On the profitability side, you should specifically address the following points: a) Is the cost structure of the two companies similar or different? Does the cost structure reflect their respective business models? b) If the acquisition goes forward, what should be the production and marketing strategy for the combined operation that is, what type of cards should be produced in which plant (Hammond or Creative) and which customers/channel should be used for selling the card (Hammond or Creative?)

IntroductIon Gregory Hammond founded Hammond Cards, Inc. 1951. The company, located in a suburb of Chicago, IL grew to become a major provider of greeting cards sold through traditional channels card store chains, bookstores, pharmacy chains and supermarkets. By industry standards, Hammond was small, with annual revenues less than 1% of industry leader Hallmark. The company produced all of its cards in a single manufacturing plant that was located adjacent to the company headquarters. Over the years, Hammond sales grew to roughly 10 million cards per year but growth had slowed in recent years. In an effort to stimulate growth, Hammond management was exploring potential acquisitions of other card companies. Wendy Hammond, President of Hammond Cards, had entered into discussions with Creative Designs owners to discuss an acquisition of the company. The owners were amenable to the sale and had provided Hammond with significant amounts of data about their business and operations during the early part of the due diligence process. Creative Designs was a privately-held greeting card company with a complementary set of offerings but a focus on different markets. Founded in New Jersey in 1986, Creative Designs was a smaller, niche player in the high-end card market. The company headquarters and manufacturing operations were located in a single facility just outside of Newark, NJ. Wendy Hammond believed that the proposed acquisition of Creative Designs would provide numerous opportunities for her company. There were, of course, some simple scale economies that could be extracted from the combination of the two businesses. The combined operations would allow production to be routed to the most cost effective facility. The consolidation would also open new markets by allowing cross-selling of the two distinct lines of greeting cards to the combined set of existing customers and new customers who might be brought into the mix by the wider variety of products. Before Wendy went any further with the acquisition talks, she felt that she needed to have better insights into the opportunities offered by the combined organization other than simple scale economies in sales and administration. She had asked Bob Martin, Vice-President of Operations at Hammond Cards, to review both operations to see if the proposed acquisition of Creative Designs could provide additional production capacity and flexibility that would allow them to leverage the combined capabilities to better address Hammonds operations and profitability challenges. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 1 Paul Mulligan Fidelity Faculty Term Chair, Assoc. Professor Technology & Operations Management Babson College Shahid Ansari Zwerling Term Chair Professor Behavioral and Managerial Accounting Babson College Alfred J. Nanni, Jr. Professor of Management Accounting Vander Wolk Chair in Management Accounting and Operational Performance Babson College ISSN 1940-204X Martin saw the acquisition not only as a way to off load demand, but given the smaller scale of operations, he wanted to utilize the Creative Designs facility as a learning laboratory to test new production methods. His objective was to implement new production methods at Creative Designs and then to migrate those methods to the larger scale Hammond operations at some later date. thE GrEEtInG cArdS InduStry1 According to Hoovers, the greeting cards industry had sales of 7.5 billion in 2005. Nearly 85 percent of the market share belonged to two major companies Hallmark (50%) and American Greetings (35%). The rest of the market was shared among 3,000 different greeting card publishers. In 2005 all of the major card companies including the big two had negative growth rates. The market was expected to be flat until 2007. On the positive side, online e-cards, once considered a major threat, did not seem to have a major impact on the printed card market. One reason may be that these cards are free. Another may be the reluctance of people to accept the e-card as a viable substitute for a printed card as it does not require the same effort as getting a printed card. Finally, card companies have expanded their product offerings to include niche markets such as guys and lesbian couples, people carrying on extra-marital love affairs, and the growing Spanish speaking population. The average household purchases 30 greeting cards per year the typical retail selling price is between $2 and $3. Most of the cards are sold through mass retailers such as Wal-Mart and Target, as well as dollar stores and grocery stores. While large printers such as Hallmark have their own stores, specialty greeting card companies generally sell their cards through boutiques or the Internet. The major card manufacturers such as Hallmark and American Greetings have chosen to diversify by opening on-line stores that deliver flowers or e-cards. They have also started selling other merchandise such as singing cards or cards with musical tones. Smaller manufacturers, however, have to compete either on price/cost basis or offering a differentiated product line with greater product variety. 