Baldwin Bicycle Case

This case looks at a private label opportunity for a small mid-market bicycle manufacturer. Analysis of the problem requires a blending of financial, marketing and strategic considerations.

In March 2009, Suzanne Leister, marketing vice president of Baldwin Bicycle Company, was mulling over the discussion she had the previous day with Karl Knott, a buyer from Hi-Valu Inc., a retail mass merchandiser with stores in the Northwest. Hi-Valu's sales volume had grown to the extent that it was beginning to add "house-brand" (also called "private-label") merchandise to the product lines of several of its departments. Mr. Knott, Hi-Valu's buyer for sporting goods, has approached Ms. Leister about the possibility of Baldwin producing bicycles for Hi-Valu. The bicycles would bear the name "Challenger," which Hi-Valu planned to use for all of its house-brand sporting goods.

Baldwin had been making bicycles for over 10 years. In 2009, the company's line included 12 models, ranging from a child's beginners model to a high-end adult's mountain bike targeted at amateur weekend competitors. Sales were currently at an annual rate of about $10 million. The company's 2008 financial statements appear in Exhibit 1. Most of Baldwin's sales were through independently owned retailers, primarily bike shops but to a lesser extent toy stores, hardware stores and sporting goods stores. Baldwin had never before distributed its products through store chains of any type. Ms. Leister felt that Baldwin bicycles had the image of being above average in quality and price, but not exclusively 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, it was very important to Hi-Valu to have ready access to a large inventory of bicycles, because Hi-Valu had had great difficulty in predicting bicycle sales, both by store and by month. Hi-Valu wanted to carry these inventories in its regional warehouses, but it did not want title on a bicycle to pass from Baldwin to Hi-Valu until the bicycle was shipped from one of its regional warehouses to a specific Hi-Valu store. At that point, Hi-Valu would regard the bicycle as having been purchased from Baldwin, and would pay for it within 30 days. However, Hi-Valu would agree to take title to any bicycle that had been in one of its warehouses for four months, again paying for it within 30 days. Mr. Knott estimated that on average, a bike would remain in a Hi-Valu regional warehouse for two months.

Second, Hi-Valu wanted to sell its Challenger bicycles at lower prices than the name-brand bicycles it carried, and yet still earn approximately the same gross margin percentage on each bicycle sold - - the rationale being that Challenger bike sales would erode somewhat the sales of the name-brand bikes. Hi-Valu expected that given the lower price there would be increased total volume that would more than offset the volume loss. Nevertheless, Hi-Valu needed to purchase bikes from Baldwin at lower prices than the wholesale prices of comparable bikes sold through the more typical market channels.

Finally, Hi-Valu wanted the Challenger bike to be somewhat different in appearance from Baldwin's other bikes. While frame and mechanical components could be the same as used on one of Baldwin's current models, the seats, handlebars and shifters would need to be somewhat different, and the tires would have to have the name "Challenger" molded into their sidewalls. 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.

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 also flatten out the past two years.[1] As a result, Baldwin currently was operating its plant at about 80 percent of its two-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 house-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

BALDWIN BICYCLE COMPANY

Balance Sheet, As of December 31, 2008

(thousand of dollars)

Assets Liabilities and Owners Equity

Cash $ 340 Accounts payable $ 520

Accounts receivable 1,360 Accrued expenses 340

Inventories 1,760 Short-term bank loan 2,640

Plant and equipment (net) 4,640 Long-term Notes payable 2,000

Total liabilities 5,500

Owner's equity 2,600

$8,100 $8,100

BALDWIN BICYCLE COMPANY

Income Statement, For the Year Ended December 31, 2008

Sales revenues $10,900

Cost of Goods Sold 8,500

Gross margin 2,400

Selling, General and Administrative (including interest) costs 1,900

Income before taxes 500

Income taxes 200

Net income $ 300

Exhibit 2

DATA PERTINENT TO HI-VALU PROPOSAL

(Notes taken by Suzanne Leister)

1. Estimated first-year costs of producing Challenger bicycles (average unit costs, assuming a constant mix of models):

Components and Materials $40.00

Assembly Labor 20.00

Allocated Overhead

variable manufacturing overhead 10.00

fixed manufacturing overhead 15.00

$85.00

Components and materials includes items specific to models for Hi-Valu, not used in our standard models. Variable manufacturing overhead costs includes an estimate of the incremental costs of handling materials, shipments out, etc. Fixed manufacturing overhead includes depreciation on the building, management salaries, etc., is allocated over total projected production volume.

2. One-time added costs of preparing designs and tooling, arranging sources for seats, handlebars, shifters, tires, and shipping boxes that differ from those used in our standard models: approximately $100,000.

3. Unit price and annual volume: Hi-Valu estimates it will need 24,000 bikes a year and proposes to pay us an average of $95.00 per bike for the first year. The contract contains an inflation escalation clause. The price will increase in proportion to inflation-caused increases in costs shown in item 1, above. Thus, the $95.00 and $85.00 figures are, in effect, "constant-dollar" amounts. Knott intimated that there was very little, if any, negotiating leeway in the $95.00 proposed price.

4. Working capital financing costs (annual variable financing costs, as percent of dollar value of working capital) are:

Pre-tax cost of funds (to finance receivables and inventories not carried by vendors) is 12.0%.

5. Other assumptions for Challenger-related added inventories (average over the year):

Materials: two month's supply.

Work in process: 1,000 bikes, half completed (but all materials for them issued).

Finished goods: 500 bikes (awaiting the next truckload lot shipment to a Hi-Valu warehouse).

6. Impact on our regular sales: Some retail consumers comparison shop for bikes, and many of them are likely to conclude that a Challenger bike as a good value when compared with a similar bike (either ours or a competitor's) at a higher price in a non-chain store. Also, our direct customers (local shop owners, etc.) are likely to recognize these bikes as Baldwin products or to otherwise learn of this private brand deal. In 2008, we sold 99,000 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 4,000 units of our regular sales volume a year, since our retail distribution is quite strong in Hi-Valu's market region.

CASE QUESTIONS - No Math

1. In a write-up format, answer the questions with an organized thought process rather than just doing the math. This is meant to help you think thru the case.

a. How did the special order/pricing case apply?

b. In your own words, discuss the blending of Cost & Financial Analysis with Marketing & Strategic consideration

c. Identify and analyze revenues and costs applicable to the special order/pricing decision.

d. What other implications are relevant to the case?

2. What are the pertinent aspects of Baldwin situation?

a. How would you describe Baldwin's financial situation including operating

b. performance as of 2008?

c. How would you describe Baldwin's strategic position at the end of 2008?

d. Is the Challenger deal a good strategic fit for Baldwin?

3. Without performing a cost analysis of the Challenger deal, talk about

a. Relevant manufacturing

b. Relevant Costs & Profits

c. Relevant Annual Costs of the Working Capital involved in the Challenger deal