- Leading product development
This strategy requires the company to invent innovated product that can lead whole market. The product’s quality is guided by customers’ need. The development of new goods must be effective and efficient. It requires publish of new product at regular intervals. Thus, leading product can ensure the leading position of Drakensberg.
Product Activity Analysis
Given the above background analysis, a detailed product activity will be analysed to determine whether to launch the new product and its volume.
Basic definition
- C-V-P analysis
- Assumption under C-V-P analysis
Though fixed cost and variable cost of the company remain unknown, High-Low method is used to calculate and estimate the fixed cost and variable cost of Drakensberg. Using the data in 2006 and 2011, the fixed cost is estimated to be £10,000, and variable cost is £1.5/unit. (See appendix 1)
Additionally, since the same raw materials, labor and machine are used to produce the new product, it is assumed that in short term the fixed cost remain unchanged (i.e. £10,000) though the output has been adjusted.
- Value chain analysis
Value chain analysis is introduced here to identify Drakensberg’s core competitiveness and present some proposals to enhance the competitive advantage and maximize the shareholders ’value.
As Porter (1985)stated: the value chain comprises the primary activities and support activities. The detailed information of the value chain activities is shown in the following graph.
Figure 2.1 the value chain activities
Source:Porter, M.E., 1985. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press.
Analysis with the two existing products
- C-V-P analysis
Prior to the launch of Dankie, the major output of Drakensberg relies on two existing product, Nkosi and Yabonga. However, the weight of output between these two kinds of products is unknown. In this case, the optimal output (i.e. to maximize the total contribution) before production of Dankieisis first analyzed.
Considering the maximum available amount of raw materials, skilled labor and machine hours, the utilization rate is calculated if all the demand is satisfied. (Appendix 2.1)
Raw materials turn out to be the bottleneck with the highest utilization rate 132%. Therefore, raw materials are supposed to be used up to generate the highest contribution.
Through calculation (Appendix 2.2), Yabonga has higher contribution per raw materials, which means most ofthebottleneckshould be expensed in producing Yabonga till it reaches the global demand (i.e. 6000 units) if possible.
With the analysis above, optimal point of output should be 6000 units of Yabonga and 3333.33 units of Nkosi. The breakeven point will be 9.14 units (Appendix2.3). The total contribution is £10,213,329.84. And total profit is £9,213,329.84
If the constraint of bottleneck is relaxed,total contribution will be different. The shadow price of raw material is calculated to be 178.16 (Appendix 2.4). That is to say, if there is an extra available raw material, Drakensberg should pay up to 178.16 pounds per unit to acquire it.
- Value chain analysis
On the basis of the two existing products, Nkosi and Yabonga, the company’s value-added activities would be analyzed as follow:
- Primary activities
- Operations
Two existing products provide the company with cost advantage: decreasing the learning cost. Specifically, since the long term production, the process maybecome more efficient and labors more skilled.Then, the company gainsa advantage by reducing the cost of these two products, as forming a more advanced manufacturing techniques and more proficient labor.
- Marketing and sales
Considering the fact that current demand cannot be satisfied with the 43% market share, it is not necessary to invest large amount of budget in the marketing and sales activity. Consequently, the company will receive a cost advantage by decreasing the marketing and sales cost.
- Support activities
- Procurement
Drakensberg obtains their raw materials through the local suppliers which are relatively high cost and with the maximum available amount of 50,000kg. However, its competitors take another choice to outsource in the foreign shores.
- Human resource management
The company has the following current situations in HR department: firstly, the domestic market suffered from lacking skilled labors; then the company tended to recruit the foreign skilled employees. However, it could not be realized in short-term due to the political restriction of immigration; the company has compiled a number of groups of highly specialized, well-educated and senior staff who required substantial promotion and bonus.
- Suggestions
Considering the above analysis, we could make a promotion for the existing two products by the following measures:
- Outsourcing
The company may benefit from outsourcing to foreign shores, since the cost will be much lower than the domestic ones. Furthermore, it would solve the problem of lacking the raw materials and skilled labor in local. However, outsourcing is risky. Since the foreign shores are in low regulated, the products maybe troubled by low-quality materials. It may increase complaints by customers and destroy the reputation of Drankensberg. Moreover, as the company would hire the new workers, it may take a great of time to practice the production process which could increase the learning cost.
