Creative Toys Inc. - Case Analysis

Enter into a sales contract with Discount Pete's Inc. (DPI). Excerpts from the discussions that took place are detailed below:

Thomas: As you know, CTI has not had acceptable financial results for a few years now, and it is time to make significant changes to our direction, before it is too late. Let's discuss each of these alternatives and determine which are the best strategic choices for CTI. Lorraine, do you want to go first? Lorraine: Yes, I am very excited about my discussions with DPI, the big-box discount retailer that we are all familiar with. I was finally able to get a face-to-face meeting with DPI's purchasing agent, Samuel Forbes. The meeting was very successful, and just yesterday, I received a draft of the terms and conditions that would be in our contract. We are very lucky to have made it this far in the negotiation process, since most companies often wait years to actually get a meeting. Samuel is very interested in building a relationship with CTI because DPI is expanding its toy line to include well-known and premium products, such as ours. Steven: This is a wonderful idea and the other employee-shareholders I represent support this initiative. The contractual commitment with DPI results in a substantial increase in volume of sales, particularly for the game/puzzle division. We could add a third shift to increase our production volumes, if it is needed to meet our other customers' demand. Thomas: I am very concerned about selling to a discount retailer. I know in the past that when one of PET's suppliers started to sell with a discount retailer, I decided not to carry their products anymore in my PET stores because I cannot compete with their prices. I am sure that we will lose some of our existing customers if we go this route. It is very likely that DPI will sell at a lower price in order to undercut the smaller, local specialty toy stores. Lorraine: I don't think this will happen, or if it does, it will be minor. In order to meet DPI's required purchase volumes, we will have to lose some customers anyways. But DPI has many retail outlets where we do not currently sell, so this will expand our geographic reach into new areas across Canada and the United States.

Krystal: This arrangement will destroy our brand name. I want to build up our reputation as a premium educational toy company, and selling to DPI will ruin our name as a premium brand. I agree with Thomas that we will lose some, if not many, of our retail customers, and this will likely lead to a reduction in our end-use consumers. Thomas: Many of these retailers have been long-term customers that we could rely on for steady sales volumes. If we pursued the DPI agreement, we might have to go and tell these loyal customers that we cannot meet their demand requirements. This will destroy our reputation with our customers and make it more difficult to gain new customers to replace the ones we lose. Steven: I think you are overreacting these customers have been with us for a while, and I don't see why they would drop us if they can sell our product. But this DPI contract will mean that we can operate more efficiently, since our production volumes will be higher. And the two-year contract gives us some stability for proper production planning. If it doesn't work out, we can always give notice. Krystal: There are a lot of contractual terms that I think are onerous for us and very beneficial for DPI. I have only had a quick read of the conditions, but it seems they are going to have a lot of control to dictate how we do business. Will Greenhaven even agree to these required audits? If not, we will have to find another doll supplier, which may be very difficult. Lorraine: I am sure we can come to some agreement on these conditions. I found Samuel to be very agreeable and easy to communicate with. Thomas: This is not consistent with what I have heard from other suppliers. I have two suppliers that used to sell to DPI but found DPI too aggressive and demanding in their requirements, and DPI was not willing to compromise on any issue. DPI knows there are many suppliers that want DPI contracts, and therefore they can stipulate their terms and wield their buying power. These two suppliers decided to terminate their contracts early, paying the penalties, and have both mentioned that they never regretted this decision.

Appendix:

The following is an excerpt of the draft sales contract, provided by DPI: Term The initial contract will be for two years, commencing July 1, 2022, and expiring June 30, 2024. This contract may be extended for another two years, if agreed to by both parties. DPI may terminate the contract with 30 days notice without penalty. CTI may terminate the contract with 90 days notice with payment of a penalty. The contract can be terminated immediately if CTI is found to be in non-compliance with any of the agreed upon terms and conditions, except as otherwise stated in the agreement. Purchase commitments DPI agrees to purchase a minimum volume per year of 875,000 units of games and puzzles, at an average selling price of $10.00 per unit. The maximum annual volume will not exceed 1,500,000 units during the term of this contract, unless otherwise agreed to by both parties. DPI agrees to purchase a minimum of 375,000 units of Sookie dolls for $6.00 per unit. The maximum annual volume will not exceed 500,000 units during the term of this contract, unless otherwise agreed to by both parties. CTI must be able to ship within 48 hours of receiving an order from DPI. If the items cannot be shipped within the specified time frame, the order will be cancelled, and it will reduce the minimum volumes that DPI commits to. DPI will be able to set the selling price of all products purchased from CTI. DPI has the right to return product for a full refund if not sold within four months. CTI will be responsible for shipping the product to DPI's stores and for shipping any returns back to its own warehouses. o Note: This cost is estimated to be $0.25 per unit for games/puzzles and $0.18 per unit for dolls. Supplier requirements CTI must list its annual financial information with Lutz and Booth Inc., a credit rating agency. CTI must ensure that each product has a Universal Product Code (UPC) printed on the packaging. CTI must comply with all product health and safety requirements and any additional DPI regulations related to the product.

DPI may require CTI to change its packaging periodically to comply with DPI specifications. Any costs for packing machine modifications will be CTI's responsibility. CTI will assign two people to be responsible for the DPI account. These two representatives will be able to deal with any issues that might arise between DPI and CTI. CTI will meet all DPI's commitments before servicing any other customers. Facility manufacturing standards CTI must comply with DPI's facility manufacturing standards, which include proper training, responsible sourcing, fair treatment of all employees including fair wages, and adherence to all other regulatory requirements for health and safety. o CTI must agree to a factory audit, allowing DPI qualified personnel access to the manufacturing plant upon request. This includes any facilities where items are manufactured by preferred vendors (such as Greenhaven). o CTI will be responsible for disclosing and scheduling audits for all facilities in which CTI products are manufactured. o CTI must manufacture product only in facilities that have been authorized by DPI; failure to do so could result in immediate termination of the agreement. o If CTI is found to be in non-compliance with any of DPI's standards, depending on the nature, CPI will have up to 15 days to rectify the issue to DPI's satisfaction, otherwise the contract will be terminated. Other items DPI guarantees it will include CTI products in its advertising at least twice during each year of the contract. DPI agrees to list CTI products on the company's online sales site with in-depth descriptions to promote consumer awareness. DPI will pay invoices within 90 days from the date the goods are received. Request: Please provide an identification of strategic decisions to be made and the operational issues to be addressed.