During the period from 1955 to 1961 the management of O.M. Scott & Sons Company ‘Scott’ launched numerous projects to experience additional growth. To achieve its goals the company grew its sales force from 6 to 150 employees, the number of products in the product line tripled, and the sales volume increased from $10 million to $43 million. Experiencing such a vast growth, Scott went through major internal changes. Unfortunately, this phase of uncontrolled expansion put Scott in a weakened financial position and the company officials were preparing to review the results of all the changes and debating if plans and financial policies needed to be changed. Scott began its operations in 1868 by selling the first clean, weed-free grass seeds on a small local market in Ohio. Later, the company started selling over a wider geographic area by distributing its orders through mail. Due to its wide spread success the company started advertising extensively and added a free magazine about general lawn care to all its orders and established early on a well-recognized brand name for its products. The company continued growing and started selling lawn fertilizer, a wide range of chemical weed and garden pest control and distributing its products through small retail stores and garden centers. Despite the striking achievement the management believed that the market share that Scott and its competitors had was small compared to the total potential national lawn care market. Scott attributed this underperformance to an inadequ ate distribution system which did not reach the customers and retailers that were either poorly stocked or not suitable to carry Scott’s products. In response to these issues Sc ott launched a program and built a national field sales organisation to increase the number, quality, and performance of its distributors. In the meantime, Scott increased its product line to better serve the customers. Sales increased dramatically and the majority of the sales came from new products developed and patented by Scott within the last few years which demonstrated the achievement in Scott’s R&D but also showed the huge capital investment undertaken by the company to extend its product line. Reviewing its success in 1959 Scott’s management was not satisfied with the accomplishment because the market potential was estimated to be much higher and several national chemical firms were expected to enter the market. Scott’s management decided that additional growth would be the most effective way to preserve its dominant market m arket position. According to the management an annual growth rate in sales and profits of up to 25% was thought to be a reasonable goal for the company over the next few years. To achieve this goal the management believed it needed to continue strengthen its sales force and dealers needed to be able to carry sufficient products to meet sales peaks during high season. Scott had shifted from selling a few single products in the past to offering a whole lawn maintenance program which meant additional space and inventory requirements for the retailers. Since most of the dealers were not able to pay upfront for the products Scott was required to help finance the dealers’ inventories and also offered generous paying terms according to industry practice, even for shipments outside of the high season. (2 months) Early payments were honoured with only a 0.6% refund which did not entice the dealers to pay early. early. Not only were the paying terms very lenient but payments were constantly deferred even after merchandise was sold. In addition, Scott wanted to have more control over pricing at a retail level since low prices were thought to devalue the brand name. Due to these problems, Scott introduced a new trust receipt plan. The main idea was lending against inventory which meant that Scott was able to check the dealers’ inventories and send out bills according to sales and dealers were required to keep funds from sales to pay bills. Dealers using a trust receipt plan were charged an extra 3%. Instead of using this percentage to entice customer to pay early Scott introduced tighter control 1
which was very labour intensive and costly. After introduction of the new plan larger chain and garden centers were still using the seasonal dating plan and taking advantage of lenient payment conditions whereas the smaller retailers used the new trust receipt plan. Unfortunately, the receivables kept on rising in an alarming fashion and the new paying plan did not have the expected impact. In addition, the physical inventory grew in an alarming fashion as well and reached an all-time high of close to a full year of sales. Instead of properly analyzing the company’s situation and take action accordingly the Scott’s strategy in 1959 was to pursue additional growth due to the threat of new entrance. Unfortunately, the managers never checked if the company could actually internally keep up with the changes required by such growth. As sales increase and more people are hired, inventory increases and sales outpace manufacturing capacity which leads to an increase in facilities and so on. Accounting systems and controls cannot keep up and cash burn accelerates.1 Once Scott decided to grow further, the company would have needed to establish a cash budgeting projection to make sure the company was able to sustain the growth.2 Moreover, Scott is not doing a good job, as already mentioned, in collecting its receivables and the new plan is not improving the situation. Further, the company is spending a ton of cash in R&D and has already maxed out its debt allowance. (Exhibit 7 from case) All this combined will lead to a cash crunch and could have, if not addressed immediately, serious consequences for Scott’s future. Analysing the financial statements the concerns above are confirmed. Calculating the 3 ratios for all years (1957 to 1961) illustrate the progression of the issues. All ratios show the same picture. Up until 1959 there was a positive growth happening (Appendix page 5, column year to year change) but after 1959 the costs outrun the revenues which led to a negative growth. To understand where the issue is coming from we need to have a closer look at the activity ratios. The day’s receivable outstanding ratio really does not look promising. The collection period has risen from approximately 52 days (1957) to 182 days in 1961 which is clearly not acceptable. Scott is obviously not capable of collecting its money. Even the new system (trust receipt plan) did not improve the situation. Having lots of money uncollected and trying to grow the business, that is not a healthy combination. We know already that Scott has reached its maximum debt allowance and reviewing the times interest earned ratio (Appendix page 5, solvency ratios) illustrates that the capability of p aying its obligations (interest payments) is rapidly declining after 1959, clearly documenting that the company is not able to sustain its current growth and for sure not an additional growth of 25%. It is only a question of time until a cash crunch will occur. Additional growth will only accelerate the problem. My recommendation is to immediately stop the rapid growth plan and work out a proper strategy of how to best collect the receivables. When Honda established a base in the USA (about same time period), Honda faced similar problems and had constantly lots of cash outstanding. Honda simply changed its policies and delivered for cash payments only. The astonishing part was that the retailers actually accepted the change. I am not sure this could work in this case, but having the right incentive plan on hand, in other words to make it attractive for customers to pay on time or even pay early, could prove to be very profitable for Scott. Instead of investing in sales people that have to constantly check inventory which is very time consuming and consequently costly, I suggest using these funds and making an attractive plan for customers that pay on time. Early payments need to be attractive for customers to see an advantage when using this option. Instead of controlling the retailers, Scott has to create value for them which ultimately will have a payback effect in early collection of the receivables. 2
Appendix References:
1
Roger Babson, Managing Rapid Growth: Entrepreneurship Beyond Startup
2
Roger Babson, Managing Rapid Growth: Entrepreneurship Beyond Startup
3
Harvard business School Press, August 21,1996, Finding meaning in financial statements, Finance for Managers
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