- Training
Facing the dilemma of lacking skilled engineers and the political restriction, the company could make a diversion tofocus on trainingthe existing labors rather than hiring outside. This measure may not react immediately, but would gain long-term advantage for the company’s human capital.
- Import raw materials
Other than the measures mentioned above which may not have effect immediately, the company could import raw material. This would efficiently ease the bottleneck. However, the cost of raw materials would be increased relatively. Therefore, to ensure profit, purchasing department should take the shadow price into account.
- Differentiation analysis
Clearly, Drakensberg has two existing products: Nkosi and Yabonga. The uniqueness and high market share has ensured its status as global market leader. Also, due to the 50% premium price over its competitors, the company could achieve an extremely high profit on these two products.
However, if we want to retain this differentiation, we should spent large amount of money on research and development activity to prevent our products from outdated. Maybe it is the reason why we insist manufacturing the products locally, which would increase the cost.
Moreover, as the two products have already reached mature stage, it is difficult to have a dramatic progress relating to the sales and cost. Hence it would be better to launch a new product in order to retain the existing customers and attract potential ones.
Analysis of three products including Dankie
The company has the chance to introduce a new product, Dankie, with the same materials and global demand of 3000units.C-V-Panalysis,value chain and differentiation analysis act as the procedure to solve the problem.
- C-V-P analysis
- Optimal product point
New optimal output and the change of contribution should be examined when the new developed product, Dankie, is taken into consideration.
Still, three potential constraints, raw materials, skilled labor and machine hours should be considered. Raw material is still the bottleneck with the highest utilization rate 168% (Appendix 3.1).
With this information, we can use the same method as in the analysis of two products above. After calculation (Appendix 3.2), Yabonga still has the highest contribution per raw material, and the new product, Dankie contributes least. So the output of Yabonga is supposed to be maximized to reach the global demand after the priority contracts of three products are completed.
Thus, optimal point should be 6000 units of Yabonga, 3233.33 units of Nkosi, 100 units of Dankie. The breakeven point will be 9.28 units (Appendix3.3). The total contribution, £10,170,929.84 can be also worked out, and total profit is £9170929.84, lower than the profit without new product.
If one extra unit of raw material is given, undoubtedly it will be used to produce Nkosi. In this sense the shadow price of raw materials will be the same as that calculated without new product, 178.16 (Appendix 3.3). Therefore, if there is an extra available raw material, Drakensberg should pay up to 178.16 pounds per unit to acquire it.
- Sensitivity analysis of the selling price
After analyzing the background information of Drankensberg, it is not difficult to find out that to Nkosi and Yabonga, a large amount of the profit comes from the 50% price premium. So it is quite necessary to analyze weather the optimal output will change or not when the selling price fluctuates.
Assuming that Drankensberg loses the market dominance and prices of two existing products drop to the same as other competitors, which will be 1200 for Nkosi and 1333 for Yabonga. New contribution per raw material needs to be calculated and showed in table 2.1
Dankie would turn out to have the highest contribution per unit of raw material, even greater than Nkosi and Yabonga. It indicates that Dankie has the potential to bring the highest profit to the company though currently having the lowest ranking of contribution on its initial stage.
Table 2.1 New contributions per raw material for Drakensberg’s three products
Source: The data of Drakensberg Limited
- Optimize value chain by reconfiguring
Reconfiguring the value chain means that one company should make structural changes, such as introducing a new production process or a new distribution channels.
By introducing the new product, the company will have the following influences in cost advantage:
- Learning
When launching a new product, it would cost certain times for worker to become skilled labors. It means that it has no positive effect on the learning cost. So the company could not receive a cost advantage on it.
- Marketing and sales cost
To promote a new product, company has to spend huge amount of money on marketing and advertising department. In the short-term, it may be a cost disadvantage to the whole business, since the money on these activities would not produce an equivalent value instantly. However, in the long run, if the new product could continuously produce huge profit, this cost can be attributed to each unit with a small amount.