1 This industry description is based on a report prepared by Linnea Anderson for the Hoover A Dun and Bradstreet Company. See the Greeting Cards Industry Overview, Hoovers On-Line Subscription Service, 2006. Product LInES And MArkEtS Hammond Cards manufactured and sold a wide range of greeting cards, but most (nearly 80%) were basically simple, standard-sized cards with a few (20%) more complex higher end cards. All of Hammonds sales were packaged in sets 20 cards to a package. This allowed the retailers the choice to sell boxed sets (e.g., a set of Christmas cards) or open the package and vend them one at a time. This approach was a factor that differentiated Hammond from most of the industrys big players. Another dimension of Hammonds competitive strategy was price. Hammonds cards were targeted at price-conscious buyers. Their average price of simple cards was 32 cents and for complex card the price was 42 cents. The sales and distribution of Hammonds cards was straightforward and a relatively low portion of total annual expenses. Sales were either direct to mass market chain stores (e.g., K-Mart, Wal-Mart, Walgreens) or to major wholesale/distribution operations. In contrast to Hammond Cards, Creative Designs specialized in so-called studio cards. These were high-end greeting cards which were sold individually at retail. Nearly 90 percent of their product line was high end cards sold at an average price of 80 cents per card. The other 10 percent were simpler cards sold at the average price of 32 cents per card. Creative Designs had not participated in the big-store supply chain. The majority of Creative Designs cards were sold through smaller niche market specialty shops and chains (stationery, cards, gifts, etc.) The difference between the two companies was where Wendy saw an opportunity for synergy. She hoped that acquiring Creative Designs would allow her to become more cost effective and at the same time exploit Creatives markets by producing a wider variety of products at a lower price. oPErAtIonS AnALySIS Bob Martin knew that the greeting card production operations at the two companies were quite similar. (See Exhibit 1). Both Hammond Cards and Creative Designs operated one production shift that worked 5 days per week. The workers at both companies belonged to the same union and were required to conform to union rules the workday was 7:30 4:30 with a one-hour (unpaid) lunch break and two (paid) 15-minute breaks. The union prohibited overtime or second shifts, which was fine with Hammond management, given their concerns with cost management. Martin intended to keep the work days and hours the same at the two plants, in order to avoid any workforce issues surrounding working conditions, pay scales, etc. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 2 Current production operations use virtually all of the available floor space in both the Hammond and Creative Designs plants. Consequently, Martin could not add machines to the system and had to manage within the constraints of current resource availability both machines and human resources. Hence Creative Designs would have to meet all of its demand and also handle any production transferred from Hammond Cards with the resources currently available at Creative Designs. The greeting card design process was outside of production and was not considered to be a significant production constraint at either Hammond or Creative Designs. ProductIon ProcESS Martin had put together a detailed description of the process steps, production times, and machine as well as human resource allocation at the various steps at both Hammond and Creative Designs. The process times for the production steps defined below represent standard completion times under normal operating conditions. Both companies used the same kind of machines in the same way. The obvious point of difference was printing. Hammond used printers that could print the entire foreground or background of a card surface in one operation. These machines also used less expensive ink and operated with fewer laborers per machine. The required class of labor was also less expensive. Hammond used a five-step process that began with template cutting and concluded with a bar-code scan and packaging operation. In between these operations, the cards proceeded through 2 separate printing steps and a folding/ UPC pricing code step. 1. Template cutting: The template cutting process cuts paper stock into the correct size(s) for card production. This batch process requires 1 minute to align the stock on the cutting machine. The stock placed onto the cutting machine is sufficient for 100 cards. Following alignment, it takes 48 seconds of cutting time per batch of 100. There are two workers and two template-cutting machines dedicated to this process. 