Hi, I have the following case to work on and I'm having trouble. The 5 questions are in bold below. Thanks!

INTRODUCTION

The vice president at your company, Columbia Holdings, has

given you a new assignment: "Recently I asked the folks at

Patterson Manufacturing to develop a strategy for improving

their profitability. They have responded with a proposal. I want

you to evaluate the proposal: Is it viable? Is it sustainable? Visit

their operations and bring back a recommendation."

As you travel to the site you review a brief history of

the firm. Patterson Manufacturing was founded in a small

northeastern city more than a century ago. Wesley Patterson

started the firm alongside a fast-moving stream that provided

mechanical power to drive cutting tools, grinders, lathes, and

polishers. These tools were used to produce precision parts

other manufacturers needed. The firm quickly established

a reputation for producing high-quality products to exacting

tolerances. The firm prospered.

Wesley studied the industries he served to develop new

products that could fill his customers' emerging needs. He

often met with customers to design unique products for

them. He referred to his approach as providing "customerdriven

creative solutions." He also kept abreast of new

manufacturing materials and technology to ensure his

products were of the highest quality.

The firm grew steadily and, by 1925, was (and still is) the

community's largest employer. Wesley donated the land that

is now the city's central park. He also paid for constructing

the first municipal buildings. More recently, the company

was the primary donor for the construction of the municipal

library and the local hospital. And the taxes paid by the firm

and its employees are responsible for an excellent array of

community services, including the Patterson Sports Complex

and Patterson Community Center.

The Great Depression in the 1930s brought hard times

to the company, yet none of its employees were discharged.

Instead, the firm and its employees cooperated to spread

the available work among its employees by reducing each

individual's working hours (and wages). During that time,

the firm also suspended paying dividends to its owners.

After the company returned to prosperity in the 1940s, it

continued to emphasize customer-driven creative solutions,

and its loyal workforce enthusiastically overcame product

design challenges.

Wesley passed leadership of his business to his son,

who later passed it down to Wesley's grandson, and then to

Wesley's great granddaughter, Jessica Patterson. But five

years ago, when Jessica wanted to retire, there was no heir

willing to take over the business. Consequently, the plant

was sold to your employer, Columbia Holdings.

BACKGROUND

Columbia invests in family-owned businesses with a strong

presence in niche markets. Columbia retains existing

management and local business practices but provides

centralized services, such as finance, accounting, insurance,

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ISSN 1940-204X

Patterson Manufacturing

Shane Moriarity

University of Oklahoma and Unitec New Zealand

Andrew Slessor

Unitec New Zealand

and corporate-level management. Patterson has remained

profitable since the acquisition, but its return on investment

has been declining.

Your first stop at the Patterson complex is a meeting with

the controller. He provides some additional background:

"Jessica, like her predecessors, spent most of her time with

customers developing new products to meet customer needs.

She didn't concern herself with costs. Customers were willing

to pay for products that solved problems. Upon Jessica's

retirement, Columbia appointed Paul, our former production

manager, to CEO. Paul has done wonders in rationalizing and

standardizing our product lines. He substantially reduced

manufacturing costs, which led to record profits in the two

years following the sale of the company. Those early results

have apparently set high expectations for our continuing

performance. Our proposal will help move us toward meeting

those expectations," he said.

"Our proposal is to stop manufacturing our largest-selling

product, the Gudgeon EH40, and instead acquire it from an

overseas supplier," continued the controller. "This product

currently represents 30% of our total sales revenue and

production volume. But sales have been declining because

competitors are offering a similar product at lower prices. We

think that by reducing our price by 5% we can increase our

unit sales volume by 15%. The increased volume coupled

with a lower product cost from the offshore supplier should

nearly double our firm-wide profit."

The controller also provided some supporting

documents. Exhibit 1 summarizes operations for the five

years since Patterson Manufacturing was sold to Columbia

Holdings. Year 1 represents the first full year after Jessica

retired, and Year 5 is the year that just past. Exhibits 2, 3,

and 4 provide an income statement for Year 5, the current

employee staffing levels by job title, and a detailed price

proposal from the overseas supplier.

