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Creating customer value at Rocky Mountain fiberboard.

CASE DESCRIPTION

The primary subject matter of this case concerns strategic planning, strategy formulation, and the alignment of functional strategies with the overall business strategy. Secondary issues examined include the incorporation of societal & environmental needs into business decisions, the strategic issues associated with staying focused, and bankruptcy. The case has a difficulty level of five. It is best suited for use in graduate level or advanced undergraduate courses given the scope of the difficulties the company faces and the complexity of the situation described. It is ideally suited for use in a capstone strategic management class because it requires the student to deal with strategic marketing, production and financial issues in an integrated manner. The case could also be used in a capstone marketing course, a small business management course, or in an entrepreneurship course. The case has been designed to be taught in 75 to 90 minutes and is expected to require four to five hours of outside preparation given the detailed financial analysis that can be done.

CASE SYNOPSIS

Rocky Mountain Fiberboard (RMF) produced particleboard out of bluegrass straw. It was established in 1999 as a joint venture between a processor of bluegrass seed and a Northwest American Indian Tribe. RMF was created to help solve the problem of waste bluegrass straw and was also part of the Tribe's effort to diversify the economic base of its reservation. RMF, however, experienced significant difficulties. It had lost $1.9 million in 2001, had $4.5 million in debt, and had no real working capital. Its Tribal owners were putting $42,000/month into the company to keep it going. While a pending grant application with the U.S. Department of Agriculture offered hope of reducing its significant debt burden, the business was also experiencing difficulties attracting and retaining customers and was experiencing significant quality problems. Luke Waterman, a trusted Tribal member who was in the process of completing a business degree at a nearby university, had recently taken over as general manager and was faced with the task of overcoming the considerable financial, marketing, and production problems the business faced. Luke was considering three options: (i) identifying additional funds to undertake a focused marketing effort and to implement process improvements in production; (ii) acquiring equipment and licenses to produce another product--wall panels--that would use RMF's strawboard; or (iii) declaring bankruptcy.

INSTRUCTORS' NOTES

Recommendations for Teaching Approaches

The case can be used to illustrate a number of business principles and accomplish a number of teaching objectives. These include:

* Illustrate the problems that can arise when a new business venture does not adequately research the assumptions upon which its strategy is based.

* Highlight the need for alignment between key business decisions (across all functions) and a firm's intended business strategy, and illustrate the problems that can occur when such alignment does not occur.

* Show why a business established to satisfy societal/environmental needs still needs to be built on a market-driven strategy that creates value for customers.

* Show how the analysis of financial and production data can lead to a better understanding of the strategic capabilities of a business.

* Illustrate the need for a firm to understand its competitive environment and the basis upon which it might build a competitive advantage within this environment.

* Provide the basis for a discussion of the pros and cons of staying focused. One alternative in the case would shift the focus of the business and add complexities to the management of the business but make limited contribution toward solving core business problems.

* Provide a context to discuss what bankruptcy really involves and when bankruptcy should be considered as a serious option.

* Illustrate both the integrated nature of the different business functions and the need for business problems to be addressed cross-functionally. Doing this highlights the importance of a general manager being able to understand finance, marketing, and production issues.

The following questions are designed to take the class through a discussion of the case. Answers and some teaching suggestions are provided for each question.

1. What are the major challenges that RMF faces currently?

* few remaining customers;

* market does not appear to perceive that product differs significantly from traditional wood particleboard;

* inability to obtain premium price for product while simultaneously costs exceed those of competitor;

* lost $1.9 million on sales of $1.7 million last year;

* production equipment is old, low volume and less automated than competitors;

* $4.5 million in long-term debt, of which $950,000 is current, plus over $800,000 in payables;

* quality problems lead to downgrading as much as 20% of certain product types;

* significant loss of a raw material, straw, during storage;

* business requires cash infusion each month from the Tribe to operate;

* the organization has been forced to lay off the majority of its employees;

* the organization currently has no marketing/sales manager;

* there appears to be a need for significant investment to refurbish basic production equipment;

2. Describe how RMF has presently positioned itself and its product. Identify and contrast the strategy RMF intended to follow with the strategy that eventually evolved.

Question #1 starts the discussion off by identifying the current challenges facing the firm. Question #2 is designed to clarify the current strategy for the students and establish why the firm faces the challenges that it does. Two important strategic lessons can be brought up in this discussion. The first lesson is that the assumptions upon which a strategy is built need to be tested to insure their validity. Otherwise, faulty assumptions can easily lead to a weak strategy. The second lesson is that the firm must take care to take actions and decisions consistent with its intended strategy. If this does not occur, the strategy that emerges from these actions and decisions will differ from the strategy it intended to follow.

RMF was formed to produce strawboard to provide bluegrass growers an outlet to sell straw refuse as well as to diversify the Tribe's economic base. The original, intended strategy was to sell strawboard as a high-quality "green" product. RMF planned to capitalize on its location in the Northwest and believed that a small plant would allow it to be more flexible and have lower costs than traditional wood particleboard producers. The case indicates that RMF expected it could find customers because strawboard plants in North Dakota and Kansas consistently sold out of product and there were no plants in the Pacific Northwest. It viewed itself primarily in competition with wood particleboard plants and viewed its product as being a superior substitute to wood particleboard. The case also states that RMF's original informal business plan called for initially pricing at a discount and then raising the price to a premium level after gaining market share, broadening its acceptance, and proving the product to be of high quality.

