An Analysis of National Bicycle Industrial Co.

University Degree Business and Administrative studies

Executive Summary

Mass customization theorizes that companies can develop, produce, market and deliver customized products and services on a mass basis. Supporters of mass customization argue that this strategy allows a company the flexibility to meet the constantly changing demands of consumers, who continuously demand higher quality, lower priced products and services delivered in a relatively short amount of time, but which are also highly customized. Most importantly mass customization implies that, by automating the customization process, companies can produce the custom good at costs competitive with standardized goods. Proponents of mass customization point out that with this strategy, low costs are accomplished primarily through economies of scope rather than scale: "Economies of scope are realized by the application of a single process to produce a greater variety of products and services more cheaply and more quickly." (Joseph Pine II, author of Mass Customization: The New Frontier In Business Competition.)

To achieve the goals of mass customization, a company must address major shifts in operating methods throughout the organization - engineering, manufacturing, and marketing - including the supply chain, with the creative use of automation and technology. Companies such as Dell Computer, HP, Toyota, Levi Strauss and Lutron Electronics have employed this methodology to their production processes and have achieved a great deal of success. Successful users of mass customization also realize the limitations unique to their own organizations, whether they are cultural or operational, and address the potential risks before fully implementing this strategy.

In the case of National Bicycle Industrial Company, Mitsuru Komoto, the new president of National Bicycle, was faced with reviving one of the “Big Three” of Japan’s bicycle industry. National Bicycle was faced with deteriorating economics and to address this situation, Komoto was determined to adopt a mass customization strategy, which he called the Panasonic Order System (“POS”), to the high margin, sport bicycle segment of his company. This paper will outline why we recommend implementing POS, and support Komoto’s decisions regarding this strategy. Furthermore, we will provide our analysis of a plausible 3-week lead-time to offer their customers and mitigate the risks, such as component stock-outs and service issues, associated with our recommendation.

Situation Analysis and Options

Our analysis of the current situation facing National Bicycle centers around answering two key questions:

Should National Bicycle implement the Panasonic Ordering System? This will be answered by evaluating the capabilities of the manufacturer, their cost structure, potential for payback, and market positioning of the POS.
If they do decide to implement POS, what should their lead-time be? This question is crucial to the implementation, as it offers potential for value creation at the market level, and has dramatic effects on production and supply chain planning.

Costs

The first step of the analysis is to compare unit costs between POS & mass produced bikes. The cost of producing and delivering a bike under POS is ~ 9.4% greater than under mass production. The key factors influencing the cost of the POS bikes include the doubling of labor costs and the elimination of carrying costs. Other factors that may influence the cost of the POS bikes include an increase in material costs due to paint, and increase in raw materials inventory due to carrying a wider selection of parts, and a reduction in SGA due to the elimination of unsold inventory and streamlined order processing. These changes in costs were assumed to offset each other, and therefore not included in the calculations. The increase in costs is in line with Komoto’s proposed increase in price of 7%-15%, depending upon the number of colors chosen. Detailed calculations are presented below.

Assumptions:

Retail Price = 100,000

Factory Price = (.70)*Retail Price = 70,000

Profit = (.05)* Factory Price

Carrying costs = (.18)*Cost

Transportation Costs = (.03)*Cost

SGA Expense = (0.0675)*Cost

Cost = Materials + Labor

Materials = (.70)*Cost

Labor = (.3)*Cost

Mass Produced:

Factory Price – Cost – Carrying costs – Transportation Costs – SGA Expense = Profit

70,000 – Cost - .18*Cost - .03*Cost - .0675*Cost = 3750

66,250 = 1.2775*Cost

Cost = 51,859 yen

Customized:

Assuming labor doubles (Yoshida)

Labor =(.6)*Cost

(.70)*Cost + (.6)*Cost = 1.3*Cost

Carrying Costs = 0, since no inventory goes unsold

Assuming material & SGA costs remain the same

Materials + Labor + Transportation Costs + SGA Expense = New Cost

.7*Cost +.6*Cost +.03*Cost + .0675*Cost = 1.3975*Cost

1.3975*51,859 = 72,473 yen

% Change = (72,473 – 66,250)/ 66,250

9.4 % increase in total costs

Possible problems with this analysis:

Labor may be greater than twice that on mass produced bikes
Material costs may increase due to extra paint
SGA may decrease because no inventory will be marked down

After comparing the unit cost differentials between POS and mass production, capacity and cost recovery issues must next be addressed. First of all, dedicated POS employee hours must be estimated to determine if the company will be able to meet the expected demand during the peak season. Given that the actual workday at the POS plant is 400 minutes, the workweek is five days long and there will be 23 technicians employed in the POS plant, the predicted worker capacity in a standard workweek is 766.67 hours. Furthermore, assuming that peak season demand is 250 bikes per week, we conclude that the POS plant will have sufficient worker capacity to meet this peak demand being that 250 bikes requires a capacity of 750 worker hours in a given week (all calculations are show below in detail).