2. Printing 1: The first printing step prints the background colors for the card. There are 4 machines and 4 workers at this process step. Each machine requires 2.5 seconds of processing time per card. 3. Printing 2: The second printing step prints the foreground colors for the card. There are 5 machines and 5 workers at IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 3 Exhibit 1 Production Process at hammond cards and creative designs. Production Process at creative designs Printing 1: Background Interior Printing 2: Foreground Interior Printing 3: Background Exterior Printing 4: Foreground Exterior Fold affix UPC Code Stamp Bar Code & Pack Cut template receive Card Stock Production Process at hammond cards Printing 1: Background Printing 2: Foreground Stamp Bar Code & Pack Fold affix UPC Code Cut template receive Card Stock this process step. Each machine requires 3.15 seconds of processing time per card. 4. Fold and affix UPC code: Step #4 involves the folding and placement of pricing (UPC) codes on the cards. This is a highly automated step that utilizes machinery that both folds the card and prints the UPC codes. There are 2 machines and 2 workers at this production step. Each machine processes a card every 1.2 seconds. 5. Bar code scan and package for shipment: This final step involves scanning bar codes and packaging the cards for shipping. A single machine scans the cards and packages the cards for shipping. There are 2 of these machines and 2 workers at this production step. Each machine processes a card every 1.1 seconds. Creative Designs used a seven step production process that began with template cutting and concluded with a bar-code scan and packaging operation. In between these operations, however, the cards proceeded through 4 separate printing steps and a folding/packing step. The Creative Designs production system required four printing steps because the print technology used by them required multiple prints to achieve multi-colored card products. 1. Template cutting: CREATIVE DESIGNS utilizes the exact same template cutting process and machines as Hammond cards. This machinery cuts paper stock into the correct size(s) for card production. This batch process requires 1 minute to align the stock on the cutting machine. The stock placed onto the cutting machine is sufficient for 100 cards. Following alignment, it takes 48 seconds (.8 minutes) of cutting time per batch of 100. There is one worker and one template-cutting machine dedicated to this process. 2. Printing 1: The first printing step prints the background colors for what will become the interior portion of the card. There are 2 machines and 2 workers at this process step. Each machine requires 2 seconds of processing time per card. 3. Printing 2: The second printing step prints the foreground colors for the interior portion of the card. There are 2 machines and 4 workers at this process step. Each machine requires 1.5 seconds of processing time per card. 4. Printing 3: The third printing step prints the background colors for what will become the exterior portion of the card. There are 2 machines and 2 workers at this process step. Each machine requires 1.6 seconds of processing time per card. 5. Printing 4: The fourth printing step produces the foreground colors for the exterior portion of the card. There are 3 machines and 6 workers at this process step. Each machine requires 2.4 seconds of processing time per card. 6. Fold and affix UPC code: Step #6 involves the folding and placement of pricing (UPC) codes on the cards. This is a highly automated step that utilizes machinery that both folds the card and prints the UPC codes. There are 2 of these machines and 2 workers at this production step. Each machine processes a card every 1.4 seconds. 7. Bar code scan and package for shipment: This final step involves scanning bar codes and packaging the cards (20 cards per package) for shipping. A single machine scans the package and packages (20 cards per 5 package) the cards for shipping. CREATIVE DESIGNS utilizes older technology than Hammond Cards for this process. The CREATIVE DESIGNS process requires .25 minutes (15 seconds) of set-up time per 20 cards and 25 seconds of processing time per 20 cards. There are 2 machines and four workers at this final production step. ProductIon SchEduLInG Both Hammond Cards and Creative Designs assumed a 20-day per month, 240-day per year production horizon. Martin instructed the consultants to use this assumption in their analysis. Demand for Hammond Cards was somewhat seasonal (See Exhibit #2). As noted in Exhibit #2, Hammond Cards followed a level production strategy, with the production rate set at 42,000 units per day. Exhibit 2 Monthly and average daily demand at hammond cards Monthly Avg. daily Production demand demand rate (daily) January 1,000,000 50,000 42,000 February 860,000 43,000 42,000 March 640,000 32,000 42,000 april 1,040,000 52,000 42,000 May 720,000 36,000 42,000 June 600,000 30,000 42,000 July 520,000 26,000 42,000 august 540,000 27,000 42,000 September 600,000 30,000 42,000 October 620,000 31,000 42,000 November 1,060,000 53,000 42,000 December 1,080,000 54,000 42,000 Martin believed that the 42,000-card daily production rate was placing too much stress on the Hammond production system. He was unsure of his plants current capacity utilization level but he was sure that it was too high IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 4 maybe even approaching 100%. His goal was to maintain level daily production but to do so at a production rate that translated to capacity utilization in the 84-86% range. He believed that this was achievable if