- Timing of market entry
The company introduces the new product when their market share is really high and they have a premium price of 50% larger than their competitors. It is a pretty well timing for launching a new product, as the company could bear the loss of the new product by making profit from the old ones in shortterm. Also, as we know the old products cannot meet the demand of the customers, the new product may perform as a substitution for the old ones.
- Interrelationship:
The combination of the new and old products may create a synergy among the business units. As these three products need the same raw material, the company could increase the bargaining power for purchasing the material. Then, it would lead to a cost advantage by reducing the raw materials cost in these three products.
- Differentiation
Although the C-V-P analysis shows that Dankie has the lowest contribution among the three products, company could diversify the product by launching the new product. Due to the existing products experiencing the maturity period of its life cycle, they would not always dominate the market. The new product with lower cost per unit is different from other two products thus canexpand the vertical differentiation to satisfy various customers’ needs. It seems to be exploited to cater for other types of customers, therefore is useful for company to keep its market position or even gain more market shares.
What’s more, the selling of new product may in turns promote the selling of Nkosi and Yabnga, since it would increase brand value if the new products with good quality are popular among the customers.Consequently, a group of potential customers would pay attention to other products of our company.
Adjustment to the optimal output point
Through the sensitivity analysis, some doubts might be cast on the optimal point. As mentioned above, the optimal output only allows Dankie, the new product to be produced at lowest level, 100 units. However, value chainand differentiation analysis show that this new product will generate great potentialprofit. In this case, if only 100 units of Dankie are produced in order to maximize the profit, the long-term development of the new product would be tremendously impeded. Therefore, a little amount of profit needs to be sacrificed to help the promotion of Dankie, which can be considered as the opportunity cost of producing the new product.
It is the market share not the current profit that the new product mainly aims at. In this sense, the global demand of Dankie (i.e. 3000 units) needs to be satisfied though a huge amount of raw materials would be transferred from making Nkosi and Yabonga. Under this circumstance 17400 kg raw materials would be spent. Obviously, if we obtain that amount of raw materials through reducing the output of only one product, it is very likely to cause a huge impact on the market. Therefore, both the output of Nkosi and Yabonga should be reduced in order to leave adequate raw materials for Dankie. Here we calculate the reduction of two products based on the materials they cost in original optimal output point.
Through the calculation (Appendix 4.1), the adjusted output should be 3,000 units of Dankie, 2,102.33 units of Nkosi, 3877.2 units of Yabonga. The breakeven point will be 10.67 units (Appendix4.2). The total contribution will be 8,416,657.84, and the total profit will be 7,416,657.84. The reduced contribution will be the opportunity cost of this plan against the profit-maximized output plan, which is 1,754,272. And under this circumstance, the shadow price of raw material will be 224(Appendix 4.3)
This plan indicates that between the existing market and potential market, the company would focus mainly on the latter in order to enhance the competitive advantages.
Summary
To sum up, there are some adjustments Drankensberg should take to improve its competitive advantages and maximize the profit.
Firstly, the weight between the output of two existing products, Nkosi and Yabonga, needs to be adjusted. In order to maximize the profit, raw material, the limited factor, should be mostly used to produce Yabonga, which has the highest contribution to the company.
Secondly, when new product is taken into consideration, the optimal output of three products should be 3,877.2 units of Yabonga, 2,103.33 units of Nkosi, 3,000 units of Dankie. Though this output would not make the highest contribution, but it take future development of the new product into consideration, so that it is very likely to bring much more profit in the future and ensure a sustainable development of the company.
Thirdly, the new product does have a relatively lower profit compared with two existing products. In order to promote the market of the new product without influencing the profit of the whole company, manufacturing technique should be improved to reduce the relevant cost of Dankie.
Investment activity analysis
Company Situation
The company now is rich on cash and the executive board has raised a maximum of 1 million for investment. There are four projects which can be chosen from. The projects, Zulu, Xhosa, Sotho and Ndebele, are mutually exclusive and each project can only be undertaken once during the period. Projects cannot be subdivided.
