Riley Young Cole Wiggins March 2nd, 2016
Precision Steel Fabricators: An Equipment Purchase Decision Case Analysis Problem Statement
The main issue that is faced by Precisions Steel Fabrications in this case involves whether or not they should purchase an industrial tube laser cutter, or if they should continue operating with the same current equipment. The final decision is in the hands of the owner of the company, Tripper Hawthorne. Although, Hawthorne gives the responsibility of analyzing and researching the financial logistics behind this decision to the company’s controller, Bobby Zane. In addition, Zane includes the company’s vice president of engineering, Sanjit Raj, in the decision process to gain knowledge about potential fabrication equipment manufacturers that PSF would purchase a laser tube cutter from. Situation Analysis
Precision Steel Fabrication (PSF) was a steel fabricator that produced components primarily for the contract office furniture industry. Tripper Hawthorne was the owner of this company, after he purchased it from his Father and Uncle in 1980. The Company rode a solid wave of increases in contract furniture sales, which started in the early 1990’s and peaked in 2001 at sales volume of $10.9 million. At this time PSF employed 105 employees. Due to a downturn in the U.S economy toward the end of 2001, the office furniture industry’s sales dropped drastically, from 13.2 billion in sales to 8.5 billion by the end of 2003; a drop of 36%. This market turn directly affected Precision Steel Fabrication. Over the next two years the company’s sales dropped to $8.3 million. This 24 percent decrease forced cost reductions throughout the company, resulting in the lay-off of 49 employees. Being a smaller family operated organization, these layoffs took an ethical toll on the management team and environment in the workplace. Thus, making the possibility of re-hiring as many of the recently laid-off employees remain amongst the top of PSF’s priorities. They hope to re-hire 6 employees by the end of 2004. In 2004, the Industry began to turn around resulting in a 2004 sales forecast of $10 million for PSF. Industry analysis predicted that the industry will continue to grow in demand, giving PSF’s management team a sigh of relief. Customers provided PSF with orders and specifications and in turn PSF would provide these customers with the best manufacturing price package. The price packages would include the part
price, tooling cost, and service costs. Price was an important factor, but customers often viewed tooling and service costs as additional expenses. Being able to produce a part with lower tooling and service costs tended to win business for a furniture supplier. According to Hawthorne’s beliefs, the contract furniture industry was dominated by four major companies: Steelcase, HNI Corporation, Haworth, and Herman and Miller. Steelcase was the industry leader with sales of $2.3 billion, and was located in Grand Rapids, Michigan. HNI was close behind with $2.1 billion, and located in Muscatine, Iowa. Haworth and Herman Miller were both located in the same geographic region as PSF and had sales of $1.4 and $1.3 billion respectively. Together these four companies occupied 80 percent of the $8.9 billion industry. Many contract furniture companies focus on the design, assembly and distribution of their products; while choosing to outsource the manufacturing of steel, wood, and plastic components to other organizations. Horizontal integration is common in this industry, pushing companies like steelcase to focus on their core competencies and move away from vertically integrated operations. PSF purchased it’s materials from three different suppliers: Roll & Weld Tube, Turner Wire, and Northern Steel & Wire Company. Roll & Weld Tube supplied PSF with rolled tubular steel, which accounted for 75 percent of PSF’s products sold. Roll & Weld tube agreed to deliver steel twice a week, allowing PSF to hold very little inventory. Turner Wire provided steel wire which contributed to 20 percent of the products sold, and Northern Steel & Wire Company supplied sheet metal which occupied the remaining 5 percent of products sold. PSF’s manufacturing process, without the use of a tube laser cutter, included three main functions: The cold saw, which cut the tubular steel to specified lengths. The hydraulic press, which punched holes into the cut tube with custom made tooling. And the deburring wheel, which smoothed the sharp edges and burrs on the steel that were created from the previous processes. All of the above operations would require an employee to operate the machines and handle the material. Once completed, the finished products would be sent to powdercoater, which then painted the steel components to match the specifications requested by the customer. After this process was completed, the customer would be responsible for the pickup of materials from the powder coating plant and at that point was invoiced by PSF. With the purchase of a tube laser cutter, PSF would be able to combine the three process steps into one by cutting and punching the tubular steel simultaneously and eliminate the need for deburring due to the clean cutting precision of laser technology. The laser cutter is said to be able to produce 200 readily punched steel pieces per hour. In addition, the use of the laser cutter would mitigate tooling costs, making PSF’s pricing packages more appealing to customers, and also giving them a competitive advantage. 2