Yet, the case states the original business plan was quickly developed, indicating that no time was invested in conducting market research to fully understand the industry, product fit, or potential customer base. In essence, RMF assumed, without research, that to-be-identified customers would understand and value strawboard's unique characteristics and would be willing to pay a premium for "green" boards. It also assumed that this premium would cover operating and financial costs, neither of which was well understood. As a result, the company invested significant money without an adequate business plan nor an understanding of the risks involved.

While basic research would have shown that at least some of these assumptions were faulty (e.g., that costs would be lower than those for particleboard or that potential customers would easily understand and value strawboard's unique characteristics), it is unclear whether this intended strategy could have succeeded because many decisions seemed to have been made without an understanding of their strategic significance. For example, RMF purchased smaller, less automated, less flexible production equipment than competitors', hired a production manager with little managerial experience or training, and failed to adequately plan for the effective storage of its basic raw material (i.e., straw). All of these decisions contributed to lower product quality and higher production costs. Likewise, RMF hired a general manager with no business experience and hired a series of marketers with no experience in selling non-commodity, new-to-market products. As such, the company experienced ongoing difficulties adequately differentiating its product from its competitors and establishing a consistent, high quality brand image.

As a result of decisions like these, the resulting emergent strategy directed the firm away from introducing and producing a high-quality product for which it could charge a premium price and towards producing, in a costly manner, a commodity of inconsistent quality. The emergent strategy lacked focus and consistency. Decisions were made and actions taken without an understanding of what needed to be accomplished for the firm to be successful; thus, there was no opportunity for a hierarchy of strategies to develop that supported the intended strategy. For example, the decision to purchase the older, lower volume production equipment was made based on its availability and low price, rather than on its capabilities relative to achieving certain goals. (Additional details on the issue of "Intended" vs. "Emergent" strategies can be found in Hill and Gareth (1998).)

Once students identify the intended and emergent strategies, and understand the differences between them, they can better appreciate what type of firm RMF has become and the type of product it is actually producing. This provides students a foundation upon which to determine what RMF has to offer the marketplace presently, in spite of its intended goals.

3. Conduct partial "Common Size" analyses with the various financial statements. What do the analyses indicate about the situation in which RMF finds itself?

Questions #1 and #2 are designed to help students understand the qualitative issues surrounding the case. This question is meant to help students methodically break down the factors underlying the financial problems. By doing so, students will not only become familiar with financial statement analysis, but also form sound financial reasons upon which to develop any action plans.

Asking students to calculate relative percentages for various accounts (a form of Common Size analysis, in which accounts for a given financial statement are made percentages of one other account) will help them begin to determine which elements of the business are contributing to the current financial situation. As a result, the students will have identified those elements that need to be changed, and how, when they analyze each of the options before Luke.

Exhibit TN-1 presents five different analyses that could be conducted. First, students are asked to develop ratios with each of the raw materials as a percentage of Direct Materials Used using the Cost of Goods Manufactured statement. For example, resin's ratio would be calculated as {(beginning inventory + purchases - ending inventory)/ Direct Materials Used = ($37,440+$560,928-$0)/$1,154,748}. This allows the students to determine relative raw material-to-input costs and shows, contrary to possible expectations, that the cost of straw is not the biggest element. Second, using the same statement, students are asked to develop ratios with each of the three major cost inputs as a percentage of Cost of Goods Manufactured. When done in conjunction with the first analysis, this deepens understanding of the role that the raw materials play by showing how the cost of direct materials drives the overall cost of manufacturing relative to the costs of direct labor or manufacturing overhead. Third, students are asked to use the Income Statement and calculate the components of Operating Expenses as percentages of all operating expenses. Operating Expenses are purposely separated into four categories, rather than collapsed into the commonly used catch-all account, Selling and Administrative Expenses, to emphasize the disparity between expenses going towards administrative accounts (88% of Operating Expenses) instead of selling or marketing or research efforts. Fourth, students must determine the relative percentages of the component accounts under Current Assets on the Balance Sheet, and this highlights additional issues. Of RMF's Current Assets, almost 59% are tied up in inventories. Finished Goods accounts for 55% of Current Assets and, as mentioned in the case, this inventory is composed mainly of downgraded shop and utility boards for which there are no customers. Lastly, comparable analysis on the Current Liabilities shows that looming debt payments are a concern.

4. Conduct a breakeven analysis for RMF. What types of changes would have to occur at RMF to reach these levels of breakeven performance (be as specific as possible and include, but don't limit yourself to, issues of pricing, quality, material cost, and labor)?

Having students conduct a breakeven analysis will help them realize how serious the problems are that the company faces. Students will need to use the 2001 Income Statement and the Cost of Goods Manufactured statements provided in the case to do this analysis and will be required to use their judgment to make some assumptions about what would be considered fixed costs and what would be considered variable costs. Exhibit TN-2 shows the assumptions that are used in this instructor's note.

