Case study
320 Purchasing and Supply Management
treasurer both turned it down, arguing that the 24-month pay-
back on the mold was far too long and that the company had
better investment opportunities with a 12-month payback.
Art was disappointed, because he had hoped this proj-
ect would assist in helping him meet his savings target
for the year. When he talked the idea over with his man-
ager, Louise Moffat, she suggested he give it another try.
She said, “I am sure that if you can get the mold pay-
back down to 15 months, you will get a warmer reception.
There are not that many deals around this company that
pay for themselves in one year.” She also suggested that
Art talk to marketing to see if some other products could
use the same packaging, and to the production scheduling
group to check if different production quantities could be
ordered.
When Art talked to the marketing people, he found
out that the package was ideal for another product to be
introduced shortly and with an annual demand estimated
at 100,000 units. Marketing had been uneasy about using
the French package because of the difficulties encoun-
tered with it and assured Art that if he could get a reliable
domestic source, this option would be highly attractive.
The scheduling group, for a number of years, had used a
modified MRP system. When Art discussed the new pack-
age idea with them, they told him that if the new product
and the older one were to be packaged in the same package,
a total package requirement of about 40,000 units would
make sense and that the master production schedule could
easily be adjusted to run the two products in conjunction.
Art also discussed the situation with the resin supplier,
who indicated that his quote to Bert Wood had been based
on the lot size of 30,000 packages, but that a 40,000 unit
lot would fall into a new price bracket 5 percent lower
than the originally quoted price.
Art wondered just what effect all of this new informa-
tion would have on his original proposal. He knew that
Bert Wood had been adamant about his $0.27 quote. Bert
Wood had said, “I know I am classified as a minority sup-
plier. But I don’t want to hide behind that fact. I want no
special favors from any of my customers. Nor am I in a
position to make special gifts to anyone else. I have had to
borrow at what I consider to be ridiculously high interest
rates to buy this company. Now I have to make it pay off.
My $0.27 price is as low as I can go, as far as I can see.”
Case 11–3
Carmichael Corporation
Amanda Tellford, purchasing manager for Carmichael
Corporation, became increasingly concerned about the
purchase of MS-7, a special ingredient used in Stimgro,
one of her company’s new products. It appeared that a
major cost increase might threaten the product’s profit-
ability, and Amanda was anxious to explore any alterna-
tives that promised at least some cost relief.
CARMICHAEL CORPORATION Carmichael Corporation was the U.S. subsidiary of
Carmichael International, a UK-based producer of veteri-
nary products and feed additives. Total U.S. sales were ex-
pected to be about $20 million with profits before taxes of
about $1.2 million. Carmichael occupied a special niche in
the market, offering small-volume specialty products that
the bigger producers considered uneconomical. However,
if sales of these products grew, the possibility existed that a
larger producer might become interested. Carmichael had
an exclusive distribution agreement with three distributors
who covered all parts of the United States. Each distribu-
tor sold Carmichael products to feed stores, cooperatives,
and farm supply stores, which, in turn, sold to the farmer.
For Stimgro the pricing structure through the distribution
chain was approximately as follows:
Stimgro $360 $520 Feed $780
Carmichael Distributor
Store
Farmer
The Carmichael plant located in Chicago employed about
70 hourly rated people. The premises were leased and pri-
mary activities involved the mixing of ingredients and the
bottling and packing of finished products. About half of the
$8 million worth of ingredients was imported from the UK
parent; the remainder and all packaging were purchased
in the United States. The executive team consisted of Tim
Paterson, president and treasurer; Charles Godfrey, sales
manager; Amanda Tellford, manager of accounting and
purchasing; and Andrew Hartwick, plant manager.
Carmichael Corporation concentrated on poultry medi-
cines and feed additives. Three years earlier, Carmichael had
introduced Stimgro, a feed additive for young turkeys, which
had shown unusual promise in promoting rapid, healthy de-
velopment in birds less than one month old. Shortly there-
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Chapter 11 Cost Management 321
after, a competitor, Brisson, introduced a similar product.
Because Brisson, like Carmichael, had its own exclusive
distributors, Brisson’s entry into the market did not result in
lower Stimgro sales for Carmichael. Small specialty produc-
ers like Carmichael and Brisson did not compete on price
or manufacturing cost. Their big concern was finding new
products to sell and making sufficient profit before the prod-
uct was taken over by a larger company or lost its market
appeal. Carmichael and Brisson had about equal shares in the
Stimgro market with annual sales of about $1.4 million each.