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Aside from determining if the POS plant will be able to meet capacity requirements, National Bicycle must also evaluate the feasibility of making a 300 million Yen investment in PP&E for the new plant. The figures presented immediately following the capacity calculations detail the expected cost recovery period for the initial capital investment. The final table presents the average (based on 1, 2 or 3 colors) profit, break-even units, and time to break-even in years given different standard retail prices of bicycles. Moreover, the sales numbers are based on an average sales calculation for 1984 and 1985. For example, it will take National Bicycle 4.12 years to fully recover the 300 million Yen investment if they are to only sell bikes with a standard retail price of 150,000 Yen. However, that same initial investment could be recovered in just over 1 year if the company were to only sell bikes with a standard retail price of 600,000 Yen. Obviously, National Bicycle would use a weighted average of these figures (based on standard retail price) to calculate an exact break-even timeframe. By no means is the break-even horizon—just under 6 years under the worst case scenario—infeasible and the 300 million Yen initial capital investment seems reasonable.

Along with the quantitative analysis shown above, there are a number of qualitative issues that need to be taken into consideration when deciding to implement POS and determining the optimal lead time to promise customers. In the mid 1980s, sales in the Japanese bicycle market had plateaued. Exports to the US were decreasing while inexpensive bikes from Taiwan and Korea were rushing into the domestic market. Bicycles had become a commodity based on low price. Furthermore, labor-intensive production processes combined with increasing labor rates left National Bicycle unable to compete. There was an immediate need for NBI to differentiate itself from its competition since there was a high possibility for the Japanese bicycle industry to move offshore.

Komoto made the executive decision to concentrate on customizing sport cycles. Since NBI was not able to increase their unit sales, his strategy was to increase average price in order to increase their overall monetary sales. There were a number of reasons why Komoto decided to enhance their sport cycle line. These particular types of bicycles were becoming something of a fashion item due to the fitness boom that was occurring at that time. The US market had recently enjoyed a healthy sales growth fueled by the popularity of high-tech sport cycles. There was also an increasing trend for customers to assemble their own bikes from purchased productions in order to tailor their bicycles to their individual size and taste.

Customer needs were becoming so diversified that NBI needed to move away from their current mass production assembly to a smaller automated system that would require less labor but produce a better quality product. National Bicycle had a competitive advantage over others in the bicycle industry due to the fact that they had a very “high-tech” plant. For example, they developed a unique computer system to test welds, which was the only one of its kind in the world. They had the technical expertise in-house to develop both software and hardware in order to increase the precision of their bicycles.

Recommendation

Based on the quantitative and qualitative analysis above, we enthusiastically recommend implementation of the POS program within National Bicycle. Establishing an appropriate lead-time for customized bicycles is a critical part of the POS system. To determine the optimal lead-time with which to launch the program, two factors must be considered.

How fast can we deliver?

What is the fastest lead-time that can be consistently provided based on constraints? This is answered by considering the following:

Order entry and processing speed – By using the proposed fax machines as part of the system, the order input and processing steps can actually be sped up from the traditional ordering system.
Plant capacity – Based on historic demand levels, what is the capacity of the plant? Previously, we outlined the capability of the plant to meet anticipated peak demand levels of 250 bikes per week. This capacity ensures that production will not be the constraint on offering a lead-time of less than two weeks.
Vendor inventory response – National Bicycle currently places orders twice a month and anticipates a 40-day lead time on the parts. Because of the length of this cycle, National Bicycle maintains a large safety stock.
Delivery time – National Bicycle’s distribution channels can ensure delivery to the customer from the factory in two days.

The critical path of the production lead-time falls across the continued supply of components from vendors. With a change in supply chain management, described below, we have no reason to consider that production constraints would force a lead time of greater than two weeks on any POS bike at the current anticipated peak demand of 250 units per week.

How fast do customers want delivery?

