Good Grains is a producer of breakfast cereals. There are 2.8 billion boxes of breakfast cereal sold each year in the United States at an average retail price of $3 per box. The company is trying to decide whether or not to launch a new type of cereal, which it thinks would garner 2% of the total market in its first year of launch, or 56 million boxes. To do so, it has to make several production and distribution decisions. It has no excess capacity, so the new product requires new capability.

On the production side, Good Grains has three options for sourcing the cereal. First would be to buy a new machine and produce it in-house. This would cost $250,000 for a machine that would make the flakes and another $200,000 for the machine that would blend the cereal with the other fruits and nuts and finish the packaging of the cereal. These machines would have a useful life of five years each. Raw material costs would be $0.60 per box (including packaging), labor would be $0.15 per box, and general overhead would be $0.25 per box. The company would be able to produce to meet demand so inventory on hand would be minimal.

Good Grains could also outsource the production in one of two ways. It could go to another large producer of cereals that would charge Good Grains $1.15 per box. The purchases would need to be made in large lot sizes of 2.5 million boxes, which would need to be stored for 30 days at a cost of 25% carrying costs for inventory. There would be a four-week lead time for an order, so Good Grains would need to factor this into its analysis. Shipment of the boxes to Good Grains’ warehouse would cost $0.05 per box.

The cereal could also be outsourced overseas, where production costs are lower. Good Grains has received a quote of $0.85 a box from a foreign producer. The cereal would need to be bought in lot sizes of 5 million boxes to garner this price. T here would be a four week lead time for production and another four weeks for delivery, so Good Grains would need to keep eight weeks of buffer stock on hand, or 9 million boxes with a carrying cost of 25% of inventory value. It would also own the inventory once it left the dock at the manufacturer, creating another 5 million boxes of inventory that would have to be charged the 25% carrying cost for the company. Shipping itself would be $0.10 a box using a container ship. Damage could occur during shipping, with up to 10% of the boxes being damaged in shipment. This would be cost borne by Good Grains. This means Good Grains would need to order 10% more product if it uses this channel.

Once the manufacturing decision is made, Good Grains has to determine the best way to get the product on grocery store shelves. It could expand its existing sales force by three people at $60,000 per year plus a 5% commission on sales. The sale price to the grocery store would be $2. If it added this volume to its existing sales by its sales force, it would need to hire one customer service representative at $45,000 per year and one additional accounts receivable clerk for $40,000 per year. Since it would have to ship to multiple store locations, it would require an additional person in the warehouse at $35,000 per year. Shipment from the warehouse to customers would cost $0.05 per box.

Good Grains could also use a wholesaler to handle the new product. It uses wholesalers for several of its products. A wholesaler would only pay Good Grains $1.50 per box in order to make its own profit on the sale. It would not need to hire any additional support staff if it took this option. It would incur shipping costs of $0.05 per box.

Good Grains could also use the jobber network. This was something it has not done in the past but has been considering as the cost of its own internal sales force keeps mounting.

A jobber would take the box of cereal at $1.60, but would also require a commission of 2% of the price paid by the grocery stores as a commission. Since the jobber network is quite spread out, it would require a customer service representative to handle its business at $45,000 per year and an additional accounts receivable clerk at $40,000 per year. It would also need an additional person in shipping to handle the increased demand, at $35,000 per year. Given the smaller lot sizes, shipping costs would be $0.07 per box.

Regardless of the channel used to move the product out to grocery stores, Good Grains would need to hire a product manager at $80,000 per year and incur marketing costs of $5 million per year in coupons and other discounts plus television and magazine advertising to gain and maintain its market share.

REQUIRED:

Given the information provided here, develop the value chain options that face Good Grains. Specifically,

a. First look at the sales aspect of the value chain. Should Good Grains rely solely on a sales force, a wholesale approach, or jobbers? Which would be most efficient (cost less)? Which would be most responsive or flexible? Make sure to include all of the costs, both sales and home office, in your analysis.

b. Calculate the target cost for the manufacturing operation. Use 20% as the target profit.

c. Look at the three options for sourcing the product. Which approach seems to be best for the firm financially (efficiency- based)? Which would be best for responsiveness? Make sure to include carrying costs for outsourced inventory using a calculation of number of days of sales the inventory represents at the 25% carrying cost noted.

d. Should Good Grains enter this market if its target profit is 20%? Why or why not?