"Now comes the real test," Giulia thought to herself, "evaluating my idea for expanding the product

offerings." She gathered up her notes and opened a blank spreadsheet file on her laptop.

Just a few months ago, Giulia Ferrato's fledgling business, TenAlpina Tools, was at a crossroads. The contract

manufacturer of her only product, rock climbing pitons, wanted to sell his business and retire. Meanwhile,

her customer wanted to quadruple purchase volume under an exclusive relationship. She had performed an

initial analysis of the profitability of running the factory herself and found it less than reassuring. In the end,

however, she felt that controlling the production facility was an opportunity she couldn't pass up. Now she

wants to offer a new product line to take advantage of the underutilized capacity in hopes of improving the

company's financial situation.

The Beginning

About a year ago, when Giulia returned from her internship between the first and second years of her MBA

program, she began to research the potential to produce high-quality pitons from titanium. Pitons are like

flat spikes, and rock climbers hammer them into crevices in the rock wall in order to attach support lines,

making them a critical tool for the climbers. She was able to design a piton made of titanium that offered

superior tensile strength while weighing significantly less than the standard steel alloy product. She also

found a company that did drop-forgingan integral part of the production processwhich had excess

capacity and could produce the product in volumes Giulia believed she could sell. Her first order of 1,000

units evolved into a guarantee to purchase a volume of at least 4,000 units per month for the length of a twoyear

contract. At that same time, the owner of the company doing her manufacturing, a man named Stanley

Kowalchek, offered to sell her his forge.

Giulia initially worried that, if the business failed, she might be left with operating capacity for which there

was little, if any, demand. However, she quickly realized that Kowalchek was already in that situation. Giulia

recognized that she was in a position of strength in the negotiation. Exercising that leverage, she got

Kowalchek to agree to sell her his business at the net book value of $86,130. At the sale date, that amount

comprised only the plant equipment because there were no receivables, inventory, or intangible assets.

Giulia's father had previously agreed to invest in her education, but in a non-traditional manner. He gave her

the equivalent of the tuition she had spent on her recently completed 2-year MBA program to gain the

practical education that would come from running a business. Adding that to her savings, she made the

purchase and invested the remainder into the business.

She kept the six experienced laborers on payroll at their existing pay rate and began production immediately.

They needed no ramp-up time to learn the process since they already had experience making the pitons. She

signed the exclusive arrangement with her customer, guaranteeing purchases of at least 48,000 pitons per

year for two years. After a short shakedown period to familiarize herself with the operations and the

administrative and record-keeping duties she had to perform, she refocused her attention on her new

product ideaa titanium wall hammer.

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The New Product

Rock climbers felt the major value provided by the titanium pitons were their performance and longevity,

characteristics that matched the best steel alloy products, but at a superior light weight. Giulia expected that

this comparative advantage would be even greater for the hammer, because current models often weighed

close to 2 pounds. Competing wall hammers consisted of a steel head and a wooden or fiberglass handle. In

contrast, Giulia's design was a "unitized" head and handle shaft (or haft). The titanium haft was very thin and

yet stronger than the competition's handles. It was also quite lightweight, concentrating all of the weight in

the head and enhancing performance for both driving and removing pitons. This thinness, however, created

a design problem that Giulia saw as another opportunity. The handle needed to be thick enough to be

comfortable in the climber's hand. Giulia designed a padded handle that not only provided appropriate gripsize

ergonomics, but also isolated the climber's hand from the considerable shock generated when driving a

metal spike into rock. This padded handle could be most effectively provided through an injection-molded

soft nylon-vinyl handle, bonded through the haft for secure hold. Refer to Exhibit 1 for an illustration of an

example of a competitor's product.

A New Machine

Since Giulia's factory did not have an injection molding machine, she would need to acquire one. Her research

found that she could buy and install the necessary equipment for $35,000. She found this machine would only

have a seven-year life and added this information to the depreciation schedule (see Exhibit 2). There would

be sufficient available floor space for an injection molding station in the factory once some of the existing

equipment and racks were rearranged.

With the design specifications and the molding machine's operating characteristics in hand, Giulia felt she

could estimate values for many of the remaining variables she needed to examine. First, she calculated the

amount of titanium alloy and plastic resin each hammer would consume. At current input prices, the cost for

volumes less than 10,000 per year would be $10.44 per unit. The engineering specifications on the molding

machine indicated that it would consume significant amounts of electricity with each injection and cooling

cycle. Based on the volume of material used in molding, she calculated each wall hammer would require a

total of $0.46 of energy cost, including power for the other manufacturing steps. Without any better

information, she assumed that the per unit supplies costs would be a little more for the hammers than for the

pitons, and estimated the amount to be $0.14 per unit. She collected some data for current operations and

projected costs, which appears in Exhibit 3.