he maintained level production at Hammond Cards but set the production rate to 37,000 cards per day, regardless of demand for the month. His plan called for producing 37,000 units per day every month at Hammond. If Hammonds average daily demand for a given month was greater than 37,000, he would produce 37,000 at Hammond and schedule the excess (difference between that months average demand and 37,000) production at Creative Designs. His tour of Creative Designs operations suggested that there was significant unused or idle capacity in their operations to absorb this additional demand. He saw this idle capacity as the answer to the excessive demands currently placed on the Hammond Cards operations. Demand for Creative Designs products was also seasonal (See Exhibit #3). Creative Designs followed a modified chase demand strategy, opting to produce product as needed in a given month but with a fixed daily rate for the month. For example, the daily production rate in February, when the monthly demand was 240,000, would be set at 12,000 per day (12,000 per day x 20 days per month = 240,000). Creative Designs management would recalculate the daily production each month, based upon orders received for delivery in that month. Martin planned to leave that system in place but, as noted above, would transfer some of Hammonds demand to the Creative Design operation. Exhibit 3 Monthly and average daily demand at creative designs Monthly daily demand demand January 200,000 10,000 February 240,000 12,000 March 280,000 14,000 april 180,000 9,000 May 320,000 16,000 June 340,000 17,000 July 360,000 18,000 august 220,000 11,000 September 340,000 17,000 October 220,000 11,000 November 160,000 8,000 December 150,000 7,500 Historical data also suggested that Hammonds current production strategy resulted in excess finished goods inventory. Since cards were a seasonal item, this excess inventory would be stored, sold at a discount or destroyed as worthless. By lowering the production rate at Hammond, Martin hoped to reduce this excess finished goods inventory. Product QuALIty Creative Designs took pride in its reputation for delivering high quality products to its customers. To that end, the company had instituted methods to ensure product quality. Creative Designs workers were responsible for inspecting product at their workstations and for taking corrective action when necessary to ensure a high quality product. These corrective actions included additional work to fix the defect or, if necessary, destroying the card. There were no designated inspectors at Creative Designs it was everyones job. The workers considered themselves to be, at least in part, artisans. As such, they took great pride in the finished product and were very selective about product quality. If the acquisition went ahead, Martin hoped to leverage that pride and commitment to create more robust quality practices both at Hammond Cards and Creative Designs. Hammond Cards had a similar approach to quality, but, given their higher levels of production, the workers had less time for inspection. However, Martin remained confident that Hammond was producing quality products. Our numbers indicate that very few products come back to us from the customer for production defects. Were proud of that fact. It tells us that we produce a quality product and that our procedures are catching most defects that do occur in the production process. However, Id like to have a more systematic approach to quality. I believe that this will be essential for me if, as planned, I have responsibility for two plants in the future. Ive read about quality management practices and process control. I know that many firms are now pursuing six sigma quality management practices. Im not sure that were ready for six sigma but Id sure like to see us operating at the 3-sigma level of quality associated with total quality management (TQM) practices. Creative Designs has very few returns. Id like us to learn from them. More than just learn from their current practices, Id like to use their smaller operations as my laboratory for new management practices. The first two management practices that Id like to explore at Creative Designs are process management consistent with TQM and the adoption of leaner inventory systems something on the idea of JIT. After we prove these methods at Creative Designs, Ill move them to the higher volume operations here at Hammond IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 5 Cards. I see this strategy of learning (at Creative Designs) and knowledge/skill transfer (to Hammond) as essential to the improvement of our operations. Other than noting the low rate of returns, Martin did not have data related to quality. He did have some data from the template cutting processes at both Hammond Cards and Creative Designs. He explained that this was a crucial step in the process. Mistakes in template cutting can affect product quality and cause problems later in the process. For example, a poorly cut card could appear unattractive to customers or be difficult to fit into an envelope. Inaccurate sizing of the card could also result in production problems at later job steps. For example, a card that was too small could drift in the printing process, which created misaligned or uneven printing. On the other hand, a card that was too big could jam some of the