This exhibit shows that for 2001, RMF's total variable costs were $2,198,397 and total fixed costs were $715,543. Total sales were $1,767,435 (from Exhibit 2 of case). This figure includes freight charges of $354,601. RMF priced its boards FOB factory, then arranged transportation of the boards for those customers who wanted delivery included and added this cost to the bill. As such, it is deducted from the sales figure for purposes of conducting a breakeven analysis, giving an adjusted total sales figure of $1,412,834. Students should recognize from this that RMF could not solve its problems simply by increasing volume, as variable costs exceed sales levels by $785,563 or by 56%. From this analysis, it is clear that RMF needs to find a way to significantly reduce costs and/or significantly increase prices to have any chance of reaching breakeven. The instructor can then press the students to critically evaluate RMF's situation to assess what it would take to reduce costs or increase price. Basically this discussion forces the students to consider what types of functional strategies the business should pursue in operations and marketing if it hopes to break even producing and selling basic strawboard. These issues (costs & prices) can be addressed in either order, but both sides of the equation need to be addressed to fully appreciate RMF's situation.

Starting on the cost side, the Cost of Goods Manufactured and the detailed description of the production process provided in the case provide students a good opportunity to dig into the cost side of the equation. Further, the Common Size analysis completed in Question #3 provides students with a better understanding of the relative importance of the different manufacturing costs. One approach to carrying out this discussion is to attempt to develop a list of changes that would allow RMF to reduce its costs to where it could at least cover all of its variable costs. One such scenario is shown in Exhibit TN-3. Clearly students will not be able to know the exact percentages of improvement that are possible, but the point is to explore both the opportunities that exist and the magnitude of change needed.

The instructor might want to start by discussing the high cost of the quality problems experienced in production and what might be done to address these quality problems. As shown in Exhibit TN-3 (items 1-3), the combination of rejected raw material (due to straw deterioration) and rejected finished product (due to 10% of boards that are downgraded on average) cost RMF $285,872 (i.e., $63,802+$212,502+$9,568) in 2001. This represents a source of significant savings if quality problems can be addressed. A portion of the Sales Returns and Allowances expense on the 2001 Income Statement would also likely disappear with significant improvements in quality. The case provides numerous examples of process upgrades that are needed to reduce quality problems. For example, new press platens ($100,000 for both lines), new cold plates ($30,000), better straw storage and/or delivery arrangements (no cost estimate given) and an upgrade for the sanding equipment (no cost estimate given) would help significantly to improve quality. Further, students might suggest that more formal production procedures would help (e.g., the case indicates that when product density is found to be too high or low, the operator "might" adjust the process to try to compensate). Also, more training is needed (i.e., $4,000 in training for a company of this size seems low, particularly given the quality and productivity challenges the company faces). The annual savings ( $285,000) that would result from these investments in better quality would likely cover the costs of the investments in less than a year.

This discussion of quality naturally leads into a discussion of labor productivity. The same informality and lack of investment and training and equipment associated with the quality problems also would suggest that labor productivity could probably be improved significantly. Students might also suggest additional training for Rich or the hiring of a new production manager with more management experience or training. It is also worth looking at labor costs as a percentage of sales. Direct labor costs are $675,712/$1,412,834= 47.8% of sales. This is an incredibly high percentage for a product that is essentially a commodity. Labor as a percentage of sales for businesses located in the U.S. is more typically 5%-15%. Products with such high labor content are usually either high end, "hand-crafted" items or are moved offshore where labor costs are lower. Labor productivity clearly needs to be improved for the company to reach breakeven.

From discussing quality and labor productivity, the instructor could move on to discussing the issue of purchasing. In terms of straw, the case states that there is an abundance of straw available and going to waste in growers' fields. While BGI clearly entered this venture to recover costs associated with baling bluegrass straw off growers' fields, it seems unlikely that RMF would have to pay this much if it sought competitive bids on straw and treated the company as an arm's length supplier. One could argue that RMF would be doing a service by removing straw from a grower's field and should be able to obtain the straw for what it costs to transport it to the factory. An even higher cost to RMF than straw is resin. The case indicates that MDI resin is three to five times more expensive than the urea-formaldehyde resin used in conventional wood particleboard, and this puts strawboard manufacturers industry-wide at a cost disadvantage. There are, however, three alternatives to MDI that are expected to become available within the next six months and have the potential to reduce resin costs for strawboard manufacturers. In the very short term, these alternatives might give RMF added bargaining power vis-a-vis BASF. In the longer term (i.e., 3-6 months out), these alternatives might provide RMF a significant cost reduction. Switching to soy-based resins, for example, could reduce resin costs by as much as 75% if it is indeed priced comparable to urea-formaldehyde resins that are on average four times more expensive than MDI. Because of uncertainties about the timing and the effectiveness of these new resins, the potential cost savings associated with them have not been incorporated into TN-3.

Looking at Exhibit TN-3, one can see that reaching profitability through cost cutting alone is not going to be easy. RMF would have to eliminate all of its quality problems, reduce the price it pays for straw by 50%, reduce the price it pays for other inputs by 15%, reduce equipment breakdowns by 50%, and improve labor productivity by 25% just to get to the point where it can cover its variable costs. Even still, these drastic improvements would not begin to cover the $715,543 in fixed costs nor provide any operating profit to cover the $359,866 interest expense, let alone pay back outstanding loans. Further, achieving these levels of improvement would be unlikely to occur without additional capital for needed process improvements, which would increase liabilities. A little further out in time though, a switch to a new resin (e.g., soy-based resins) could further reduce variable costs by as much as $378,000 {(.75)(.90)(560,928)}. This, in turn, would provide RMF with some contribution to begin to cover fixed costs and/or interest expense.