The controller continued: "The analysis is pretty

straightforward. Sales of the Gudgeon EH40 were $27

million last year. The direct material costs came to $14.3

million, while overhead costs of $4.2 million were allocated

to the product. But only $2.9 million of the overhead will be

avoided if we stop manufacturing the Gudgeon EH40. The

remaining overhead costs are nearly all fixed and not subject

to reduction in the near future. Our direct selling costs consist

mostly of an 8% commission paid to sales representatives. In

addition, there's a $2 million advertising allowance devoted to

promoting the Gudgeon EH40 in trade magazines."

He also said, "By outsourcing the Gudgeon EH40, we can

release three administrative managers, eight administrative

support staff, 128 general production personnel, and 10 supervisors.

The firm will incur a one-time charge of $1 million for severance

pay and pension contributions for dismissed employees. We'll

also need to spend $200,000 for the construction of receiving

facilities for the outsourced product."

The controller continued: "The supplier's cost quotation

(Exhibit 4) needs to be adjusted for the expected 15%

increase in volume. The cost for materials and labor will

increase proportionately, but the overhead and 'other' costs

are unlikely to be affected. The supplier's mark-up will be

10% of the new total cost. In addition to the product cost,

Patterson will incur transportation costs to get the product

from the manufacturer to our warehouse. The transportation

costs are variable and would have been $0.6 million for the

volume of product in Year 5."

THE TASK

After his brief overview, the controller hands you the exhibits

and says, "You should go through the numbers yourself to

ensure that my projection for the increase in profit is correct."

As you make your way to an empty office to review the

numbers, the marketing manager approaches you. She pleads,

"Don't let them. The proposed action will deal a

devastating financial blow to our community. Wesley Patterson

would have never approved such a move. He loved this town."

REQUIRED

1. Using the controller's projections, an analysis

of the expected effect of outsourcing the product on

Patterson's profitability.

2. Would it be a viable alternative to produce the product

locally and lower the price to achieve the increase in sales

volume?

3. Does the firm have an obligation to maintain

employment levels in the town?

4. What risks are associated with the proposal?

5. Make a recommendation to your vice president on

whether the proposal should be accepted. Provide

your reasoning and any suggestions for additional or

alternative actions that Patterson should take.

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Year 5 Year 4 Year 3 Year 2 Year 1

Total Revenues $90.2 $94.9 $99.1 $106.2 $111.4

Net Income $3.1 $3.8 $4.4 $7.3 $7.5

Domestic Sales $74.7 $76.9 $79.3 $85.0 $88.1

International Sales $15.5 $18.0 $19.8 $21.2 $23.3

Sales of Established Products* $73.9 $75.1 $74.4 $76.3 $76.6

Sales of New Products* $16.3 $19.8 $24.7 $29.9 $34.8

Research and Development $0.9 $1.1 $1.5 $1.2 $1.3

Return on Assets 2.0% 2.3% 2.7% 4.1% 4.2%

Number of Employees 480 485 502 492 510

Exhibit 1:

Patterson Manufacturing Five-Year Summary of Operations

Note: Dollar figures are in millions.

*Established products are those that have been marketed for five years or more. New products have been marketed for less than five years.

Year 5

Sales $90.2

Cost of Goods Sold (COGS) 74.3

Gross Margin 15.9

Administrative Costs 1.6

Selling Costs 11.2

Operating Income $ 3.1

Exhibit 2:

Summary Income Statement for Patterson Manufacturing

Note: Dollar figures are in millions. Interest expense and income taxes are only

shown on Columbia's consolidated financial statements.

Material Costs $12.7

Labor Costs 1.8

Overhead Costs 2.7

Other 1.5

Total 18.7

Profit Mark-Up (10%) 1.9

Total Price $20.6

Exhibit 4:

Off-Shore Supplier's Price Proposal for the Volume of

Product in Year 5

Note: Dollar figures are in millions. The total price is quoted for supplying the quantity of

product Patterson sold in Year 5. The quoted price is FOB the supplier's manufacturing plant.

Job Title

Number of

Employees

Average Salary

Per Employee

Administrative Manager 10 $45,000

Administrative Staff 24 32,000

Production Supervisor 29 50,000

General Production Personnel 417 37,000

Exhibit 3:

Distribution of Current Patterson Employees by Job Title

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