Finished Inventory is much too High!! - Analysis I

By Eli Schragenheim

This is a case study by Eli Schragenheim that he has allowed me to publish here. Your goal is to analyze the current situation, comment the proposals and develop what you believe are the best strategy and tactics for the company to pursue. The first post is the current situation. (If you are interested in such business cases and their analysis I recommend Eli's book, "Management Dilemmas". The book has many different case studies for you to work through. Eli gives his analysis which he does not claim to be the best possible - nevertheless they are thought provoking.

Analysis of Lisbon Motors’ Current Situation:

Lisbon Motors has about 60-65% fixed cost (materials and transportation) in their products – so only 35-40% of their cost is controllable (they can of course try to purchase at lower prices). In any case their situation appears to be approximately as shown in the logic tree

to

the left. You read such a logic tree from the bottom up, the ovals between the entities indicate an 'and'. The first entity is "we operate in the same way as our competitors". If you look at most industries this will be true - competitors generally operate in the same way (this can lead to a lot of discussion whether or not it is true - for many companies it is true and for Lisbon Motors it is also).

So if this entity is true, then it follows that our clients select our products for minor reasons. From here, if price of our products is very important for our clients, and our competitors compete largely on price, and our clients choose our products for minor reasons it is clear that we (Lisbon Motors) must be under constant price pressure. If our costs are not reduced as fast as prices (in absolute terms) and if we are under constant price pressure then our profits might disappear in the (near) future.

 

 

Clearly Lisbon Motors has a problem which, if they do not solve, ensures that their already low profitability is likely to disappear altogether. They are in fact in a dilemma as described in the conflict between Arturo and Ernesto. Arturo represents the status quo – Lisbon Motors continues to operate in much the same way as all their competitors do. Ernesto represents change – Lisbon Motors

operates in a unique way – different from all other competitors. The dilemma or conflict looks something like the following generic representation:

The conflict is read as follows – starting from the left and reading the top arm first.

1. In order for Lisbon Motors to be profitable now and in the future their business must be adequately secure.

2. In order for the business to be adequately secure Lisbon Motors must not change the status quo ...

• • The risk of being forced out of business is very low as all competitors are about the same

  • It is very unlikely any competitor will develop a strikingly new, different and attractive offer.

  • Making significant changes to our way of operating can be risky.

The lower arm is read in the same way. We have the ‘conflict’ that Lisbon Motors cannot both maintain the status quo and operate in a new and unique way.

BUT, the two suggested actions – maintain the status quo or operate in a new way are actually just 2 of the potential actions Lisbon Motors could take. More important are the two prerequisites Lisbon Motors has – to have adequate business security (minimize risk) and to expand their business (and maintain higher prices). What is needed is to fulfill BOTH these two prerequisites.

Would it be fair to say that any solution should meet the following criteria?

1. The new offering must be difficult for competitors to copy.

2. It must give new added value to clients;

   Otherwise continued price pressure will undermine any cost improvement

3. Clients must understand and appreciate the value of the new offer

4. The offer must be good enough to lead to additional sales

5. Must show significant improvement to the bottom line improvement even with a conservative assessment

6. The offer must not add significant risk

What do you think of these criteria? Do you see a way of achieving them?

The picture below is from the highest peak on Madeira - 1800 meters.