How is demand affected by lead times? Hata’s assertion that two weeks may be too quick has merit. A longer lead-time magnifies the individuality of the product, the exact value basis for POS, and a fit with Japanese consumer culture. A quote from New Yorker magazine encapsulates the cultural implications of the desirability of perceived scarcity:

“The crucial element that is being sold…is scarcity. ..[Japanese consumers] want to be seen wearing an item that hardly anyone else owns but that everyone will recognize as exclusive. Scarcity, of course, is an integral part of high fashion, but it often has a basis in the practical difficulties of supplying consumer demand: customers will wait months for a Birkin bag from Hermès not just because the company knows the marketing value of making a product hard to get but because the bags are painstakingly created by a small number of highly skilled craftsmen.” (Rebecca Mead, “Shopping Rebellion”, New Yorker, March 18, 2002)

Longer lead times, whether caused by smart marketers or constrained production teams, will potentially enhance the experience of buying and owning a POS bike.

Subjectively, we can argue that service lead times should be considerably better than the 3 to 4 months of a current custom bike, but we should not be driving up against our minimum achievable lead time. Therefore, we recommend that National Bicycle institute a delivery time of three weeks from the date of order for three reasons:

This time is a considerable improvement over existing custom lead times
This offers one week of slack in the critical chain where information (orders placed) can be used to increase profitability through batch flow planning, component receiving, and finished product distribution.
We believe that consumer demand will be between neutral and positive when comparing two weeks to three weeks

Stockout Discussion

When considering stockout, National Bicycle maintains very high service levels (averaging 99.4% over the last two years) in its current mass production model. In determining the new stockout probability, we must make assumptions around the differences between inventory planning models.

Old model = Periodic Review, New model = Continuous Review

National Bicycle’s inventory management model most closely approximates that of a period review; the new model proposed above is a continuous review model. A continuous review of inventory (ordering Q when inventory reaches R), compared with the periodic system (ordering S when on-hand inventory through periodic checks is at or below s), along with vendor initiatives outlined above should help National keep the probability of a stockout at least as low as it is currently (pstockout <= 0.006) Both Q and R approach 1 in the new model, and orders are based on real information. The old system bases production on forecasting and a 40-day lead-time.

Our implementation tactics below outline critical steps to achieving this lead-time and minimizing the risk of a stockout.

Recommendations and Implementation Tactics

In order to successfully implement POS, our proposed recommendation contains the following items.

Implement the Order System within a 6 month period – This involves NBI making the bicycles as they receive customer orders with the goal of individualizing each product. They will need to utilize their current computer system to differentiate this new strategy from the current custom order processing already in place at the plant. They will also need to evaluate and implement product planning software that will allow customers to configure their orders as well as for retailers to provide their input of the process

Build a new plant for custom production – NBI will need to outline their entire production process for this new plant including all steps from supplier to customer delivery and the length of each step. They will also need to work with their suppliers to find out appropriate times to fill replenishment orders by studying historical demand patterns. Finally, they will need to establish safety stock date ranges while keeping inventories low enough to avoid obsolescence.
Require retailers to invest in the custom bike building program – National Bicycle needs to convince their retailers to invest in color samples, fitting scales, and fax machines in order for this plan to succeed.
Develop target market – They will need to devise a way to accurately estimate demand for their custom bikes. This would include surveying and advertising to retailers. They will need to find a percentage of customers that would be “hard-to-fit” while targeting racers and other serious riders already buying custom bicycles.
Set a fixed price – NBI would need to set a goal for the number of bikes each week (as described above) and calculate a price to charge their customers. They will need to set a price threshold and dynamically adjust this threshold until they reach their weekly goal.

In order to achieve their desired lead-time profitably and minimize the probability of a stockout, National Bicycle should take the following steps:

Reevaluate vendor delivery procedures (immediately) – The degree of customization available through POS will cause rampant inventory proliferation and a potentially catastrophic drop in service levels if forecasting and periodic inventory review is used. National Bicycle needs to seek opportunities to institute just-in-time delivery methods with their vendors based on actual demand rather than forecasted. National Bicycle should take immediate action to minimize inventory on-hand until information provided by POS necessitates the ownership of that component or inventory by National Bicycle. Concepts such as consignment inventory and vendor-managed inventory should be considered with all Tier 1 suppliers.
Establish Kanban (or equivalent) inventory pull technique in production (immediately/during production layout) – This should be incorporated with part 1.
Require retailers to purchase fax machines along with the measuring stand. (immediately) – This step ensures that orders are placed with the factory as quickly as possible. Co-op marketing monies may also be allocated for the retailers to “ease the pain” of the investment and show partnership in launching POS as a team.
Establish logistical network with hansha to realize potential 2 day delivery time (immediately)
Maintain consistent updates with retailers relating to component availability (ongoing through POS lifecycle) – All retailers must be on the same page with regard to available versus obsolete components.