Carmichael imported the two primary ingredients for
Stimgro from its UK parent and mixed and packaged them
in the Chicago plant. The manufacturing cost for Stimgro is
shown in Exhibit 1. Carmichael’s selling price of Stimgro
was $360 per kilogram. Amanda Tellford had tried to find
a North American source for MS-7 over the past few years
but had found that all potential sources, pharmaceutical,
and specialty chemical firms had declined serious interest.
They claimed the volume was far too low, and the price
would have to be at least $800 per kilogram before they
could be persuaded to manufacture MS-7.
BRISSON Brisson Corporation was a U.S.-owned manufacturer
of products similar to those marketed by Carmichael.
Brisson’s range of products was greater than Carmichael’s,
and its annual sales volume was about $24 million. Brisson
had originally obtained its MS-7 from a UK competitor of
Carmichael International, but in the spring of the current
year it had placed orders for equipment to manufacture its
own MS-7. This action had surprised Amanda Tellford
because, like Carmichael, Brisson had been relatively
poorly prepared to take this step. For example, the North
American market demand for MS-7 was limited to its use
by Carmichael and Brisson. Although future growth might
show a healthy increase, total current market demand cer-
tainly did not warrant the $1 million investment Brisson
had to make.
Moreover, MS-7 was tricky to produce, requiring very
careful temperature, pressure, and timing control. The
main equipment item was a large glass-lined autoclave
ingeniously instrumented and constructed to deal with the
unusual demands of MS-7 production. The autoclave was
normally a fairly general-purpose type of equipment in
the chemical industry. However, the special conditions
required for the manufacture of MS-7 made this reactor a
special-purpose tool, certainly overdesigned and overen-
gineered for the other uses to which Brisson might apply
it. MS-7 manufacture was a batch production process, and
the expected capacity of the equipment was about 40,000
kilograms per year based on two-shift operation.
In Amanda Tellford’s eyes, Brisson’s action affected
her own purchases of MS-7, which up to this point had
been at an advantageous transfer price from the UK
parent. Although the exact impact was still not entirely
clear, she expected at least a 40 percent increase in her
laid-down cost. Amanda had no doubt that Brisson would
aggressively seek customs protection from undervalued
MS-7 imports and that at least a 20 percent duty would be
applied on the American selling price.
Amanda Tellford, therefore, requested information
from the parent company concerning manufacturing costs
of MS-7. She added several other data from her own
knowledge and prepared the following summary:
Summary of MS-7 cost and price data
Minimum equipment outlay installed $1 million Delivery on equipment 9–12 months UK normal market price $224/kg Our laid-down current cost from Carmichael, UK $200/kg Carmichael (UK) out-of-pocket cost (material, labor, and variable overhead) $160/kg Estimated minimum laid-down cost in Chicago after Brisson starts production $280/kg
EXHIBIT 1 Stimgro manufacturing
(cost/kg)
MS-7 (500 grams) $ 100 Other ingredients (500 grams) 48 Packaging 4 Labor 8 Overhead 20 Total $ 180
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322 Purchasing and Supply Management
Amanda Tellford went to see Charles Godfrey, Carmichael’s
sales manager, to discuss possible sales requirements for
the future. Charles said, “It’s really anybody’s guess. First,
it depends on the popularity of turkeys. We are banking on
continued growth there. Second, as soon as the feed compa-
nies can develop a suitable substitute for our product, they
will go for it. We appear to be very expensive on a weight
basis, although research and actual results show we repre-
sent excellent value. It takes such tiny quantities of Stimgro
to improve the overall quality of a mix that it is difficult
to believe it could have any impact. More competition can
enter this market any day. We are just not large enough
in the U.S. market to have any strong promotional impact.
Each of our product lines is specialized, of relatively small
volume, in an area where the big firms choose not to oper-
ate. Should a larger firm enter this market, they could flat-
ten us. Now you tell me how to turn this into a reasonable
forecast.”
Amanda Tellford replied, “I’m glad that’s your prob-
lem and not mine, Charles. Anytime you feel you’re ready
to put some figures down, please let me know, because
it may become very important for us in the near future.”
In looking over past figures, Amanda estimated that
the second half of this year’s requirements would total
about 1,000 kilograms of MS-7. Amanda decided that
she had better think out the effect that Brisson’s deci-
sion to make MS-7 might have on her future purchasing
strategy.
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