Hansson Private Label, Inc.: Evaluating an Investment in Expansion A Case Study from the Harvard Business Business School
Presented to the Accountancy Department Department De La Salle University
In Partial Fulfillment of The Course Requirements in ACFINA2 K32
Albano, Reynald Joshua Joshua C. Guingcangco, Christian Mark Laguatan, Charlie Sergie Lapuz, Carl Jay A. Singian, Gemar
The Company and its Investment Hansson Private Label, Inc. (HPL) is a manufacturing company,
owned by Tucker Hansson, of personal care products such as shampoo, soap, mouthwash and the like. They sell these products under the brand label of its retail customers, which can be a retail partner and mass merchants having a supermarket or drugstore. HPL have been surviving in the personal care category by doing things like persuading large chains to carry their products by providing adequate and highly visible shelf space. In this case study, HPL is considering a three-year contract from its largest retail customer that could give a significant rapid growth and value for the company. Since the company is already operating almost at its full capacity, the three-year contract would require them to expand their production facilities to meet the demand of the customer. However, this opportunity entails also with it a significant risk, including Hansson’s personal risk, which may also lead the company and
Hansson into a recession. Pursuing this investment would also close off all the investment opportunities for the foreseeable future. Unlike HPL’s usual investment it has more macro focus when it comes to risk and payback because of additional risks. The interest expense and restrictive covenants would be more expensive in terms of the cost of debt. It would also be rare to have an equity financing that is favorable.
Factors to be considered in Decision-Making: GOAL HPL’s goal is to be a leading provider of high quality private label personal care products to America’s leading retailers. This is a very important factor to
be considered because the decisions to be made by the company should be in parallel or align with the company’s objective. In this case, having additional
capacity will give HPL a better customer-client relationship with its largest customer. As a result, expansion would directly help the company to achieve their main objective. However, the said investment would initially be done in only three years according to the contract. Hansson considered this fact and thought that the customer’s demand might disappear right af ter the
commitment. Product-Customers
Products such as soap, shampoo, mouthwash, shaving cream, sunscreen and the like was sold to HPL’s retail partners as their private label
brand product, which included supermarkets, drug stores and mass merchants which serves as the distributors of their products. These distributors are the ones who sell their product to the patronizing customers. Also. in this kind of industry, manufacturers rely heavily on a relatively small number of retailers that has a ubiquitous presence since consumers purchased personal care products mainly through retailers. As for HPL, their share in totals sales of personal care products through retail stores is about 28%.
Limitations:
The company is already operating at more than 90% of its capacity. To accommodate the increase in the level of production, It would require an additional facility. The financial structure of the company will have a significant change in its financial structure together with its debt management. The company, in its existing management, maintained debt at a modest level in case of financial distress involving lost of big customer. But now with the expansion, the company will have to incur a high level of debt to finance the project. Another thing to be pointed out, is that the sales that would support the capacity growth coming for the new investment might come from what was already HPL’s largest customer. COMPETITION As mentioned in the case, most of the manufacturer’s unit sales came
from its private label products distributed. In many years, the unit growth was growing steadily. Given this, this will be too modest to support significant expansions by different producers. As a result, the competitors of HPL may be deterred from also expanding their production capacity in HPL’s personal care sub segments. More importantly, this announcement by HPL will give more pressure to its competitors since it will be supported by a contract with a powerful customer.
COLLABORATORS
The collaborators in the case are Robert Gates-HPL’s Executive VP of Manufacturing that led the team that developed the proposal (the investment), Sheila Dowling, CFO, who did the cost of capital analysis and the scoring to compare projects, and his staff and the managers who helped Hansson review the analysis prepared by Dowling. CAPITAL BUDGETING TECHNIQUE
The capital budgeting technique like NPV, PI, Payback Discounted Payback and IRR, was computed using the discounted cash flows in order to account the time value of money. The net present value (NPV) was calculated by getting the excess of the present value of cash inflows over the present value of the net investment (-45,000 + 56,538.81). Since the NPV is positive based on the calculation to obtain the net present value, it means that there will be an addition to the shareholder’s wealth due to the execution of the project. As for the profitability index, it was calculated by dividing the present value of future cash flows by the initial outlay (56,538.81/45,000). Since profitability index (PI) is greater than 1, it means that the net present value will be positive so the decision, if the PI is used as basis, would be to accept the project. Skipping to internal rate of return (IRR), it is the rate that will yield a zero net present value. The criteria whether to accept a project by using the IRR as basis is when it is greater than the required rate of return, in this case the WACC, which is 9.38%.