Financial Data Analysis
The Net Present Value of the projects is shown in the table 3.1.
Table 3.1 Net cash flows of each project
Source: The data of Drakensberg Limited
Using the information for these four projects calculates interest rate during the period and each project’s profitability index(PI), IRR, modified IRR and discounted payback period.
- Interest rate
Interest rate is equal to the cost of capital and used to discount the cash flow of each period. The interest rate of four projects is the same.
r = 10%
- PI
PI attempts to identify the relationship between the costs and benefits of a proposed project. It is the ratio of present value of future cash flow to initial investment. If PI>1, the investment is good. If PI<1, the investment is bad.
Zulu: ==1.10
Xhosa: ==1.10
Sotho: ==1.08
Ndebele: ==1.52
Ndebele has the highest ratio. So from PI analysis, it can be known that the investment in Ndebele is the best.
- IRR
IRR is a cost of capital at which the NPV of a project would be £0. It is used to measure and compare the profitability of investment. The project with an IRR above the cost of capital can be accepted.
Zulu:
=14%
Xhosa:
=14%
Sotho:
=14%
Ndebele:
=29%
All projects have the IRR which is greater than the interest rate. The Ndebele has the greatest IRR. So from IRR analysis, the investment in Ndebele is the best.
- MIRR
Taking the relative size of the project into consideration, MIRR is calculated. Reinvestment is assumed at cost of capital (10%).
=12%
=12%
=12%
=20%
All projects still have the MIRR above the interest rate. The Ndebele has the greatest IRR. So from MIRR analysis, the investment in Ndebele is the best.
- Discounted PAYBACK PERIOD(DPP)
DPP is the time it will take before the NPV of a project turns from being negative to positive. The project that pays back within its lifetime can be accepted.
Table 3.2 DPP of each project
Source: The data of Drakensberg Limited
Zulu: =5
Xhosa: =5
Sotho: =5
Ndebele: =4
It is known that the Ndebele has the shortest discounted payback period. It can get cost of investment back within 4 years, while others need 5 years. So from DPP analysis, the investment in Ndebele is the best.
Summary
From different analysis methods, the result turns out that the investment in Ndebele is the best. The cost of this project is £500,000. If the company puts money in this project, it can get £200,000 annually and get the initial cost back in the fourth year. The residual £500,000 can be used in following orders.
Firstly, research and development department can use part of money to decrease the cost of the current three products, especially Dankie, so that the company is able to boost profit margin and compete over other companies. Furthermore the development fee can be used to developnew products which have new functions to hold more potential customers and occupy more market share.
Secondly, the Dankie as a new product needs advertisement propagation to improve its sales. Even though the old two products have a high market share, the new product is targeted at different customer base. Due to the fact that the new product uses the same materials and skilled labors as the old ones, the new one should have the similar utility as the old goods. But its price is lower. Therefore the new one may focus on lower market. With name brand of products and marketing approaches such as media advertisement, Dankiemay insure the company’s market share or even enlarge its market share. So part of money should be used as advertisement expenses.
Thirdly, the raw materials are the bottleneck of production. Through calculation, the shadow price of the raw material is £178.16. If the imported price of the raw materials is below 178.16 and there is some money left, the company can import raw materials from other countries to increase its output and satisfy excess demand.
Over all, the spare £500,000 should be allocated to in the sequence of R&D, marketing and procurement department. R&D department is responsible for perfecting new product and developing other dominant products. Marketing department adopts marketing strategy to assist in boosting new product’s sales and enlarging its market share. Procurement department’s duty is to search cheaper raw materials to expand the company’s production.
Conclusion
According to changing external business environment and company’s internal environment, it is necessary for the company to strengthen competitive advantage. Through C-V-P analysis, value chain analysis and the analysis of differentiation strategy, Drakensberg Limited should launch this new product to insure its market share instead of focusing on maximizing profit. The new product has dominant advantage and is likely to earn more profit in the short future, which can increase the company’s value and shareholders’ value as well. For the £1,000,000 to investment, it can bring in the highest profit if it is spent on the project Ndebele. The cost of this project is £500,000. The excess £500000 can be allocated to research and development department, marketing department and procurement department.
