News Reel Inc was incorporated in 1958 and has been wholly owned by members of the Xiang family since that date. The board of directors consists solely of family members. The company manufactures newsprint for sale in the newspaper and magazine industry at a single site in Hoyan Province, to the northwest of Eastlandia. Eastlandia is a small island, approximately 200 kilometres off the coast of the mainland continent. In terms of the paper industry, News Reel may be regarded as a small to medium-sized manufacturing company.

Markets

The company s major customer has for many years been the Eastlandian Evening Star (EES), for which it is the sole supplier of newsprint. The contract is renewable each year and the prices determined on a cost-plus basis

Historically the EES contract has made up about 30% of the companys revenue, but during the economic recession other business has suffered significantly. As a result the EES contract made up 40% of total revenue in News Reel's last accounting year.

The remaining 60% of sales was mainly to magazines and free newspapers published and circulated across Eastlandia. Frequently orders have been won by News Reel's willingness to provide small quantities of newsprint from short production runs and its promise of prompt delivery.

Raw materials

The major raw material for News Reel is pulp. Rather than rely on the major pulp manufacturers, which import limber from Canada and Scandinavia, the company is supplied exclusively under short-term contracts from a privately-owned Eastlandian mill, Quickpulp Inc, which possess local softwoods.

In recent years News Reel Inc's purchases have accounted for 8% to 10% of Quickpulp Inc's revenue. Whilst these supplies of pulp are slightly more expensive than those that can be purchased from the larger manufacturers, they have the advantage of short and certain delivery times, enabling News Reel to carry negligible inventories of raw materials.

Production

News Reel makes a single product, reels of newsprint. The company's manufacturing operations have been built up over time; as a result a small proportion of its operating non-current assets are replaced each year. Given the scale of its activities, the business is not as capital intensive as many of its larger competitors in the industry; consequently, has a higher proportion of labour costs per tonne of output than the industry average.

In fact, News Reel struggles to compete when tendering for major order as it uses more pulp per tonne of output than would be the case if it could operate large scale, modern machinery. In compensation however, set-up costs are much lower, and this enables small production runs to be accommodated, ensuring greater flexibility in production scheduling. Due to weak trading volumes the company has only been operating at 70% of productive capacity this year, and a similar level of 30% surplus capacity expected next year.

The competitive environment

The Eastlandian paper industry is dominated by ten listed companies, whose operations are primarily based on the mainland continent. All produce both commodity newsprint and a variety of branded paper products for specialist markets.

There are also a number of smaller companies, of a similar size to News Reel, which mainly specialise in niche markets. A new phenomenon affecting all sectors has been the growth of low-cost, low-quality recycled paper, supported by subsidies from some foreign governments for their own producers.

The paper industry has been affected significantly by the recession, with most companies operating with excess capacity. This in turn has led them to cut margins when tendering contracts. The following are the features of the competitive environment:

Depressed pulp and paper prices (a reflection of their historic value)

The failure of one or two small operators and downsizing by survivors as they rationalise their operations

An increased tendency towards diversification

A strategic dilemma

The chairman of News Reel has recently been informed that the EES has been acquired by a multinational and that when the existing commitment expires at the end of this year, the contract to supply newsprint will be put out to tender on an annual basis.

He has also been told that the terms of the new contract will be that all newsprint which the EES requires next year will be supplied by the successful bidder at a predetermined tender price per reel. The bids have to be submitted by 30 November and the successful bid will be announced a month later. The contract will not be awarded solely on the basis of price, but this is likely to be a major factor. At the board meeting to discuss these developments the following views were expressed:

The marketing director

It has long been my view that we have been over-dependent on EES as a customer. Even if we do win the contract next year there is no guarantee that we will be able to retain it in the future. In my view it Is essential that we seek out new markets and new product.

In particular we are too small to be a commodity producer of newsprint without the EES contract we need to develop into niche markets within paper sector differentiated branded products.

'In fact, there is currently an opportunity for us. A small local firm, MedicNote Inc, is currently looking for a buyer. It has been very profitable, specialising in exploiting the growing demand in the market for pharmaceutical paper products, but it has experienced severe cash flow problems recently due to overtrading.

The production director

'I agree with the need to diversify, but making newsprint is what we are good at. We have no experience in other markets. I have just been told that Quickpulp shareholders are looking to sell the company due to recent losses arising from weak world pulp prices. In my opinion this represents an ideal opportunity to secure pulp supplies at a low cost. I am also in favour of more modern large scale machinery in order to drive down marginal costs. This will enable us to compete in the long run in our core activity.'

The finance director

'Even if an acquisition strategy is felt to be appropriate, it is very difficult to evaluate the feasibility of the two options in precise monetary terms as much will depend on the prices of the two businesses. In my judgement News Reel is sufficiently liquid to fund one or other of the options suggested but, given current uncertainties, it would be difficult to raise finance for both of them.'

Required:

Asa management consultant you have been commissioned to prepare briefing notes for the directors of News Reel covering the following areas:

(a) Analyse the company's current strategic position (8 Marks)

(b) Evaluate the future strategic options available to the company by appraising the potential growth strategies that the company could pursue, and the diversification/acquisition strategies suggested (12 Marks)