In addition to cost cutting, students must also consider the possibility of increasing price to reach breakeven, even if they decide it is not possible. Strawboard appears to be a commodity product as it is a substitute for wood particleboard, which is already marketed as a commodity product. This presents an opportunity to discuss the pricing implications for commodity versus differentiated products. It is difficult to make a case for getting much of a premium for strawboard over particleboard. Environmental benefits are the primary additional benefit of strawboard versus particleboard, and one could lead a discussion about the challenge of convincing customers to pay more to support a cleaner environment. The case provides data on the green marketplace suggesting that the current premium of around 20% is about the most that RMF can expect to obtain unless it is able to further differentiate its product. The Wall Panel alternative does provide an opportunity to include strawboard in a value added, differentiable product. Note, however, that strawboard still does not have any unique property in this application compared to the more economical particleboard except that it is a "green" product.

5. Based on the preceding analysis and the industry and market information in the case, how might RMF create a competitive advantage for itself?

Questions #1 and #2 provide students with an overview of the current situation and an understanding of RMF's current strategy and how it came about. Questions #3 and #4 require students to do a detailed analysis of the production and financial data to better understand what RMF needs to do to get its revenues and costs more in line with each other. Question #5 is intended to provide a bridge between the detailed Common Size and breakeven analyses and the consideration of alternatives. That is, it asks students to synthesize the analyses, clarifying RMF's strategic strengths and weaknesses relative to competitors, in order to understand the basis upon which RMF might be able to build a competitive advantage.

Competitive advantage derives from creating superior value for customers, and this can be done by either driving costs down or by differentiating products sufficiently from competitors so that customers value them more.

The analysis completed so far indicates that RMF cannot compete on cost with particleboard manufacturers. These competitors have significant scale economies and significantly lower resins costs, not to mention much deeper pockets to fund investment. New resins coming on the market, plus improvements in manufacturing and purchasing, however, do offer RMF some opportunity to reduce its costs so the cost difference between RMF and these large producers is not as great.

RMF's potential as a competitor to particleboard manufacturers, then, must come from how it is able to differentiate itself from its competitors in ways that customers value. Strawboard does have differences compared to particleboard, but the problem for RMF is that it has been unsuccessful at finding customers who value the differences and/or educating customers about the value of those differences. As Luke's research in the case indicates, this has been an issue for the strawboard industry overall.

Compared to other strawboard manufacturers, the cost picture is less clear (and was less clear to Luke and RMF). RMF's manufacturing costs are likely higher than those of other strawboard manufacturers because of its relatively small size (i.e., it lacks the scale economies of its strawboard competitors) and the inefficiencies in its production process as discussed in the preceding question. Improving operations offers the potential to significantly reduce this cost disadvantage. RMF, however, does have one significant source for a cost advantage compared to other strawboard manufacturers--lower shipping costs to the Pacific Northwest region by virtue of its location. While it is unclear whether this currently gives RMF or its competitors an absolute cost advantage (i.e., lower shipping costs that more than offset scale and efficiency advantages of competitors), students can determine that shipping costs are quite significant in the industry because RMF's freight charges are 20% of total sales. With improved manufacturing efficiency and improved purchasing practices, RMF might be able to achieve a cost advantage compared to other strawboard manufacturers for sales to the Pacific Northwest.

Finding a basis for differentiation compared to other strawboard manufacturers would likely be more difficult, as the product sold is physically so similar to the product of other strawboard competitors. RMF's smaller size might allow it to respond more quickly to customers or be more flexible than competitors, but there is no evidence in the case that RMF has found a way yet to capitalize on this. RMF might be able to gain short-term advantage over strawboard competitors by more quickly moving to one of the new resins coming on the market, which would give RMF both lower costs and a differentiated product (particularly if it switched to the soy-based resins).

In summary, then, RMF's basis for competitive advantage likely lies in its ability to better differentiate itself from particleboard manufacturers and its ability to provide its product to customers in the Pacific Northwest at a lower cost (and possibly with shorter lead time) than other strawboard manufacturers can.

6. What are the pros and cons of each of the alternatives Luke is considering?

Exhibit TN-4 provides a summary of the pros and cons of each of the alternatives that Luke is considering. Two important concepts should be emphasized when discussing these alternatives. One, RMF does not want to repeat its earlier mistakes. Specifically, the instructor should ask students whether an option is built on a foundation of pursuing RMF's intended strategy and creating value for an identified customer. Two, the instructor should raise the issue of focus. That is, does a suggested option broaden or narrow RMF's focus, and as a result, does that help or hinder RMF's efforts to be successful?

Discussion of the pros and cons can begin by using the earlier analyses of the current financial, production, and marketing situations, which suggest that simply producing the strawboard and finding new customers (e.g., furniture manufacturers) may not be enough to achieve profitability.

The discussion can then focus on the strategic benefits of changing the product offering by partnering with another organization to create a more differentiated value-added product. It is recommended that students be questioned as to whether the existing problems need to be solved before the company is in a position to move toward the Wall Panel options. It is unclear whether the Wall Panel option simply adds greater complexity to the current situation without addressing the underlying causes of the current difficulties. To some extent it seems to follow the original motivation of trying to create a product (albeit a different one) out of the bluegrass straw residue, rather than being based on a careful evaluation of how RMF could create value for its customers. Further, this option represents an attempt to address the problem primarily from the sales side without providing a clear solution to the production problems. In addition, this option really doesn't address the market's apparent view that strawboard is, at best, comparable to traditional particleboard. Thus, the option would need to be viable at price levels that customers would expect if the wall panels were made from traditional wood particleboard.

