Becker Textilwerk GmbH' Edi Soler Fernando Penalva One morning in January 2013 Albert Klein, sales director at Becker Textilwerk, came into the office of CEO Ralf Lorenz to announce news that could signify major changes for the company in the future. A competitor had contacted Stein, one of Becker Textilwerk's most important customers, offering a 15% discount. Now Stein's purchasing manager wanted to know whether Becker could offer a similar discount. Volume discounts were common practice in the industry. Becker offered its customers discounts averaging 5.7% (around 7% to the larger customers and 4% to the smaller ones). Because Stein was such an important customer, Becker had increased its discount to 8% the previous year. But Lorenz and Klein thought that increasing the discount to 15% would be excessive, although sales to Stein would still have a positive contribution margin (CM) even with a 15% discount. Company Background Becker was a family business, founded in early 1961 and headquartered in the heart of Bavaria. Its main product was a specialized fabric with expanded polytetrafluoroethylene (ePTFE) membrane finishes. ePTFE is a polymer similar to polyethylene in which the hydrogen atoms are replaced by fluorine atoms. ePTFE was one of the strongest, most chemically inert and most electrically insulating polymers on the market, and Becker was a pioneer in ePTFE manufacturing, thanks to an exclusive expansion technique that had been key to the company's success. In 2012, despite the prevailing economic crisis in Europe and the United States, Becker had posted pre-tax profit of over 100 million euros on sales of more than 1.2 billion.ePTFE had numerous applications, ranging from sport and industrial fabrics to cable insulation, filters, and medical and pharmaceutical products. Becker was one of the largest manufacturers of high-performance fabrics for elastic, breathable, water and wind-resistant sportswear, which was marketed under several different models and brands. Since it was founded, Becker had had an excellent R&D team. Despite the competition, it had stayed true to its R&D orientation, adding further innovative properties to its products (breathability, impermeability, elasticity, strength, etc.] and dropping any products that became less protable due to stronger competition. In 2012 Becker spent more than 100 million euros on R&D (see Exhibit 1] and had very advanced technology, which allowed it to charge somewhat higher prices than most its competitors. Despite this aggressive innovation strategy, and in tune with the family nature ofthe rm, Becker's owners were very conservative in other aspects of management. The oompany had been nanced from the outset almost entirely with equity and did not usually make major investments without being sure that there was sufficient demand to ensure the minimum required return. Although this way of doing things was a source of pride for Becker, it had meant losing out on certain growth opportunities, which had been much remarked upon in the industry. Products and Production Process Becker manufactured twelve types of fabric from textile fibers and other raw materials which, when laminated with the ePTFE membrane, gave the end product impermeability and breathability. These fabrics were sold to manufacturers, which used them to make garments for end consumers. Approximately 58% of gross sales were to large manufacturers and the remaining 42% to small firms. Becker had large numbers of extrusion machines and other plant and equipment which, operating continuously, could produce up to 13,500,000 meters per month of all the different types of fabric. The company also had a small business unit that made sportswear for direct sale to end consumers. This unit gave Becker direct contact with the market and allowed it to learn about and adapt to customers' demands, which was essential to the company's continuous innovation strategy. Becker's production was stable over most ofthe year, which meant that it could maintain a more or less stable workforce, working three shifts. The first shift was used for maintenance and machine set-up as well as production, while the other two shifts were devoted entirely to production. The less qualified workers were usually assigned to the last two shifts, while the more qualified workers worked the first shift. Recruiting skilled workers for the first manufacturing shift was a critical issue for Becker. On the one hand, recruiting good workers to fill vacancies and training them up in a short period of time was a challenge [Bavaria had one of the lowest unemployment rates among the German Lnder, below 4%]. 0n the other, in order to retain these employees the company had to steadily increase their wages [faster than for the rest of the workforce]. What was more, the unions, which wielded considerable power in the company, insisted that all employees [approximately 1,800] must work all three shifts at least once per month, a requirement which was very rarely met, given the pressure to have the qualified workers running the first shift. Becker did all it could to allow this to continue, as the set-up tasks performed during the first shift required great precision and skill. Accordingly, every effort was made to ensure that these tasks were carried out by qualified workers. Cost Accounting System Becker used a variable cost system described in Exhibit 1. The company's management thought that a variable cost system would more accurately reflect economic reality, as it would explicitly show the contribution margin and other key decision variables, while at the same time allowing better control of fixed costs. With this system, it would be easy for Lorenz to decide whether or not to accept an order at a discounted price, or whether to devote more effort to selling a particular product. Variable costs consisted mainly of raw materials, which were allocated