TENALPINA TOOLS:

PRODUCT LINE EXPANSION

"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-forging?an integral part of the production process?which had excess capacity and could produce the product in volumes Giulia believed she could sell. Her first order of 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 rock-climbing 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.

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 work station. 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 work flow 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 work flow by moving some of the existing equipment. The new machine and the redesigned work flow 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 work stations:

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?"