Students also need to recognize that the first two options will require time to implement before they can deliver any real return to RMF's original investors. As such, if RMF pursues either of these options, it will need to work with its lenders and those it owes money to in the form of payables if there will not be new investment from some source (e.g., the Tribe, Bluegrass Growers, Inc., or an outside investor) to cover the liabilities.

The discussion of options can be concluded with a discussion of the consequences of and alternatives to bankruptcy. Although RMF was pro-active in seeking modified lending terms with Northwest Farm Credit Service, if the grant conversion request presented to the USDA is not approved, RMF could consider filing for bankruptcy under Chapter 11 provisions. Bankruptcy law is separated into "chapters." Under Chapter 11, a business petitions the court to approve a reorganization plan that it develops describing which creditors will be paid, how they will be paid, and how much will be paid. A firm has 120 days under which to get a reprieve from its creditors and develop the plan. After this six-month process, not only must both the judge and the creditors approve this plan, but also every business decision and cash flow movement thereafter must be approved by the judge and creditors. Moreover, obtaining approval for filing Chapter 11 bankruptcy requires RMF to show that in a reorganized form it could become a profitable business. This would be a difficult case to make given the results of the financial analysis outlined in discussion Questions #3 and #4 above. RMF would also need to have enough cash (typically $5,000-$20,000) to pay up front all legal fees associated with the bankruptcy proceedings. Chapter 11 bankruptcy is a long and difficult process if granted (fewer than 25% of Chapter 11 filings are approved). Reorganization experts say it should be a last option.

A Chapter 11 type reorganization can also be accomplished informally with creditors in what is commonly referred to as a workout. In such a workout, RMF would need to meet with all of its creditors collectively and try to present a plan that these creditors can collectively accept. Workout plans involve a restructuring of debt where creditors agree to either an extension of debt terms (i.e., interest and or principal payments are postponed) and/or a partial reduction of claims by the creditors (i.e., either accepting a lower principal amount, a lower interest amount, or taking equity in exchange for debt). Typically a firm would present several scenarios to creditors in such a meeting (including a scenario of simply selling off all assets and closing the business) in an effort to convince creditors that accepting a debt restructuring is in their best interest. Creditors are at times willing to work out informal reorganizations like these because they tend to return more to creditors and can be completed more quickly than Chapter 11 reorganizations. Workouts are usually preferable to the firm involved because it allows for more managerial freedom (i.e., management does not need to have key decisions approved by the courts) and avoids the publicity and stigma associated with formal filings. The biggest challenge with informal filings is getting all creditors to agree to the plan. Because of this, informal reorganizations are most common among firms with only a few creditors. In this respect, RMF would be a good candidate for an informal reorganization given its limited number of creditors. The challenge, of course, would be developing a plan that would allow RMF to generate sufficient contribution to pay off at least a portion of its debt in the future.

Whether accomplished informally or through a Chapter 11 filing, reorganizations typically involve the following actions (Brigham & Daves, 2002, p. 844): (i) debt maturities are usually lengthened, interest rates may be lowered, and some debt is usually converted into equity; (ii) a new management team is given control of the company; (iii) obsolete or depleted inventories are replaced; (iv) plant and equipment is sometimes modernized; (v) improvements are made in production, marketing, advertising, and other functions; and (vi) new products or markets are sometimes developed to enable the firm to move from areas where economic trends are poor into areas with more potential for growth. Such reorganizations usually require an infusion of new money, often from a new investor. It is quite possible that all of the listed actions would need to be taken for RMF to win support for a re-organization. Through discussion of these issues, students should realize that a Chapter 11 (or informal) reorganization is not simply a case of taking the easy way out of the situation.

An alternative to re-organizing in this fashion is a simple liquidation. As in the case of reorganization, liquidation can be accomplished either informally or through the bankruptcy courts. An informal liquidation is usually accomplished through a process known as assignment, where the title to assets are given to a third party (i.e., a trustee or assignee) who is responsible for selling the assets and distributing the resulting money to creditors. Creditors can also force a firm into liquidation via Chapter 7 bankruptcy provisions. In fact, the vast majority of firms that apply for Chapter 11 protection are denied and instead forced into following Chapter 7 provisions. Under Chapter 7, the court closes the firm, liquidates its assets, and uses proceeds to pay off the creditors. If RMF does not resolve its operating problems shortly, creditors could choose to try to convince a bankruptcy court judge that liquidating the firm is the only recourse and force a Chapter 7 filing. Sufficient information is provided in the case for students to realize that the sale of RMF's assets would generate insufficient cash to pay off all creditors.

For instructors less familiar with the details of bankruptcy, many intermediate financial management books provide some coverage of this topic. Several useful references are also included at the end of this document that deal with the issue of bankruptcy in more detail. The American Bankruptcy Institute website is a particularly valuable resource. Instructors may wish to point out to students skeptical about the importance of understanding bankruptcy that over 38,000 U.S. businesses either filed for or were forced to bankruptcy by their creditors in 2002.