Timeline

The following timeline highlights our expectations to implement the stages of the POS plan. Given the amount of work that Komoto and his team were able to accomplish in the first three months, we are confident that National Bicycle is capable of these final implementations within the final three month period, thus achieving Komoto’s six month deadline.

Execution of blueprint to create the new factory. The execution of the blueprint to an operational factory will ultimately require the most time, and thus should be underway immediately. This should take no longer than two months.

Notify retailers of the POS strategy. The company should begin notifying retailers of the POS strategy, thus allowing them to begin creating demand and prepare for the new product launch. During this time, retailers should also be informed of their level of investment. Begin immediately.

Supplier Negotiations. Begin negotiations with suppliers to minimize amount of excess inventory due to technological changes in bicycle components. Move toward JIT relationship with vendors to accommodate POS strategy. This should also begin immediately, and improved over time.

Test Run. Once the construction of the new factory is complete, the technological systems should be in place and prepared for the first “test-run” to allow for time to work out any operational issues. This should be completed by month four.

Finalize distribution plans. This would encompass working with the hansha to ensure distribution channels are in place to accommodate for the logistics of a potential two-day turnaround time from factory to retailer.

Delivery of fitting scale. Beginning in the sixth month, after production and logistical issues are completed, the fitting scale should be delivered to the retailers along with educational training to properly customize the bicycles. Additionally, retailers should be required to complete their level of investment.

Advertising, final stages. Beginning in the sixth month, in connection with the delivery of the fitting scale, the POS advertising campaign should be underway. Additionally, during the last half of the sixth month, the system should be in working order with only continued vendor negotiations in process.

POS implemented. During the beginning of the seventh month, the POS plan should be in working order, with retailers processing their first customized bicycle orders.

Risk Analysis

There are several risks associated with the POS implementation, which could potentially hinder the success of this project.

Accurate demand predictions are extremely complex – The popularity of this program is at the mercy of customer preference. Purchasing raw materials will be more difficult since the production is based entirely on demand.
Assembly labor may not be reduced to twice that of mass produced bikes – The POS bikes are profitable at Komoto’s suggested price points only after the learning curve has been conquered and labor is reduced from 3 times to double that of mass produced bikes.
There is a huge investment to be made in the new plant – The required investment was twice the company’s usual annual investment. There was also a risk that this new plant would disrupt their current factory, which is fully occupied making their current models.
Sales of bicycles in Japan had been flat for some time - Sales of domestic products were being eroded by an influx of inexpensive imports. Sport cycles only comprised 15% of the Japanese bicycle market. Also, success in the US did not necessarily mean there would be success in Japan.
Custom orders require so much human interaction that all of their technical expertise may not help
The most experienced and talented workers will be pulled away from mass produced bikes – NBI’s position as industry leader could be threatened by a possible decline in quality and production of their high volume bikes due to a lack of technical expertise on the production line.

There are also multiple risks associated with our proposed lead time. These risks, along with steps for mitigating them, are listed below:

This could be seen as too long/too short by consumers – National Bicycle should solicit customer responses from their retailers relative to the proposed lead time, and possibly experiment with 2, 3, and 4 week lead times in test markets to ensure that lead time is maximizing demand.
Demand for POS could outpace capacity, leading to extremely long lead times and resources being directed away from mass production – National Bicycle needs to minimize this risk by staying current on a week to week level with the percentage of bikes being ordered through the POS rather being bought off of the showroom floor. National Bicycle can control what models of bikes are available through POS and should do so actively to ensure a smooth ramp up of demand. Conversely, if demand is too low, they should make more models available through POS.
Ensuring availability of components - As stated in the case, National Bicycle’s suppliers were continually making improvements to components. Because of this, the POS must include provisions to ensure that what the retailers are selling and offering to customers is aligned with the components being offered by suppliers. This can be done by maintaining excellent communication channels with National Bicycle’s retailers.
Despite VMI and other inventory initiatives, vendors may still have supply issues – This risk is real in any production scenario, but can be easily reduced in National Bicycle’s case by ensuring that the customer’s contact information is part of the order entered at the plant. If parts are indeed unavailable, the customer can be contacted to propose substitution or upgrading to one in stock.