Industry analysis Case Scenario

Register Inc. is a manufacturer of office stationery and supplies operating in a Namibia. The manufacturer heavily relies on paper as an input material which is widely produced in the country in which it operates.

Over the years, Register Inc. has been able to acquire significant economies of scale in its production activities. Relative to its competitors, these cost savings have enabled the company to secure operating flexibility and a dominant share in the product market.

Register Inc.'s consumers are primarily divided into two categories - 1) offices and 2) retail outlets. The offices to which Register Inc. supplies stationary represent a fragmented consumer base. On the other hand, Register Inc. shelves its stationary in one specific chain of retail outlets.

Register Inc.'s management has always preferred the retail chain as it offers the best shelving space to the manufacturer compared to competing retail outlets. Mona Jefferson is an equity analyst serving Time Traders, a portfolio management firm situated in the U.S. The firm is interested in investing in international companies such as Register Inc. Jefferson would like to conduct an equity analysis of the manufacturer and the industry conditions in which it operates prior to investment.

Jefferson begins his analysis by collecting the per unit sales price, cost of sales, selling and administration expenses as well as the number of units sold in Exhibit 1 for the current financial year, 2019.

Exhibit 1: Sales and Cost Information for 2019

Units sold 350,000

Average sales price per unit $15

Cost of goods sold per unit $8

Selling, general and administrative (SG&A) expenses per unit $4

The price of paper is forecasted to increase in the following year following the enactment of an environmental legislation which limits the number of trees which may be cut down on an annual basis. This has drastically restricted the supply of paper leading to an increase in the price of the input component by 20%. Paper is Register Inc.'s sole variable component and constitutes 30% of its production costs. The remaining production costs are fixed. SG&A expenses are expected to remain fixed over the coming years. Jefferson predicts that the 20% increase in input costs will have two effects (Exhibit 2).

Exhibit 2: Effect of a 20% Increase in Input Costs

Effect1 : The company will be able to fully pass the 20% increase in input costs in the form of higher selling prices. A 0.8 price elasticity will result in the number of units sold declining by 16%.

Effect 2: Company management are eager to respond to the cost increase by raising its selling prices shortly afterwards.

Jefferson's colleague, Ralph Smith, points out that the analyst has failed to consider the impact of inflation on the remaining costs of the manufacturer. Smith points out that inflation will raise all company costs by 15% and that the company will be able to pass the increase to customers beginning in the year 2019. Smith assumes that overall net sales will remain constant for the purposes of his analysis.

Question

The intensity of rivalry in the stationery market is most likely classified as being:

• A.
• medium
• B.
• high
• C.
• low

Question

The bargaining power of suppliers to the paper industry is low because:

• A.
• they are smaller in size compared to Register Inc.
• B.
• paper is not a unique resource.
• C.
• they place a low level of importance on paper as an industry product.

Question

The bargaining power of offices and retail outlets is most likely classified as being:

• A.
• Offices : low and Retail Outlets : high
• B.
• Offices : high and Retail Outlets : low
• C.
• Offices : high and Retail Outlets : high

Question

Using the data in Exhibits 1 and 2 and forecasts concerning individual cost components, Register Inc.'s operating profit considering Effect 1 only will be closest to:

• A.
• $1,540,000.
• B.
• $1,226,400.
• C.
• $1,450,400.

Question

Which of the following risks may most likely be encountered with respect to Effect 2 considering that demand for stationery is price elastic?

• A.
• Volume losses
• B.
• Loss of market position
• C.
• Profit margin squeeze

Question

Based on Smith's prediction for the impact of inflation on company costs and using the data in Exhibit 1, the forecasted gross profit for the company in the year 2019is closest to:

• A.
• $1,207,500.
• B.
• $420,000.
• C.
• $1,050,000.