Guillermo's furniture manufacturing company strategic alternatives and financial analysis

Gullermo

Guillermo Furniture Store Analysis

Situation Overview

Guillermo's furniture manufacturing company is located in Sonora, Mexico which was formerly a quiet vacation spot but has undergone a significant amount of development including an international airport. The organization is the largest furniture manufacturing company in this area and has been manufacturing furniture for some time now. Although the company was profitable until the late 1990's, the industry began to change. The competition was composed of firms that implemented the latest automation technology available. This allowed them reduce expenses in manufacturing which also allowed them to come in with lower prices to the customers. Guillermo has realized that their current strategy is no longer competitive and the company must consider a new direction for the company. They can decide to upgrade and try to compete with the new competition or continue operations as they are with some or no modifications to their strategy.

Furthermore, with the combination of the new competition and the presence of a weak economy, Guillermo could choose to become a distributor of furniture instead of being a manufacturer. This move would allow the company to stay in the industry but take on a different role in their business model. However, in order for Guillermo to determine the most financially beneficial route for the company in the future, Guillermo must first create some financial metrics for their alternatives. This will allow them the data they need for financial decisions and determine which alternative would the most profitable for Guillermo.

Financial Analysis

Guillermo has three basic options available to the company. If Guillermo wishes to remain a competitor in the manufacturing industry it will definitely have to modernize operations to any chance of creating the types of efficiencies that the foreign competitors have gained. It has been identified that a semi-automated lathe will allow Guillermo's Furniture Store to reduce their operating overhead and create gains in efficiency. Although Guillermo wouldn't anywhere close to fully automated system, this would act to modernize some of their operations and make them more competitive overall. Therefore the lathe in the manufacturing process will add significant value to the operations.

The other alternative considered was ceasing the manufacturing operations and focusing on becoming a distributor of the Norwegian manufactured furniture products. This strategy would increase Guillermo's incremental cash flow, profits, and allow the company another path to future profitability. Furthermore, this option would also allow Guillermo to be competitive against other foreign furniture manufacturers who have created mass quantity efficiencies. It would also reduce the capital expenditures that the store would no longer require the expensive high tech investments in equipment to modernize its operations.

Guillermo's Furniture Store would have to integrate itself with its foreign partner. This would require that Guillermo become a supply chain distributor of the Norwegian furniture manufacturer. This move would also benefit the foreign partner who would benefit by granting them easy access to the North American market; a key market to tap into. Guillermo could also retain the capabilities to produce a very small amount of custom high end furniture products for their loyal customers or other consumers who prefer the high-end custom furniture products.

The Net Present Value (NPV) of this strategy was calculated as $108,812. Additionally, there is an estimated payback period of about six years. The weighted average cost of capital (WACC) was calculated to be 9.27%. This figured was also used as the basis to calculate the IRR which was found to be roughly 15%. Although this option has financial potential and strategic benefits, it was not the most financially appealing alternative

The case also mentions that Guillermo's Furniture had an option to lower the costs per unit of their operation. In its production process, Guillermo uses a patented coating in the assembled furniture that is relatively expensive. This coating requires the use of a flame retardant chemical in combination with a stain resistant final coating. Therefore Guillermo could purchase a pre-fabricated and less expensive coating material that can be applied to the furniture after assembly which would not significantly alter the products value. This would eliminate the costs associated with the expensive chemicals in the patented coating that is currently applied to the furniture products. The Net Present Value (NPV) of this production change, was calculated as a positive value of $735,142. The payback period would allow investors to recover their initial cash outflow in only three years. The weighted average cost of capital (WACC) was calculated to 9.27% under this scenario. The IRR reflected an internal rate of return of 45%, which is the highest of all of the potential possibilities that were identified.

The Internal Rate of Return (IRR) was used in evaluating the different alternatives because it makes comparisons easy. The IRR creates single number that is easy to compare among different types of considerations. IRR calculations associated with the strategy of modernizing with computerized lathe yielded a value of 10%. It is also easy to see that this figure is higher than the required rate of return. This option also gives the company the greatest possible financial returns of the different scenarios that were compared.

Conclusion

Based on the analysis of the industry as well as the proposed strategies, it is recommended that the company purchase the computerized lathe. This option would allow the manufacturer the greatest ability to improve its financial position while also enabling future possibilities by staying in the market. Although the industry is expected to become even more competitive, if Guillermo continues to modernize as many processes as possible it is feasible that their location and access to relatively cheap labor would give the organization a competitive advantage in the future when the industry rebounds.