other machinery something the operators found very annoying. We use the same machinery at both plants for template cutting, which is to our advantage. One of our most popular card sizes is a 9-inch by 5-inch card that requires a cut of 18 inches by 5 inches. Once folded, this becomes the 9 by 5 card. I have some data from both the Hammond (Exhibit #4) and the Creative Designs (Exhibit #5) template cutting processes. I dont know if this is helpful for you, but youre welcome to take what I have. Both sets of data are samples from the long cut (18 inches) of that 9 by 5 card. The specification for the long cut on that card is 18 inches plus or minus 0.02 inches. Our process engineers tell us that we wont compromise the printing or jam the other machines if we stay within those specification limits. Exhibit 5 Process results from creative designs template cutting machine* units units units units units units 111 1222 23-33 3444 4555 5666 18.020 17.998 18.001 17.996 18.025 18.020 17.996 18.025 17.998 18.011 17.998 18.002 18.005 18.006 17.996 18.002 17.994 17.995 18.001 17.998 17.998 18.001 18.001 17.999 17.991 17.998 17.998 18.015 17.999 17.985 17.999 17.998 17.996 17.998 17.996 18.017 17.991 17.997 18.001 18.007 17.999 18.005 18.025 18.004 17.999 17.991 17.985 18.001 17.998 18.001 17.985 18.001 18.001 17.985 17.999 17.985 17.985 18.010 17.998 17.996 17.991 17.999 18.002 17.998 18.006 18.001 * These measurements are from the long cut paper stock for a standard 9 by 5 greeting card. The specification has a target value of 18 inches with a tolerance of (+ or -) 0.02 inches. coSt AnALySIS -- ProductIon Wendy called in Lucy Canella, Controller at Hammond Cards, to begin investigating the cost and profit implications of the acquisition. Canella had overseen data collection at the two production facilities for the process costs and activity drivers associated with the production process (see Exhibit 1) and she had done a similar process map for sales & administration activities. Exhibit 6 contains Canellas summary of cost, price and production data. Three principal forms of direct materials were involved in the production of greeting cards: card stock, ink, and envelopes. Both Hammond and Creative Designs purchased card stock in sheets pre-sized for their template cutting machines. The ink for the printing machines at Hammond was a bit less expensive than the ink used in the printers at Creative Designs. Both companies bought premade envelopes. Since both companies rent their facilities, plant and equipment asset values are relatively low. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 6 Exhibit 4 Process results from hammond cards template cutting machine* units units units units units units 111 1222 23-33 3444 4555 5666 18.020 17.998 18.001 18.002 18.001 18.020 18.001 18.011 17.998 18.011 17.998 18.002 18.005 18.006 18.001 18.002 17.994 17.995 18.001 17.998 17.998 18.001 18.001 17.999 18.015 17.998 17.998 18.015 17.999 18.015 17.999 18.017 18.011 18.002 18.003 18.017 18.005 17.997 18.001 18.007 17.999 18.005 18.001 18.004 17.999 17.999 17.999 18.001 17.998 18.001 18.001 18.001 18.001 18.001 17.999 18.011 17.999 18.010 17.998 18.003 18.003 17.999 18.002 17.998 18.006 18.001 * These measurements are from the long cut paper stock for a standard 9 by 5 greeting card. The specification has a target value of 18 inches with a tolerance of (+ or -) 0.02 inches. The book values of the production assets did differ between the two companies. As mentioned earlier, Hammond used more expensive printing machines. These machines performed more printing on a single pass. They were also more economical in that they used less expensive ink, used less labor, and allowed the use of a lower pay grade of laborer. The Creative Designs plant needed two of its less sophisticated printers to ink each side of a greeting card. Other machines were quite similar across the two companies, but, again, Creative Designs employed machines that were less complicated and needed more labor support. The details related to the machinery for the two plants appear in Exhibit 7. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 7 Exhibit 6 Selected comparative cost and Volume data hammond creative design data Item Plant Plant average selling price per card (Note 1) $0.34 $0.75 average oder size (number of cards) 2,500 500 annual base production volume for analysis (volume of greeting cards) 10,000,000 3,000,000 Material costs at projected base volume Card stock $437,500 $131,250 Greeting cards per card stock sheet 20 20 Ink $272,500 $105,900 Envelopes $25,000 $7,500 direct labor costs (includes fringes) Hourly wages, non-printing processes $7.75 $7.75 Hourly wages, printing operations $7.75 $8.25 Paid hours per day 8 8 working days per year 240 240 Paid days per year 260 260 Production overhead (excluding machine depreciation) Variable overhead $45,000 $13,500 Building rent and occupancy costs $24,000 $20,000 Indirect labor, Plant administration, etc. $324,000 $175,000 Note 1: Weighted average Prices Low end 80% @ 32 cents and 10% @ 32 $0.256 $0.032 High end 20% @ 42 cents and 90% @ 80 0.084 0.720 $0.340 $752 Exhibit 7 comparative depreciable Machine Purchase costs hammond creative designs Machine type cost Per Machine Quantity cost Per Machine Quantity template Cutting $295,000 2 $295,000 1 Printer #1 950,000 4 175,000 2 Printer#1a n/a none 225,000 2 Printer #2 950,000 5 225,000 2 Printer #2a n/a none 160,000 3 Folding/UPC Code 205,000 2 205,000 2 Scanning/Packaging 215,000 2 95,000 2 Note: All machines to be depreciated using straight-line depreciation over a ten year period. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 8 Exhibit 8 contains Canellas cost driver analysis for production costs. She explained the content as follows: As part of my data collection at the two plants, I have analyzed the cost drivers that relate the shared costs to each process step. Total variable overhead can be assigned to each process step as a function of the percentage of machines found at each process step. Building rent, heat and other occupancy costs can also be distributed to each step as a function of number of machines. Plant personnel costs other than direct labor can be divided up among the steps by the percentage of direct laborers working in each step. That is, those costs are a function of direct labor headcount. Finally, there is no need to allocate machine depreciation. These costs can be matched directly since each machine is uniquely associated with only one process step. Exhibit 8 cost drivers for Process Steps at hammond and creative designs Process Step Activity driver hammond cards creative designs template Cutting Number of card stock sheets used 500,000 150,000 Printer #1 Number of printer #1 impressions 10,000,000 3,000,000 Printer #1a Number of printer #1a impressions N/a 3,000,000 Printer #2 Number of printer #2 impressions 10,000,000 3,000,000 Printer #2a Number of printer #2a impressions N/a 3,000,000 Folding/UPC Code Number of folds 10,000,000 3,000,000 Scanning/Packaging Number of packages produced 500,000 150,000 Note 1: Costs shared across production process steps. Variable overhead costs are driven by the number of machines in each production step. Building rent and occupancy costs are also proportional to the number of machines in each process step. Costs of indirect labor, plant administration, etc. are proportional to the number of direct workers at each process step. Canella felt that it was important to use cost drivers that reflected the underlying causes when allocating costs from the process steps to actual products. She explained: Since both factories currently process in very standard ways, we could probably use the number of cards processed at each step and get a good measure of general production cost right now. However, since specific designs and production requirements differ from one card style to another, I want to use better drivers to capture the causeeffect relationships. For example, the cost of cutting out cards on the template cutter is really not a function of number of cards of output. It is related to the number of card stock sheets fed into the template cutting process. coSt AnALySISSALES And AdMInIStrAtIon Lucy Canella had also put together a preliminary plan to combine sales and administrative activities for the two firms in order to reduce costs and gain some scale advantages. She told Wendy that both firms performed the same set of customer sales and support activities often in overlapping geographical locations. The one big difference between the two companies was that Hammond sold primarily big orders to big customers while Creative Designs was focused on small orders to small customers. Nonetheless, she said, the basic nature of the sales activity and administrative tasks was quite similar. Even the salary for each salesperson and administrative support person were not that different across the two companies making the merger of the two operations a little easier. I have done a basic activity analysis for the combined sales force, distribution activity, and administrative support. (See Exhibit 9). I did not include the executive personnel in this analysis because, by contract, those costs would be independent of the business activity over the first couple of years after any acquisition. tEStInG thE AcQuISItIon A FuturE Product dESIGn As she had promised Wendy, Canella wanted to test the implications of the acquisition against the design of the proposed new, more complicated card line. Currently, both plants produced simple cards with the characteristics shown in Exhibit 10A. This proposed new card would fit into a standard size envelope, but used two folds and, consequently, more paper. It also featured a more vibrant multicolored graphic design. Data contrasting this proposed design to the current standard design is given in Exhibit 10B. IMA EducAtIonAL cASE JournAL VOLUME 1 (1), art. 1, MarCH 2008 9 Exhibit 9A Activity Analysis of combined Sales and Administration Functions Call on Customers Process Orders Pick Orders Pack/Ship Orders Bill Customers

Exhibit 9B Activity cost drivers of combined Sales Activities driver Quantity Sales Activity Activity driver used Call on Customers # of Customer Contact Hours 15,210 Process Orders # of Orders 9,600 Pick Orders # of Different Card Style Shipments 165,000 Pack/Ship Cards # of Boxes Packed* 24,400 Bill Customers # of Billing transactions 10,160 * A box is not the same as a package of cards. A package is a collection of 20 greeting cards put together at the last production process stepScan and Pack. A box is a shipping carton filled with 25 packages (500 cards). Boxing is part of the order filling and distribution function.

