Deere Case the Gatherer Chain Is Selling

Deere Case

The gatherer chain is selling for less and costing more, putting a squeeze on the margins at Deere. The supplier, Saunders, is likely increasing prices to Deere to help cover fixed costs in the face of declining demand, as revenue to Saunders from Deere has declined 16.3% even with the price increases.

For Saunders, variable costs of production are $12.43 per unit based on last year's figures; indirect labor is $1.36 and overhead allocation is $4.52, with profit of $4.29 per unit. If Deere wants to stick to a 50/50 split, it needs to buy from Saunders at $15. This would leave Saunders with $2.57 (profit margin = 20.67%) once direct costs are excluded, and that would go towards Saunders' profit but not indirect cost and overhead allocations. It is reasonable to argue that overhead allocations and indirect costs should be incorporated into the profit margin that Saunders takes anyway.

According to the estimates of raw material that Deere has, 13.92 lbs goes into the gatherer, which equates to $3.90 per units including scrap, plus $1.61 for the pins and some extra for the packaging. Thus, material costs that Saunders faces are likely to be significantly lower than the $9.50 estimated based on the manufacturer's survey. Again, this points to the excess cost going to Saunders' profit margin or to allocated overhead.

There are a number of business issues at play in this situation. Deere at this point only has one supplier -- the competition is using a cheaper one but Deere does not have a cheaper one. The competition is leveraging their cheaper supplier to undercut Deere, stealing market share in the process. By matching prices, Deere is unlikely to win back lost market share -- it would need to undercut the competition. This is not a scenario that will work for Deere in the long-run. Deere needs to find a better solution to this problem. Saunders' lack of transparency is an issue -- if his firm was public Deere would know what his margins here. The basis of any trade relationship is trust and at this point there is no reason for Deere to trust Saunders. He appears to be increasing his price in the face of declining demand to maintain a contribution margin, and overhead is likely to be part of that. Saunders' is, whether he realizes it or not, gambling with his business by taking this approach in a changing environment. He needs Deere more than Deere needs him -- if Deere exits the gatherer chain business altogether it will lose $10 million in revenue, which for a company with $14 billion in sales is infinitesimal.

Thus, Deere needs to improve its relationship with Saunders, in particular with respect to transparency and a mutual commitment to winning the competition for the gatherer chain business. The trust is this relationship has deteriorated -- Saunders is trying to win a zero-sum game with Deere, rather than focusing on the long-term impacts of the new competitive environment.

It is recommended that Deere stand firm and demand the chains for $15. Deere can then cut its margins in order to sell in the market below $30. That will allow it to build volumes back, which is beneficial for both firms. Deere has a sense that Saunders' variable costs are fairly low in relationship to its selling price to Deere, and unless Saunders is willing to open his books Deere can view its assumptions about Saunders to be correct.