directly to the products according to consumption and actual value. Exhibit 2 contains information on variable costs and contribution margins for every product line. Fixed costs included direct labor, other direct production costs, and all indirect costs} The Decision on Stein's Request Stein was one of Becker's most important customers. It regularly purchased five of Becker's fabrics: Mariner, Stormex, Marathoner, Seashell and RainStop. Exhibit 3 shows the composition of sales to Stein in 2012. Given the level of price transparency in the market, Lorenz was concerned that if Becker offered Stein a discount similar to that offered by its competitor, other large customers might also start demanding discounts. Ifthe competitor was offering such a large discount, Lorenz and Klein thought it was because it was keen to gain market share and strengthen its position. Competition from foreign manufacturers was growing, and they were clearly aiming to offer the same quality of fabric as Becker, although they still had quite a long way to go, especially in the more high-tech products. Another possible interpretation was that the competitor had a temporary capacity surplus and was offering a much higher than usual discount in order to use that capacity. Forthese reasons, Lorenz and Klein thought that if Stein did not accept the offer and stayed with Becker, the competitor would most likely offer the same discount to other customers. The best thing, they agreed, would be to analyze what would happen if Stein accepted the competitor's offer and Becker lost those sales. To do this they assumed that Stein would still need to purchase 549,000 meters of Mariner and 952,000 meters of Stormex from Becker, as Becker was the only company in the market producing these types of fabric. They also assumed that even if they were able to retain Stein as a customer by granting a 15% discount, they would still lose the sales of RainStop, as Stein was most likely to source this type of fabric from the competitor, in recognition of the discount it was offering. Exhibit 1 Income Statement for 2012 (in Thousands of Euros) Gross sales revenue 1,326,055 Average discount 75,585 Net Sales Revenue 1,250,470 Variable Costs Raw materials 476,147 Other variable production costs 75,271 Total Variable Costs 551,418 Contribution Margin 699,052 Fixed production costs Direct labor 103,917 Other fixed production costs* 84,892 Total Fixed Production Costs 188,809 Other fixed costs Marketing and selling expenses 95,347 Administrative expenses 112,280 Depreciation and amortization expense 42,653 R&D expense 102,487 Other overhead expenses 56,091 Interest expense 1,235 Total Other Fixed Costs 410,093 Income Before Tax 100,150 *Includes depreciation and amortization expense in the amount of 27,432 euros. Source: Own elaboration.Becker Textilwerk GmbH C-770-E Exhibit 2 Margin by Product Line (2012) Other Contribution variable Total Contribution margin Meters Net sales Raw production contribution DL Machine margin (by machine sold revenue* materials costs margin hours* * hours (by DL hours) hours) Product (m 'ooo) (E 'ooo) (C 'ooo) (E 'ooo) (C 'ooo) (h) (h) (E) (E) Dryex 13,104 96,831 40,088 6,659 50,084 307,434 1,684,002 162.91 29.74 Endurance 8,355 63,955 20,031 3,225 40,699 148,876 1,013,094 273.38 40.17 Fireshield 197 2,178 772 108 1,298 4,988 30,275 260.22 42.87 Marathoner 16,627 195,313 73,131 12,378 109,804 571,415 3,710,234 192.16 29.59 Mariner 5,272 60,716 23,346 3,252 34,118 150,153 852,084 227.22 40.04 RainStop 20,851 209,481 88,841 12,625 108,015 582,870 4,104,567 185.32 26.32 Seashell 4,986 43,150 15,493 2,869 24,788 132,474 799,212 187.12 31.02 Stormex 30,486 339,356 129,362 18,686 191,308 862,689 4,583,108 221.76 41.74 Summit-L 2,295 16,354 6,310 1,003 9,041 46,314 255,634 195.21 35.37 Summit-X 1,561 10,642 4,495 745 5,402 34,401 192,234 157.03 28.10 Thermoline 10,023 101,600 29,444 5,796 66,360 267,595 1,387,402 247.99 47.83 Windbreak 13,988 110,894 44,834 7,925 58,135 365,891 2,140,678 158.89 27.16 TOTAL 127,745 1,250,470 476,147 75,271 699,052 3,475,100 20,752,524 201.16 33.69 * Prices include an average discount of 5.7% on the list price. ** These direct labor hours are estimated and are based on meters of fabric sold in 2012. The actual meters produced in 2012 were 125,296,000 and the direct labor hours for this number of meters were approximately 3,406,231 hours. The difference between production and sales generates changes in inventories. Source: Own elaboration.Exhibit 3 Margin on Sales to Stein Assuming Average Discounts of 7%, 8% and 15% (2012) 7% Discount Meters Net sales Variable Total DL Machine sold revenue costs contribution hours hours Product (m 'ooo) (C 'ooo) (E 'ooo) (C'ooo) (h) (h) Mariner 549 6,189 2,770 3,419 15,635 88,727 Stormex 952 10,376 4,624 5,752 26,945 143,149 Marathoner 1,687 19,402 8,677 10,725 57,983 376,486 Seashell 1,685 14,273 6,205 8,068 44,764 270,056 RainStop 1,196 11,761 5,819 5,942 33,428 235,396 TOTAL 6,069 62,001 28,095 33,906 178,755 1,113,814 8% Discount Meters Net sales Variable Total DL Machine sold revenue costs contribution hours hours Product (m 'ooo) (C'ooo) (C'ooo) (C 'ooo) (h) (h) Mariner 549 6,122 2,770 3,352 15,635 88,727 Stormex 952 10,265 4,624 5,641 26,945 143,149 Marathoner 1,687 19,193 8,677 10,516 57,983 376,486 Seashell 1,685 14,120 6,205 7,915 44,764 270,056 RainStop 1,196 11,635 5,819 5,816 33,428 235,396 TOTAL 6.069 61,335 28,095 33,240 178,755 1,113,814 15% Discount Meters Net sales Variable Total DL Machine sold revenue costs contribution hours hours Product (m 'ooo) (C 'ooo) (C'ooo) (C'ooo) (h) (h) Mariner 549 5,657 2,770 2,887 15,635 88,727 Stormex 952 9,484 4,624 4,860 26,945 143,149 Marathoner 1,687 17,733 8,677 9,056 57,983 376,486 Seashell 1,685 13,046 6,205 6,841 44,764 270,056 RainStop 1,196 10,749 5,819 4,930 33,428 235,396 TOTAL 6,069 56,669 28,095 28,574 178,755 1,113,814 Source: Own elaboration