Exhibit 9c detailed Breakdown of Sales and Administrative costs Full time creative Equivalent (FtE) Space hammond designs Employees used Plant Plant combined Sales account representatives 3.80 9.00% $125,000 $375,000 $500,000 Order entry clerks 2.20 5.00% 33,000 33,000 66,000 Warehouse staff salaries 1.60 43.00% 8,900 43,300 52,200 Shipping and packing salaries 5.40 13.00% 5,950 28,850 34,800 Billing associate salaries 2.20 17.00% 45,000 70,000 115,000 General administrative staff salaries 4.80 13.00% 305,000 155,000 460,000 Packing materials and supplies 1,800 3,700 5,500 annual furniture and fixtures depreciation* 48,300 43,700 92,000 Building rent, heat, and other occupancy costs** 82,250 65,250 147,500 total 20.00 100.00% 655,200 $817,800 $1,473,000

Exhibit 10A data for current card design current Simple card design Cards per stock sheet 20 Number of background colors 2 Number of foreground colors 2 Number of folds per card 1 Standard number of cards per package 20

If the merger went through, it is unlikely that this card design would be put into production in the near term. However, the existence of this design prompted Lucy Canella to consider how the various portions of a new, combined company might work together to improve profits overall. She knew that Hammonds current customers would probably pay no more than $0.65 per card regardless of quality. This was because Hammond customers were price conscious large chain stores operations such as Wal-Mart. Creative Designs, however, sold through small specialty retail outlets and there the same card would probably sell for $0.90 per card. Besides price sensitivity, there are other differences between selling and serving a Hammond customer and selling and serving a Creative Designs customer. These differences are summarized in Exhibit 11. As Canella confided to Wendy, It is still unclear to me not only to whom we should market the new card, but where we should produce it. Solving this problem may help us to devise a strategy about how the two organizations could combine forces to improve profits. rEQuIrEd: Assume that Wendy Hammond wants your help in evaluating the acquisition. Provide her with your analysis and opinion on whether she should proceed with the merger. If you think she should acquire Creative Designs, what actions would you recommend to ensure that the profit potential from the acquisition is realized? Your response should cover both operational and profitability issues raised by this acquisition. 1. On the operations side, comment on the benefits from the combining the operations of Hammond and Creative Designs after the acquisition. a) Will the combined operations give Hammond greater production capability, more flexibility, result in quality improvements, and create learning opportunities? b) What do you think of Martins post acquisition plan? Can you improve upon his plan? 2. On the profitability side, you should specifically address the following points: a) Is the cost structure of the two companies similar or different? Does the cost structure reflect their respective business models? b) If the acquisition goes forward, what should be the production and marketing strategy for the combined operation that is, what type of cards should be produced in which plant (Hammond or Creative) and which customers/channel should be used for selling the card (Hammond or Creative Exhibit 10B data for Proposed complex card design Proposed complex card design Cards per stock sheet 15 Number of background colors 4 Number of foreground colors 3 Number of folds per card 2 Standard number of cards per package 20 Note: Each printing machine at each plant can print up to two colors in a single pass. More than two colors from one machine will require more than one printing pass. Although there are more ink colors in the proposed complex design, the total amount of ink consumed is the same as the current standard card. Exhibit 11 typical customer Profiles for current Sales hammond cards creative designs (Mass Mkt) (niche Mkt) average number cards per order 2,500 500 average number styles per order 20 10 average number cards per style 125 50 average boxes per order 5 1 average sales contact hours per order 0.96 1.92 Standard number bills per order 1 1