1. Read the case "Baldwin Company" and answer the questions given at the end of the case.

BALDWIN BICYCLE COMPANY

In May 1983, Suzanne Leister, marketing director of Baldwin Bicycle Company, was mulling over the discussion she had had the previous day with Karl Knott, a buyer from Hi-Valu Stores. Hi-Valu operated a chain of discount department stores in the North West. Hi-Valu's sales volume had grown to the extent that it was beginning to add its "own-brand" (also called "private-label") merchandise to the product lines of several of its departments. Mr. Knott, Hi-Valu's buyer for sporting goods, had approached Ms. Leister about the possibility of Baldwin producing bicycles for Hi-Valu under its own-brand name of "Challenger". Baldwin had been making bicycles for almost 40 years. In 1983, the company's line included 10 models, ranging from a small beginner's model with training wheels to a deluxe 12 speed adult's model. Sales were currently at an annual rate of about $10 million and Baldwin's 1982 financial statements appear in Exhibit 1. Most of Baldwin's sales were through speciality bicycle shops. Baldwin had never before distributed its products through department store chains of any type (e.g. Rebel Sports, K-Mart etc). Ms. Leister felt that Baldwin bicycles had the image of being above average in quality and price, but not a "top of the line" product. Hi-Valu's proposal to Baldwin had features that made it quite different from Baldwin's normal way of doing business. First, Hi-Valu wanted to sell its Challenger bicycles at lower prices than the well-known brandname bicycles it carried (e.g. Trek), and yet still earn approximately the same dollar gross margin on each bicycle sold - the rationale being that Challenger bike sales would take away from the sales of the brandname bikes. Thus, Hi-Valu wanted to purchase bikes from Baldwin at lower prices than the wholesale prices of comparable bikes sold to Baldwin's speciality bicycle shops. Second, Hi-Valu wanted the Challenger bike to be somewhat different in appearance from Baldwin's other bikes. While the frame and mechanical components could be the same as used on current Baldwin models, the mud-guards, seats, and handlebars would need to be somewhat different, and the tyres would have to have the name "Challenger" molded onto them. Also, the bicycles would have to be packed in boxes printed with the Hi-Valu and Challenger names. These requirements were expected by Ms. Leister to increase Baldwin's purchasing, inventorying, and production costs over and above the added costs that would be incurred for a comparable increase in volume for Baldwin's regular products. On the positive side, Ms. Leister was acutely aware that the "bicycle boom" had flattened out, and this plus a poor economy had caused Baldwin's sales volume to fall in the past two years.1 As a result, Baldwin currently was operating its plant at about 75% of a one-shift capacity. Thus, the added volume from Hi-Valu's purchases could possibly be very attractive. If agreement could be reached on prices, Hi-Valu would sign a contract guaranteeing to Baldwin that Hi-Valu would buy its own-brand bicycles only from Baldwin for a three-year period. The contract would then be automatically extended on a year-to-year basis, unless one party gave the other at least three months notice that it did not wish to extend the contract. Suzanne Leister realized she needed to do some preliminary financial analysis of this proposal before having any further discussions with Karl Knott. She had written on a pad the information she had gathered to use in her initial analysis; this information is shown in Exhibit 2.

EXHIBIT 1: FINANCIAL STATEMENTS ($000s) Balance Sheet (as of December 31, 1982) Assets Liabilities and Owners Equity Cash $ 342 Accounts payable $ 512 Accounts receivable 1,359 Accrued expenses 340 Inventories 2,756 Short-term bank loans 2,626 Plant and equipment (net) 3,635 Long-term Note payable 1,512 4,990 Shareholders' equity 3,102 Total assets $ 8,092Total liabilities $ 8,092 Income Statement ($'000) (for the Year Ended December 31, 1982) Sales revenues ............ $ 10,872 Cost of Goods Sold ........... 8,045 Gross margin ............................. 2,827 Selling and Administrative expenses 2,354 Income before taxes ............ 473 Income tax expense ............. 218 Net income ................................. $ 255 EXHIBIT 2 DATA PERTINENT TO HI-VALU PROPOSAL (Notes taken by Suzanne Leister) 1 Estimated costs of producing a Challenger bicycle (average unit cost, assuming a constant mix of models): Materials $39.80 * Labour 19.60 Overhead (@ 125% of labour) 24.50 ** $83.90 * Includes items specific to models for Hi-Valu, not used in our standard models. ** Accountant says about 40% of total overhead cost is variable; 125% of DL$ rate is based on volume of 100,000 bicycles per year. From this information, fixed manufacturing overhead can be calculated at about $1.5m per year. 2. One-time added costs of preparing drawings and arranging sources for mud-guards, seats, handlebars, tyres, and shipping boxes that differ from those used in our standard models: approximately $5,000. 3. Unit price and annual volume: Hi-Valu estimates it will need 25,000 bikes a year and proposes to pay Baldwin (based on the assumed mix of models) an average of $92.29 per bike for the first year. Knott indicated that there was very little, if any, negotiating leeway in the $92.29 proposed initial price. 4. Impact on our regular sales Some customers compare bikes from shop to shop, and many of them are likely to recognize a Challenger bike as good value when compared with a similar bike (either ours or a competitor's) at a higher price in a specialist bicycle shop. In 1982, we sold 98,791 bikes. My best guess is that our sales over the next three years will be about 100,000 bikes a year if we forego the Hi-Valu deal. If we accept it, I think we'll lose about 3,000 units of our regular sales volume a year, since our retail distribution is quite strong in Hi Valu's market regions. These estimates do not include the possibility that a few of our current dealers might drop our product line if they find out we're making bikes for Hi-Valu.

REQUIRED:

a. On the basis of Michael Porter's (1980) competitive strategies, how does Baldwin currently compete? Justify your answer. [25%]

b. If Baldwin took up Hi-Valu's offer, how might this change the way Baldwin competes? In particular, think about the effect on Baldwin's costs and distribution channels (i.e. the retailers). [45%]

c. Using Miles and Snow typology, speculate on Baldwin Bicycle Company's strategic positioning. [30%]