7. What would you recommend Luke do? Why? How exactly would he do it?

The analyses in Questions #3 and #4 indicate that it would be extremely difficult for the plant to break even by continuing to produce strawboard, even if new customers could be found. Some students may support this option on the basis that core problems related to the strawboard business should be solved before the business attempts to create new products from the strawboard. In addition, some students may fall prey to "escalation," which arguably happened with RMF. That is, students may identify with Luke (a University student trying to help a small company) and be unwilling to give up on this venture, instead arguing for more time and resources. Students advocating this approach need to recognize that radical change and funding are required to make this option viable, escalating the financial commitment even more.

The Wall Panel option holds a little more hope for RMF because it provides the business with a more differentiated product that would justify a somewhat higher price and margin. RMF, however, lacks fundamental market and production data for either of these options to know just how much higher a price and margin are achievable. This raises the issue of "risk" and could lead to a discussion of whether RMF ever really considered whether it expected to earn a return on its project commensurate with the risk it was undertaking. Further, the Wall Panel option is potentially viable without RMF's strawboard (i.e., through the use of regular OSB).

Students who support the Wall Panel option should be challenged to make a case for why they would even use RMF strawboard in the product. In 2001, excluding freight, RMF produced $1,412,834 worth of strawboard. It spent, excluding freight and interest expense, $2,913,940 (fixed costs plus variable costs) to produce this much strawboard. The case states that OSB, the current material used to produce wall panels, is cheaper than strawboard. Students can be presented with the scenario of a wall panel business needing as many boards as RMF produced in 2001. If that business owned RMF's processes and used RMF strawboard, it would spend $2,913,940 (and be saddled with $4.5 million of debt and over $800,000 in payables) to obtain those boards. Instead, if it simply bought OSB by competitive bid, it would spend somewhat less than $1,412,834, for a savings of approximately $1.5 million (again excluding debt). Students then must answer the question of why they would spend $1.5 million more to acquire an input material. Going through this scenario will make it clear to students that RMF can not escape addressing its current problems simply by incorporating its strawboard into another product.

This line of discussion may also cause students to ask why Quickstart would be interested in RMF. This is a good question, and takes the discussion back to the risk/return issue. Wall panels represent a relatively new product without an established market, and as such there is significant risk associated with them. The case indicates that Quickstart hired Stanford Financial to help it find an investor. Stanford Financial, in turn, approached the Tribe, knowing that the Tribe was looking for ways to create business diversity on its reservation and that it had money to invest in such ventures. The logical inference is that Quickstart is looking for an investor willing to take a significant risk. RMF, the Tribe and BGI need to assess whether the potential return is worth the risk.

This brings the discussion to bankruptcy and business objectives. Bankruptcy will be the easiest case for students to make, but this result fails to achieve either BGI's objective of finding a solution for dealing with leftover bluegrass straw or the Tribe's objective of adding to the diversity of the reservation's economy. One might legitimately argue that given the owners' objectives, the business need not achieve profitability. While this is true, the business does need to at least approach breakeven to satisfy the owners' objectives over the long-term.

It is interesting to consider both of these objectives in the context of the current financial situation. In 2001, RMF lost $1.9 million and ended the year over $5 million in debt including payables. This provided Bluegrass Growers, Inc. less than $425,000 in economic return for its straw (less because of straw purchases from Oregon Hay) and the Tribe with jobs on the reservation that generated a payroll of $740,000 {$630,000 (production labor) + $110,000 (office salaries)}. In total, the financial equivalent of these other benefits ($1,165,000) was well below the $1.9 million loss. Clearly this calculation does not include other intangible benefits associated with the venture (e.g., manufacturing experience gained by employees, the environmental value of putting the straw into a useful product instead of the landfill). However, it does make clear that the strawboard business is an expensive way to achieve these objectives. It is also interesting to note that two of the major areas suggested for improving RMF's financial picture--improved labor productivity and better straw purchasing practices--both reduce the achievement of these other objectives.

TEACHING PLAN

The discussion questions have been developed so that the instructor can use them in the order presented to lead the class through the case. The first question is designed to quickly engage the class and have students see the significance of the current problems that RMF faces. Question #2 is designed to clarify the current (emergent) strategy for the students and establish why the firm faces the challenges that it does. In a 90-minute class, we suggest spending about 20 minutes on these first 2 questions. Questions #3 and #4 send students into the detailed analysis and ask them to draw strategic conclusions from these analyses. Going through this discussion in the context of the financial statements forces students to quantify their thinking. Question #4 will require significantly more time to discuss, and instructors should be prepared for the fact that students will have made a variety of assumptions in attempting to understand what it will take for RMF to reach breakeven. We suggest allotting about 30 minutes of the class to these two questions. Question #5 helps focus the class on strategy as the discussion transitions from the quantitative analyses in Questions #3 and #4 to the evaluation of alternatives, and it should be allotted about 5-10 minutes.

We think it is worthwhile having this "ordered" discussion to more fully understand RMF's situation before discussing the alternatives. Students will probably offer statements early on in the discussion favoring one or another of the alternatives. However, delaying discussion of the alternatives allows the instructor to make the following point: the company would be likely to repeat its past mistakes unless it understands why it is in its current situation and what changes it would take to turn it around.