There are some suggestions to assist Drakensberg Limited in performing better in the future.
1)The weight between the three products needs to be adjusted for the future market share because the old ones become outdated gradually and the new one has the potential to enlarge market share.
2)Current product cost needs to be decreased to enhance profit margin and develop more leading products to consolidate its market share.
3)The marketing department should be devoted to strengthen new product’s propaganda to increase its sales effectively. And if possible, the company can import raw material to solve the bottleneck of production and boost output.
Reference list
Christiansen J.K. et al.,2010.Living Twice: How a Product Goes through Multiple Life Cycles.Journal of Product Innovation Management, 27, pp.797-827.
Porter, M. E., 1985. Competitive Advantage: Creating and Sustaining Superior Performance. Free Press.
Datamonitor, 2010.Chr Hansen Holdings Swot Analysis [online]. London: Datamonitor Plc. Available from: http://www.datamonitor.com [Accessed 12 January 2010].
Appendix
Estimation of fixed cost
y2 is the total cost at highest level of activity;
y1 is the total cost at lowest level of activity;
x2 are the number of units at highest level of activity;
x1 are the number of units at lowest level of activity;
In this case, y1=10000; y2=16000; x1=6000; x2=10000.
Variable Cost per Unit = (16000-10000) ÷ (10000-6000) = £ 1.5 per unit;
Fixed Cost = 16000 − (1.5×10000) = £ 10000;
Cost Volume Formula: y =10000 + 1.5*x
Thus we assume that fixed cost is 10,000 pounds.
Analysis of two existing products
2.1 Find the bottle neck
Before the new product Dankie is developed, the major output of Drakensberg relies on two existing product, Nkosi and Yabonga. However, the weight of output between these two kinds of products is unknown. In this case, we firstly analysis the optimal output (i.e. to maximize the total contribution) before Dankie begins to be produced.
Here is the cost card of Nkosi and Tabonga:
The output of these two products is determined by three potential constraints: raw materials, skilled labor and machine hours. In order to avoid exceeding constraints, we need to find the bottleneck.
Here is the input each product needs:
Combined with the maximum available quantity of input, we are able to calculate the utilization rate of these three inputs if all the demand is satisfied:
From the calculation, raw materials should be the bottleneck, and is the only constraint in these three inputs.
2.2 Find optimal point through the contribution ranking
Therefore, raw materials are supposed to be used up when the product with highest contribution is produced as much as possible. That requires the contribution ranking of Nkosi and Yabonga:
Yabonga turns out to have higher contribution per raw materials, which means most of the raw materials, the bottleneck, should be expensed in producing Yabonga till it reaches the global demand if possible.
The global demand of Yabonga is 6000 units. After producing this amount, remaining raw materials would be 50000-5*6000=20000 kg. It can be used to produce 3333.33 units of the other one, since 6 kg/unit is required for Nkosi. Of course, the priority contracts of both products have already been satisfied.
With the analysis above, optimal point of output should be 6000 units of Yabonga and 3333.33 units of Nkosi. In this case, the total contribution is 10,213,329.84. Since the fixed cost, 1,000,000 has been calculated, the total profit can be worked out, which is Total Profit= Total Contribution - Fixed Cost=10,213,329.84-1,000,000=9,213,329.84
2.3 Breakeven Point
Average contribution=(1048*3333.33+1120*6000)/(3333.33+6000)=1094.29
Breakeven point=Fixed Cost/Average Contribution=10000/1094.29=9.14 units
2.4 Shadow price of raw material
If the constraint of bottleneck is relaxed,total contribution will be different. In this sense, shadow price need to be calculated. Provided that one extra unit of raw material is given, the output of Nkosi would change to 20001/6=3333.5 units, and total contribution would be 10,213,508, which increased by 178.16 from 9,213,329.84. That is to say, if there is an extra available raw material, Drakensberg should pay up to 178.16 pounds per unit to acquire it.