Estimating Price and Demand

In the case of the pitons, her customer was the one who gave her the price and quantity. She did not want to

be constrained by a similar relationship going into a new product line, so she tried to reverse-engineer those

parameters from other information. After doing some online investigation and talking with several rockclimbing

equipment retailers, she arrived at a target retail price of $94, the same price as a high-quality

competitor. Reversing the markup her piton customer used (he was getting about a 35% gross margin), she

determined that her price to retailers and distributors should be $61. Based on what she had been told by the

retailers with whom she spoke, she decided that the hammers would generate a demand equal to about 350

units per month.

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Manufacturing Parameters

Giulia sat down with her production team to discuss the effect on production of adding 350 hammers to the

monthly production schedule. The experienced workers' analysis of the new work requirements based on the

hammer's design revealed that it would require more labor effort per unit at each existing workstation. Talking

through the manufacturing process, they quickly determined that the current staffing level would be

insufficient. The inadequacy of the resources was due in large part to the current workflow that had

employees moving from station to station, thereby reducing available productive time. They decided that the

installation of the new machine also provided an opportunity to rearrange the workflow by moving some of

the existing equipment. The new machine and the redesigned workflow meant that they could easily handle

the additional demand of 4,200 hammers a year with just two more laborers.

In the new arrangement, there would be six workstations:

1. Roll/cut

2. Heat/forge

3. Bore (drilling)

4. De-burr and Polish

5. Injection Molding

6. Packing

Under the proposed staffing plan, each of the six steps would have one permanently stationed employee

except for the first two, which would have two each. Overall, given the total expected demand, they

estimated that the hammers would consume 37% of the total productive labor time. (Giulia decided to use

this percentage of direct labor time as the basis for allocating production costs other than materials to each

product line in order to calculate product gross margins.)

The work team told Giulia that she could simply follow tradition in filling the new two additional positions.

She could hire the last two workers that had been laid off by Kowalchek a few months previously. The two

would be ready to return to their old work arrangements (which included the same policies and wage rate

paid to the current workers).

Selling and Administrative Costs

Giulia's current customer for the pitons was willing to absorb the cost of delivery, but she did not think this

arrangement would hold for the hammers. She estimated shipping costs to be $1.00 per unit. She also felt

that it might be time to start taking a modest salary. Giulia decided that a salary and benefits amount just 10%

above that of the factory workers would be appropriate at this stage in the company's life, but she also

wondered what kind of effect this would have on profits.

"Before entering data into the blank spreadsheet," Giulia thought to herself, "I ought to spend some time

trying to organize my thoughts. First, I want to know what to expect in terms of the overall profit effect of

adding the hammer to my product line. How many hammers will I have to sell just to keep my annual profit

the same as it is now? Also, is the investment in the new injection molding machine justified? What will the

gross margin be on the new hammer? And will it affect the gross margin on the pitons?"

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Part B Questions:

1. TenAlpina is adding a new product line, which will add some new costs as well. Based on Giulia's

estimates, and assuming that the volumes for piton production and sales do not change, how many

wall hammers would TenAlpina Tools have to sell in order to have the same annual gross margin (in

dollars) as it would have if only pitons were sold? That is, at what demand level for hammers would

Guilia be indifferent (from a total profitability point of view) as to whether or not to add the new

product line?

2. In question 1 you computed the number of hammers to sell to find a point of indifference for demand

to decide whether or not to add the hammers. Now, using Giulia's estimates and assumptions for

both piton and hammer production and sales, what would be the total annual aggregate effect on

total gross margin of adding the production and sales of the new wall hammer product line?

3. Giulia wanted to look at financial risk another way, from a breakeven and margin of safety point of

view. What is the breakeven point and margin of safety for TenAlpina? Assume the mix of 4,200

pitons for every 350 hammers will remain fairly constant.

4. Gross margin is one measure of profitability. Before adding the wall hammer, pitons were the only

product the company manufactured.

a. Now, assuming the rock hammers have been added, and employing the estimates and

assumptions provided in the case, what will be the unit gross margins for each of the two product

lines?

b. Focusing on the pitons, how can you explain to Giulia the logic behind the results of your

computations? That is, explain the results in conceptual terms, not in terms of the computational

mechanics.