Steel Rings
Normal sales volume for either rings 12,400 49,600
PWI Market Share 10% 90%
Volume sold based on market share 1,240 44,640
Revenues $16,740.00 $602,640.00
Variable Cost 1,680.82 270,242.95
Contribution Margin $15,059.18 $332,397.05

 

Advantages:

  1.  Total contribution margin from both steel and plastic rings is at $347,456.23.
  2. PWI will maintain its dominance in the retaining rings market by canceling out whatever advances HP has already
  3. PWI will recover the cost of special steel inventory amounting to $110,900.00 and variable cost of previously finished ring inventory of $102,015.60

Disadvantages:

  1. There will be a negative impact on customer loyalty once these customers become aware of the availability of a superior retaining rings made of plastic being sold by PWI in other
  2. Sales of PWI’s industrial machines could be affected if customers learns of a cheaper replacement parts not available to

 

VI.        Recommendation

 

Thorborg of PWI is facing a key decision whether he should authorize production of plastic retaining rings and sell them simultaneously with steel rings or wait until all finished steel rings and special rings inventories on hand are disposed before selling any plastic ring. This is amidst the introduction of a retaining ring substitute made of plastic by a French competitor, HP, for French market. Based on the preceding analysis of the alternative courses of actions available, we therefore recommend that PWI implement alternative course of action number 4.

The impact of this action will both allow the recovery of costs associated with steel rings inventories and halt HP’s advance into the French retaining rings market.

 

VII.        Potential Problem Analysis

 The potential problem lies in the fact that a superior retaining ring product is only being made available in the French market by PWI and not all its areas where they have major presence. Henk voiced his strong opposition to this plan. He said that once customers who purchased steel rings find out of plastic rings being sold elsewhere, it would harm the sale of PWI machines.

He is justified, if only retaining rings in question are major industrial components, meaning its value is significant enough command attention among industrial machines customers. 100 retaining rings only cost $1,350 or just $13.50 apiece. This amount is immaterial in an industrial settings where machines cost between $18,900 to $28,900. Secondly, differences in product features, even from a single manufacturer, are common. This is done to maximize profit margins or increase market share or both. Third, the product in question is confined to industrial use; meaning only industrial consumers are using it. It’s highly unlikely they will start comparing the features of their retaining rings, especially between companies located in different countries.

Therefore, the likelihood that customers will know of the presence of superior retaining rings in other markets is remote. Even then, the amount is insignificant. The important thing is to ascertain that PWI made industrial machines are as competitive as ever especially with the entrance of Japanese companies and other makers in the industry.