This leads to a discussion of the alternatives in Question #6. In discussing the alternatives, the instructor should make a point of going back to the cause of RMF's current predicament--whether decisions have been made that supported the intended strategy and created value for the customers. A related and central component of this discussion should be whether RMF must have a viable strawboard business model before trying to integrate forward into the production of wall panels. Time can also be spent discussing the option of bankruptcy generally. The case provides students opportunity to consider some of the issues involved with filing for bankruptcy.

Finally, the discussion should conclude with concrete recommendations and action plans for Luke. This discussion should include the non-financial motivations of the owners mentioned earlier, but by waiting until the end to really introduce these, students will be in a better position to evaluate the costs associated with these non-financial motivations. We suggest allotting about 25-30 minutes to discussing these final two questions.

It should be noted that fairly specific discussion questions have been provided. Some instructors may want to use the case with somewhat less specific questions, particularly if working with more advanced students. The following three questions represent a greatly simplified set of preparation questions that might be appropriate for an advanced MBA class:
 Identify and contrast the strategy RMF intended to follow with the
 strategy that eventually evolved.

 Based on the financial, production, industry and market data in the
 case, what is RMF's potential as a competitor?

 What would you recommend Luke do? Why? How exactly would he do it?


EPILOGUE

On April 30, 2002 RMF announced it was closing its strawboard business. RMF was continuing to evaluate the proposal to partner with Quickstart Building Systems to build wall panels, either out of strawboard or through the purchase of OSB. Interestingly, after informing its lone remaining customer about the move, the customer expressed willingness to pay RMF a higher price for strawboard if it re-opened.

RESEARCH METHODOLOGY

The case describes a real company and a real situation. The actual names of the company and the individuals affiliated with that company, however, have been disguised at the request of the company. This case was prepared based primarily on field interviews with the general manager of the organization--in the case, Luke. Information for the case was also obtained from interviews with the production manager and the president of the board of directors, as well as from some library research to obtain relevant industry and competitor information.

INSTRUCTOR'S MANUAL REFERENCES

American Bankruptcy Institute website--www.abiworld.org.

Brigham, E.F. & P.R. Daves (2002). Bankruptcy, Reorganization, and Liquidation. Intermediate Financial Management, 7th edition. London: Southwestern Thomson Learning, 834-855.

Fitts, P. (1991). Bankruptcies, Workouts, and Turn-Arounds: A Roundtable Discussion. Journal of Applied Corporate Finance, 4(2), 34-61.

Hill, C.W.L. & G.R. Jones (1998). Strategic Management: An Integrated Approach. Boston, MA: Houghton Mifflin Company. (For information on Intended vs. Emergent strategies.)

Sandlund, Chris. (2001, September). Born Again. Entrepreneur Magazine, 71-74. (For information on bankruptcy.)

CASE REFERENCES

Christianson, R. (1999, November). Wheat Field of Dreams. Wood & Wood Products, 21-25.

Gorzell, K.E. (November, 2001). Finding an Economic and Environmental Balance to the Technology of Producing Building Materials from Agricultural Crop Residue. Presented at 2001 ASAE Annual International Meeting.

Green Gauge Report. (2000). New York: Roper Starch Worldwide.

McCoy, M. (2001, May 28). Dow Picks Up Plywood Stand-In. Chemical & Engineering News, 11.

Potlatch 10-K405 report, year ended December 31, 2001, filed March 27, 2002.

Sellers, T. (2001). Wood Adhesive Innovations and Applications in North America. Forest Products Journal, 51(6), 12-22.

Yost, P. (2001). Getting the Right Stuff: A Guide to Building Material Retailers. Environmental Building News, 10(4), 1-3.

John J. Lawrence, University of Idaho

Doug Haines, University of Idaho

Michele O'Neill, University of Idaho
Exhibit TN-1
Partial Common Size Analyses

Relative costs of raw materials as a percentage of direct materials
used

Resin 51%
Straw 37%
Propane & Nitrogen 8%
Release Agent 4%

Material, labor and overhead as a percentage of cost of goods
manufactured

Direct Materials 44%
Manufacturing Overhead 30%
Direct Labor 26%

Individual operating expenses as a percentage of total operating
expenses

Administrative 88%
Research 9%
Selling 2%
Marketing 1%

Individual current assets accounts as a percentage of total current
assets

Finished Goods 55%
Cash 24%
Accounts Receivable 17%
Raw Materials 4%

Individual current liability accounts as a percentage of total current
liabilities

Current Debt 53%
Accounts Payable 47%

Exhibit TN-2
Assumed Classification of Costs as Fixed or Variable for Breakeven
Analysis

Variable Costs
Cost of Direct Materials Used $1,154,748
Cost of Direct Labor 675,712
Manufacturing Overhead
 Equipment Repair & Maintenance 131,701
 Plant Electricity 69,912
 Production Employee Taxes, Benefits & Insurance 120,560
 Miscellaneous Factory Consumables 36,196
 Off-cut & Waste Straw Disposal 9,568
 --
Total Variable Costs $2,198,397
Fixed Costs
Manufacturing Overhead
 Contract Management $41600
 Depreciation, Building & Plant Equipment 320,615
 Building & Equipment Lease Payments 43,706
 Miscellaneous Factory Supplies & Services 15,372
 Training 4,141
Selling & Administrative Expenses 290109
 --
Total Fixed Costs $715,543

Exhibit TN-3
One Scenario That Allows RMF to Cover Variable Costs

Change #1: Eliminate straw storage deterioration loss by changing
 Straw delivery and/or storage arrangements. The Case
 states 15% of straw disposed of due to deterioration. The
 cost of that straw is (.15)($425,346).

