Case Study Assignment

Johnson Matthey is one of the worlds leading suppliers of catalysts and process technologies. Over the past ten years, the companys sales of process technology and catalysts for oil refineries has increased significantly. This is due to a strategic focus on the development of specialist catalysts for the production of ultra-low sulfur diesel (ULSD) and the tightening of environmental legislation with regards to sulfur content in fuels.

Johnson Matthey has created and delivered catalysts for oil refineries worldwide. Catalysts called JM series are used for cleaning oil and for the production of refinery products including gasoline, diesel, kerosene, fuel oil and asphalt. Also, raw materials for a variety of other products are also produced. It is estimated that more than 2000 products can be produced using crude oil as a raw material.

After an intensive research program, Johnson Matthey developed a new catalyst, JM-2, with an even higher efficiency than the previous catalyst, JM-1. In the part of the refining process where the catalyst is used, a semi-processed product called LCO (liquid cycle oil) is recovered. LCO is critical to the production of ULSD. By employing JM-2, the amount of LCO recovered increased from 25.0% to 29.2% of the amount of oil passing over the catalyst. This adds value to the production of LCO by an amount of US$10 per barrel.

In answering the following questions, you may base your calculations on a refinery that processes 30,000 barrels per day, operating 365 days per year. Typically, 110 tons of catalyst must be used in such a refinery and it must be replaced every 2.5 years.

The company must first establish a selling price for the catalyst JM-2 before they try to sell it to refiners. A common approach is to use a specific margin for the variable manufacturing costs. In a research- intensive company such as Johnson Matthey, this method is not valid, because the variable manufacturing costs are relatively small in comparison with the considerable development costs. To determine the selling price based on the development costs is also not economically rational, as already incurred costs (sunk costs) should never influence future decisions.

An idea of what will be an upper limit for the selling price may be obtained from an assessment of the products usefulness to the customer: EVC (Economic Value for the Customer).

Question 1

If the refinery has previously used JM-1, what is the absolute highest additional cost for JM-2 the refinery should be expected to accept?

The development of JM-2 has taken 3 years and the development cost is calculated to be $0.6 million per year.

The price of JM-2 has now been established, and on that basis, sales of JM-2 in the next 5 years will be: Year 1: 400 tons

Year 2: 700 tons

Year 3: 2400 tons

Year 4: 3800 tons Year 5: 4200 tons

For the next 5 years, the marketing costs for JM-2 are planned to be $33,000 per year. Assume that the gross margin on JM-2 at the established selling price is $5000 per ton. Also, assume that Johnson Matthey applies an MARR of 20% per year.

One problem in assessing profitability in developing a new technology (JM-2 in this case) that replaces an existing technology (JM-1), is that the assessment should be based on assumptions about what would have happened if the new technology had not been developed.

Question 2

What is the payback period for the development of JM-2, if it is assumed that it would not have been possible to sell JM-1 in years 1-5?

When marketing JM-2, it is likely that the company will acquire new customers who previously used competing products. In this case, JM-2 will contribute to increased sales of catalysts. However, when JM-2 replaces JM-1, it is expected that existing customers will switch over from JM-1 to JM-2, with reference to Question 1. In this case, the contribution of JM-2 will only be an additional gross profit with respect to JM-1.

Question 3

Assuming that the JM-2 does not contribute to increased sales, but merely replaces a similar sale of JM- 1 that could be achieved over the five years, what should the additional gross profit on JM-2 be for the project payback to be 3 years?