We conducted a SWOT analysis to clearly identify Precision Steel Fabricators position in its market environment. Listed below are the internal and external factors that affect PSF’s market position: Strengths ● Financially stable - no long term debt, 2 million line of credit ● Optimally located ● Supplier for Herman and Miller ● Industry is in an upward movement, jobs expected to increase Weaknesses ● Small family business with a conservative budget ● Niche market ● 75 percent of our business in tubular steel, and from one supplier, which is risky ● Lack of diversity Opportunities ● Buying the Laser Tube Cutter ○ Reduced tooling costs of $20,000 - $30,000 ○ Have addition contracts of 160,000 in the first year and 600,000 in the second ○ The machine is able to do the job of three machines and be more effective ○ 50 percent depreciation bonus with capital expenditure before end of 2004 ● Moving into the I-beam industry and diversify the business ● Gaining steelcase’s business ○ Biggest company in the industry Threats ● Influential Market ● Lack of supplier capabilities ● Small competitor in the contract furniture industry ○ 4 companies control 80 percent of the industry
Key Decision Criteria
The main criteria in this case involves the decision of whether or not PSF should invest in the new laser tube cutter. Contributing factors include: ● How quickly will this machine pay itself off. ● Will this purchase help PSF gain a competitive advantage in their market. 3
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Will this machine be in production by the end of 2004. If the purchase is proven feasible, which laser cutter will they purchase. Will it live up to increased sales forecasts associated with the purchase of the laser cutter. Will the purchase of the laser cutter help the company expand into new markets. Can PSF’s inventory and staff handle the faster production rates. Will these faster production rates and automatic machines eliminate more jobs for PSF employees.
The Alternatives
PSF is faced with 4 alternatives to choose from. The first being not buying the laser, and continuing with the current traditional 3 step production process. The second being purchasing the new laser from JLS/Brodure, the third being buying Nakamura’s, and the fourth being choosing to buy the machine from Luxembourg. Option number one saves the company the large expense of buying the machine, which could allow them to hire back six of the employees that they had to lay-off because of the economic downturn. We have decided to not choose this option because this will make PSF less competitive. If we continue production the traditional way, PSF will miss out on new contracts that would become available with the purchase of the more efficient machine. Precision will not be able to mitigate their tooling costs, which is an expense that their customers grieve to pay. Failing to invest in this capital expenditure will void PSF of the potential savings they could achieve with the 50% depreciation tax benefit that is offered for the capital expenditure in 2004. This alternative will only hinder PSF’s options to expand and be competitive in the contract furniture industry. The second option is to buy the laser tube cutter from JLS/Brodure, a steel fabrication producer from France that exclusively specializes in laser tube cutters. This machine is used for smaller diameter cuts and thinner walled tubing, which is primarily what PSF cuts. This machine has an autoloader on the back giving it the ability to run autonomously. The machine can be bought and in production at PSF factory by the end of 2004. There are fifteen of these machines already being used for production in the United States. Option three involves buying the laser cutter from Nakamura, a large Japanese steel fabrication equipment manufacturing company. Nakamura has been a leader in laser cutting technology and has been producing sheet metal lasers for seventeen years. Precision actually bought a metal sheet laser in 1996 from this company. This machine has more capabilities than the other two 4
cutters because it is twenty feet larger in length, which allows it to handle thicker walled larger pieces of steel. Although, due to its larger size and diverse capabilities, the production rates associated with this machine are significantly lower. It has an automatic loading feature as well, but only one model with this feature currently exists, and it is located in Japan. The purchase of this machine could potentially allow PSF to expand into new markets by utilizing its capabilities to process and manufacture larger pieces of steel. We decided to not pick this alternative because it will not be able to produce as much as the other machines. The machine is capable of cutting thicker steel, but PSF does not use thicker walled tube in much of its production. This laser cutter is 20 feet longer than the other two machines, which could potentially be a problem for the factory in terms of available space on the operating floor. Also, Nakamura did not indicate when the machine could be delivered and ready for production, which is a big