Analysis of three products including Dankie
3.1 Find the bottleneck
fter the optimal output of two existing products has been carefully analyzed, new optimal output and the change of contribution should be examined when the new developed product, Dankie, is taken into consideration.
Here is the cost card of all three products:
Still, three potential constraints, raw materials, skilled labor and machine hours should be considered. Utilization rates of these three factors need to be recalculated because of the new product.
With the limiting factors per unit Dankie requires, new utilization rates can be calculated if all demand is satisfied:
Therefore, raw materials and machine hours are two limitations; raw material is bottleneck. If figures are examined much more carefully, the constraint of machine hours will always be satisfied when that of raw materials is satisfied, since the demand of raw materials will always higher than that of machine hours and the amount of available raw materials is smaller than machine hours. That means, the amount of raw materials is still the only constraint in those three.
3.2 Find optimal point through the contribution ranking
We can use the same method as in the analysis of two products above. Raw materials should be used to maximize the product with highest contribution, which requires the ranking of contribution per raw materials.
It is not difficult to find that Yabonga still has the highest contribution per raw material, and surprisingly the new product, Dankie contributes least to the materials it used. So the output of Yabonga is supposed to be maximized to reach the global demand, after the priority contracts of three products are completed.
After the priority contracts have been fulfilled, remaining raw materials is 50000-600-600-500=48300kg.
5900 units of Yabonga can then be produced, which will cost 5*5900=29500kg raw materials. Remaining raw materials change to 18800kg.
With these materials, Nkosi, the No.2 product should be produced as much as possible. The proper amount is 18800/6=3233.33 units. At this point, raw materials have been used up.
Now optimal point has been reached, which is 6000 units of Yabonga, 3233.33 units of Nkosi, 100 units of Dankie. The total contribution, 10,170,929.84 can be also worked out, and total profit is that total contribution minus fixed cost, 10,170,929.84-1,000,000=9170929.84, which is lower than the profit without new product.
3.3 Breakeven Point
Average Contribution
=(624*100+1048*3233.33+1120*6000)/(100+3333.33+6000)=1078.19
Breakeven point=Fixed Cost/Average Contribution=10000/1078.19=9.28 untis
3.4 Shadow price of raw material
If one extra unit of raw material is given, undoubtedly it will be used to produce Nkosi. In this sense the shadow price of raw materials will be the same as that calculated without new product, 178.16. Thus, if there is an extra available raw material, Drakensberg should pay up to 178.16 pounds per unit to acquire it.
Calculation of the adjusted optimal point
4.1 Adjusted optimal point
In the optimal point, the output of Dankie is 100 units. However, the new product on its initial stage cannot be produced in that tiny amount. Instead, the global demand should be satisfied in order to obtain the biggest market share. So 3000 units of Dankie need to be produced. Compared with the optimal point, extra 2900 units will lead to 2,900*6=17,400kg raw materials.
This amount will be saved from reducing the production of Nkosi and Yabonga, and their weights will be calculated based on the materials they used in the optimal output point.
The calculation indicates that Nkosi needs to reduce 0.39*17,400=6,786kg raw materials, that is to say, 1,131 units. Remaining output of Nkosi is 3233.33-1131=2102.33 units
And, 0.61*17,400=10614 kg raw materials will be saved from producing Yabonga, which equals to 10614/5=2122.8 units. Remaining output of Yabonga is 6,000-2,122.8=3,877.2 units
The total contribution will be 624*3,000+1,048*2101.33+1,120*3,877.2 = 8,416,657.84. And the total profit will be 8,416,657.84-1,000,000=7,416,657.84.
The reduced profit compared to the original optimal output is 10,170,929.84-8,416,657.84=1,754,272.
4.2 Breakeven point
Average Contribution
=(624*3000+1048*2102.33+1120*3877.2)/(3000+2102.33+3877.2)=937.43
Breakeven point=Fixed Cost/Average Contribution=10000/937.43=10.67 units
4.3 shadow price
If one extra unit of raw material is given, it will be used to produce Dankie. In this sense the shadow price of raw materials will be 224. Thus, if there is an extra available raw material, Drakensberg should pay up to 224 pounds per unit to acquire it.
Task allocation