 Savings from Change #1: $63,802

Change #2: Improve production process to eliminate approximate 10%
 reject rate (classified as shop or utility board, which
 are difficult to sell, even at steep discount). The cost
 savings is (.10)($2,198,397-$63,802-$9,568). This
 represents 10% of all variable costs that are spent
 making low quality boards that end up as unsold inventory
 or scrap. Savings from straw deterioration & disposal
 deducted so not double counted.

 Savings from Change #2: $212,502

Change #3: Completing changes #1 and #2 above eliminates off-cut and
 waste straw disposal cost. The value of this is taken
 directly from cost of goods manufactured statement.

 Savings from Change #3: $9,568

Change #4: Negotiate 50% reduction in the price of straw--the case
 states that waste straw is in abundance and rotting in
 fields. With competitive bidding RMF should get lower
 cost--possibly simply the transportation cost to Plummer
 since excess straw in fields deteriorates quickly and is
 of little value to others. The savings is (.50)(.90)
 ($425,346-$63,802). This represents 60% of straw
 purchases after accounting for straw savings gained from
 changes #1 and #2 above.

 Savings from Change #4: $162,695

Change #5: Negotiate 15% price reduction from vendors of resin
 (BASF), propane, nitrogen, release agent & packaging
 material. Bargaining position may be that it's better to
 sell to RMF at discount than not at all, or in the case
 of BASF, that a discount is justified to keep MDI resin
 competitive with alternative resins coming on the market.
 The savings from this is
 (.15)(.90)($560,928+$42,864+$94,178+$37,023). This
 represents 15% of all non-straw purchases after
 accounting for savings gained from change #2 above.

 Savings from Change #5: $99,224

Change #6: Reduce repairs & maintenance expense by 50% by
 implementing ongoing, preventive maintenance program &
 selective equipment investment. The savings is
 (.50)($131,701).

 Savings from Change #6: $59,265

Change #7: Improve labor productivity by 25% through process
 improvement efforts and possibly selective investment in
 equipment automation. The savings is
 (.25)(.90)($611,519+$120,526). This
 represents a reduction in both direct labor and
 production labor benefits, taxes & insurance, after
 allowing for change #2 above.

 Savings from Change #7: $164,710

 Total Savings from All Changes: $771,766

Exhibit TN-4
Summary of Pros and Cons of Options Under Consideration

Option 1: Focus on strawboard, possibly focus on furniture makers

 Pros

 Allows RMF to focus on addressing current plant problems.

 Would allow RMF to avoid dealing with a distributor.

 Cons

 It is unclear whether additional investment money would be
 available from either the Tribe or an outside source.

 Furniture makers mainly use 3/4" board, which is the type of
 board that RMF has the most problems producing.

 Shipping costs would be a potential issue since most furniture
 makers are in the eastern half of the U.S.

 If RMF did stimulate interest from a furniture manufacturer,
 the manufacturer would probably solicit bids and RMF might
 lose the business to a closer, larger strawboard competitor that
 offers a comparable product at a lower price (i.e., PrimeBoard in
 North Dakota or Prairie Forest Products in Kansas).

 The financial analysis outlined above suggests that RMF cannot
 achieve profitability without receiving a significant price
 premium for its product relative to particleboard, which seems
 unlikely to occur.

Option 2: Production of wall panels

 Pros

 Creates a higher margin product from strawboard.

 Generates sales for strawboard.

 Cons

 OSB provides comparable or superior performance to strawboard
 in wall panel application and is cheaper to produce than is
 strawboard.

 The market is unlikely to pay premium for strawboard wall panels,
 and it may even expect to pay less for strawboard wall panels
 compared to OSB panels.

 It would introduce an entirely different production process that
 RMF would have to master.

 It would represent a different customer group than RMF is used
 to working with and would therefore require at least some changes
 in marketing/sales approaches.

 The shipping cost of wall panels is significant and RMF is
 located a considerable distance from major metropolitan markets
 (e.g., Seattle, Portland).

 Strawboard is not rated for exterior use so RMF would either
 produce only interior walls or would have to purchase OSB and
 build some wall panels partially or completely out of OSB.

 It would require some additional investment capital to obtain,
 move, and setup the production equipment needed to produce the
 wall panels.

 It would not address current cost and quality problems associated
 with production of strawboard and would likely divert management
 attention away from these issues.

 The production capacity of existing strawboard equipment is less
 than capacity of wall panel process.

Option 3: Bankruptcy

 Pros

 The tribe will no longer need to put additional money into the
 business.

 Cons

 Bluegrass Growers, Inc.'s objective of finding a solution for
 dealing with leftover bluegrass straw is not achieved.

 The Tribe's objective of adding to the diversity of the
 reservation's economy is not achieved.
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Article Details
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Title Annotation:CASE NOTES
Author:Lawrence, John J.; Haines, Doug; O'Neill, Michele
Publication:Journal of the International Academy for Case Studies
Article Type:Case study
Geographic Code:1USA
Date:Mar 1, 2005
Words:8551
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