concern for PSF if they want to reap the benefits of the 2004 depreciation tax benefit. Another factor to take into consideration is that this a newly produced product, and there is currently only one that exists in the world (Japan). So the long term effectiveness and operating capabilities are not proven adequate. This machine could be beneficial for PSF in the future. With the increased sales forecast, the company may be able to afford the purchase of another laser cutter. And with the purchase of this particular machine, they could expand into new markets and begin producing larger steel products useful for other industries. The final option is Luxembourg, a German manufacturing company that is one of the biggest in the world. Luxembourg has been making laser tube cutters for ten years. One of the problems with this company is that they are a massive company and the laser tube division is only a small sector of the organization's business. Resulting in Luxembourg having a less knowledgeable and inexperienced service team, compared to the other two companies. This could cause problems for PSF in the future if they encounter any problems with the machine and are in need of troubleshooting assistance. It has similar production rates compared to the JLS/Brodure machine, and is also primarily used for thinner walled steel. It has an automatic bundle loader and like the Japanese cutter, has no indication of when the product could be delivered to PSF and ready for production. Recommendation
We recommend that PSF should buy the laser tube cutter because it will save the company money and it will make them eligible for contracts that they otherwise would not have had a chance to obtain. The laser tube cutter will allow PSF to increase their production by 4.77 times and reduce labor by 3.36 times compared to the production numbers in 2003. These number can 5
be found in Exhibit 1. The inclusion of this machine in the company's production process will eliminate the three process system that they had currently been operating with, and instead implement a new process that will produce the steel components in a more efficient and effective manner. Leading to PSF saving valuable time and money. With the purchase of a laser tube cutter, PSF will mitigate their tooling costs that customers assume responsibility for, and give them an overall more competitive and appealing pricing package. PSF will save $53,375.88 annually after they put the tube laser into production. By purchasing the tube laser, PSF will be able to get new contracts worth a forecasted $160,000 in the first year and $600,000 in the second year. The organization will receive a tax deprecation deduction of 50%, meaning they will not have to pay taxes in 2004, equal to $184,775 in tax savings. This provides the company with a large down payment for the machine. The laser tube cutting machine that we chose to purchase was the JLS/Brodure model, for this particular cutter is best suited for this business. An appealing factor that comes with the choice of this option is that Brodure only specializes in laser tube cutting equipment and has a great service team. PSF is able to get this machine by the end of 2004, while the other companies did not say if whether or not they can as well. This machine is used for thin walled tubing which PSF uses for most of its products. It also has one of the highest production rates.
Action and Implementation Plan
We will buy the JLS/Brodure Laser Tube Cutter and have it installed into our factory by the end of 2004. We have predicted that this will increase our business at PSF, while saving money at the same time. With the increased sales and cost saving from the machine we hope to hire back the six employees that we had to lay off. We are hoping to get the business of Steel Case, since have recently decided to move away from their vertically integrated production process and focus primarily on their core competencies, which are design, assembly and distribution. Steel Case is the biggest player in the contract furniture market, it would be huge for PSF to get their business. Also, Steel Case is located in the same geographic area as PSF, making for easy transportation and lower costs. If everything goes well and we keep increasing our sales, as forecasted, we would like to progress into a larger variety of steel products. One example could be steel I-beams that are used in the construction industry. If down the road, we decided to horizontally integrate, we would look into investing into a laser cutter that was more similar to the dynamics of the Nakamura laser tube cutter. 6
Another potential movement PSF could one day consider if business continues to flourish, is looking into expanding business to Canada. Since London, Ontario is only four hours away it is not out of the question to sell to Canada. If the duty fees and extra costs of exporting the steel doesn’t make us uncompetitive we should look into this market. Exhibit 1
This graph shows the production costs associated with labour in 2003, with or without a laser cutter. As you can see PSF will save $37,982.64 in labour costs alone. Their production line would be 4.77 times more productive and would also operate with 3.36 times less labour hours required.
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