Alternative Courses of Action
If Hansson could not decide whether to accept or reject the expansion or decided to reject it, the group proposes three independent alternative courses of action; Invest in treasury bonds, harvest mode (sell the company), or continue to have incremental addition of new product types while waiting for other investment opportunities. The first alternative which is to invest in treasury bonds also sticking with the current capacity. This alternative helps to avoid risks in expanding since they are uncertain of how their customer would behave at the end of the three-year contract. Only to cover the growing demand of their long-time customer would be risky since factors that affects the performance of that customer would affect their demand and it would really require a solid backup plan in order for them to utilize well this additional capacity provided by the significant expansion in case this risk materialize. In this alternative, the advantages are the consistency of Hansson by being conservative in his investments, avoids the risks of losing his personal money if the three-year contract went wrong, and having safer earnings than expanding. The disadvantage of this alternative is the opportunity loss of the sure earnings for the first three years and as stated in the case, there are numerous private label and branded businesses who took the same risk that experienced a big payout. Also, earnings in expanding are larger than just investing in treasury bonds. The second alternative is the harvest mode. Since Hansson was a serial entrepreneur who spent 9 years buying businesses and selling them for
profit after he improved its efficiency and grew their sales. Now that he improved HPL, he could now sell it for profit to escape the large risk of concentrating his personal wealth to this business. In this alternative assuming that he can’t sell it within the allotted decision time of the contract, Hansson can choose to accept the three-year contract without having any doubts because he will later sell it for a profit before the expansion effects in the operations of the business, positive or negative, takes place. This becomes an advantage to Hansson if the expansion didn’t go out well
because he had sold the company before its value decline and a disadvantage to HPL employees that some of them might lose their job because of losses that can’t be handled. On the other hand, it’s a disadvantage to Hansson if the expansion improved the company so much that it creates an opportunity loss to Hansson and an advantage to HPL employees. Another advantage to him would be that he can buy another business he can improve and or diversify his investments to avoid the same dilemma he is currently encountering and to comply with his risk-averseness. The disadvantage here is loyalty or trust issues in future business acquisition that Hansson might do the same thing as HPL whenever there are big decisions to make. The last alternative is to continue having incremental addition of product types. The company has been doing this for the previous years by taking small risks from introducing a new product to their shelf. With this they could take advantage of the consumer acceptance of their product given that the market for their products is growing. Another advantage of this is the growth of private label and personal care products as shown in Exhibit 2 and
3 of the case but the disadvantage is the growth is slow and as stated in the case it seemed meager and unambitious. Moreover, while doing this alternative, they buy themselves a little more time to wait for another opportunity that has lower risk than the current opportunity at hand. Recommendation
Our group recommends that Hansson Private Label, Inc. should take this opportunity to expand since this is a good investment opportunity for their business in a number of ways and also has repercussions if forgone. First on the list is that if the company turns down this opportunity it might influence the future transactions this long-time and trusted customer with them as the supplier of private label products. We should remember that this customer is a business too and if their management decides that they could expand by entering a contract with a supplier, which in this case is HPL, Inc., and if HPL declines then they could just look for another supplier to do this for them and this possible outcome is really unfavorable for HPL since it would benefit their competitors. Another reason for our recommendation is that with 2007 data available regarding dollar share of HPL in their target markets, it shows that HPL holds 28% of the total for that year for private label wholesales and also considering that 99.9% of U.S. Consumers purchased at least 1 private label product for 2007, which means market acceptance and for a business, you should take advantage of this and establish market dominance. By expanding, you could increase your market share up to a rough estimate of 30.40% 31.46% (computed by adding the incremental revenues to the current revenues that represent 28% of the total then dividing it by the total wholesale dollar sales) and this is a good thing for you since the more dominant you are
in the market, the better since it you could make it harder for new competitors to penetrate. Our recommendation is also backed up in the quantitative side such as project NPV, IRR, MIRR, profitability index, payback period, and discounted payback period. As per exhibit 3, we can see that project NPV is positive $11,538,810.96 which means that this project should be accepted. It also has MIRR of 13% is greater than WACC of 9.38% so under cost-benefit analysis benefit is heavier than costs and as for profitability index, this project gave us 1.26 P.I. which shows that for every dollar spent on this project it will give us a return of 1.26 or .26 additional or return on investment. However, the payback period of 6.68 years may be good but we cannot say as of now since the case didn’t provide data about the benchmark or standard payback period for their
projects and maybe because this is their first time to commit to a big investment that will benefit them long-term. Since they would be able to generate more products, they could try exporting as so that the demand for their product will never be dependent to the market of United States only as this would reduce the risks inherent in expanding. They should also try to look for partners and more customers willing to give them a conspicuous shelf for their products as it may maximize or help them be able to generate more sales than forecasted. It is shown in Exhibit 5 that a 10% change in selling price would have the biggest effect or change in NPV as compared to 10% change in capacity and direct costs. With this, our group recommends that HPL should try to gain market dominance so that they could somehow dictate the price for private label products. They should hire a reputable company for their market
research in order to optimize the selling price without jeopardizing the demand for their products. Differentiating their products from others could also have an impact in the market that their product is worth more than how much it is priced. Conclusion
Hanson Private Label, Inc. (HPL), a manufacturing company of personal care products, is considering a three-year contract from its largest retail customer that could give a significant rapid growth and value for the company. However, in order to comply with the demands of the contract, the company would need to expand its production facilities, thus introducing significant risks which would involve not only the company but also Hansson himself, and would close off all other investment opportunities for the near future. Due to the firm’s goal of being the leading provider of high quality private label personal care products to America’s leading retailers, it is
important to take note that the three-year contract, which could give a significant rapid growth and value for the company, could lead to a huge step up in achieving the goal and be the leading provider themselves. It is also important to take note of the risks involved, where the company will have to incur a high level of debt to finance the project. As seen in the exhibits presented, the NPV, MIRR, and the PI of the project is accepted, and shows that the benefits outweigh the costs, although the payback period shown may be seen as good or bad depending on their standard payback period for projects, as it will benefit them long-term. Also, it
is probable that if HPL declines the offer, another company may choose to accept it which would then lead to an unfavorable outcome for HPL. Due to these circumstances, our group recommends that Hansson Private Label, Inc. should take this opportunity to expand and accept the contract.
