Palliser Furniture Ltd. (Case No. 1)

I. Problem statement: Arthur DeFehr is confronted with a situation where he along with the board must decide how to expand the company; if so, when and where this expansion should take place. This can be either in Mexico and/or China.
II. Alternatives:
1. Status Quo. Do not do anything different from what the company is doing now.
2. Build a factory in Mexico.
3. Establish a joint venture with the Chinese company. III. Analysis:
1. Status Quo. Do not do anything different from what the company is doing now. According to the company's condensed income statement as of December 31, 1997 Palliser Furniture Ltd. did very well financially. The net income for the year grew at an astonishing rate of 92.6% from last year’s net income of CDN$5.96 million to CDN$11.478 million. The sales volume increased 16.9% from CDN$277.21 million to CDN$324.061 million. Yet, the cost of sales increased by only 14.5% from CDN$ 182.091 million to CDN$208.532 million. This difference in the increase rate of sales volume and the cost of sales has generated greater profit margin. Even though, the company has done very well throughout the years, can Palliser afford to stop being innovative—in its product as well as its market strategy—and still maintain its market share? Most analysts would say yes, if they limit themselves to only Palliser's income statement. However, the international market is a dynamic environment. It's constantly changing rather than remaining the same. These changes are brought about by the social, technological, economic, and political (STEP) differences in each of the countries. When an international trade is engaged, the STEP environment for both countries will change over time which can cause a great barrier to one country's export compare to the others. This is precisely what happened in 1975. The CDN$:US$ currency ratio increased to the point where exporting became increasingly difficult, therefore, Palliser withdrew entirely from the export market. However, Palliser did not limit its sales to Canada only, instead, it decided to purchase a plant in the US when the opportunity came. This plant would not be affected by the currency rate change. This small Fargo plant was eventually shut down due to redundancy and inefficiency when Palliser purchased an idled 400,000 square foot furniture production facility in Troutman, North Carolina in 1991. Unable to achieve acceptable quality of output or productivity per worker at this plant, Palliser converted this plant from manufacturing wooden furniture to leather furniture. Since the demand for leather furniture outpaced the demand for others, it was indeed a good idea to move towards that direction. This innovative thinking enabled the company to survive in the US and capture a portion of the market share in this lucrative market. Palliser also made changes in the Canadian market. Because of the FTA and the NAFTA, the competition in Canadian market became very fierce. In anticipation of this, Palliser knew that the company couldn't compete head-to-head with U.S. producers. This caused Palliser to become protective of its Canadian market by narrowing its selection of furniture. This meant only bedroom and living room furniture markets would be targeted rather than all different types of furniture, since these two were the retailers' top two choices, Palliser also reduced the number of distributors overall to strengthen relationships with its top distributors. This eliminated almost half of its 800 distributors and wiped out 10% to 12% of its Canadian sales. In response to increased competition from overseas, such as Taiwan, with their cheap labor market, Palliser established a trading company in Taipei in 1986. This had two purposes, first to help the management think internationally and second to establish a foothold in the foreign market. All these changes that Palliser made due to the environment strengthened the company's finances. However, more changes are coming. Since Palliser had become one of the largest furniture manufactures in Canada with almost 2,900 employees in Winnipeg, the firm offers great opportunity for union recruitment drives. If unionization occurs, the cost of the furniture would most likely increase due to employees wanting higher labor wages. This will make Palliser's market vulnerable to the competition from U.S. manufacturers as well as the Asian manufacturers. Though the Asian manufacturers made gains in the North American market in the low-cost furniture, most firms did not considered the Chinese companies to be serious competitors. However, STEP environment has changed to put Asian companies in better advantage. Better technology combined with cheaper labor force and lower tariff by Canada as well as U.S. made their product very competitive—it's no longer a "cheap" product, rather it's a "quality" product for its price—and their company a formidable competitor against Palliser. What concerns Palliser is the willingness by some retailers to buy directly from the Chinese without the assistance of Palliser World Trade. The best Chinese producers were able to market without intermediaries. All these changes mean Palliser would lose its influence, revenue, and ultimately even its market. Due to this dynamic environment caused by different STEP associated with their respective countries, a company cannot lie still and assume everything will be back to normal later on. These changes are not temporary changes, but permanent, therefore, the company must plan to meet these challenges or face extinction. Therefore, maintaining status quo is unwise at this time.
2. Build a factory in Mexico. The NAFTA has created an environment where many manufacturing plants in the U.S. moved their plants to Mexico because of the cheaper labor force. In 1996, the wage rates in the industry in Canada were CDN$10.66/hour whereas in Mexico in 1997, the workers were paid US$1.00-1.50/hour. Taking the currency exchange rate into account, there is still a huge wage difference. Besides the wage difference, the weak performances by the Mexican upholstered furniture producers created an opportunity for competitors to move in and attack the local manufacturers. This opportunity was created, even though the retailers prefer to purchase products from Mexican plants, because of lack of supplies and too many delivery delays. The retailers were looking for alternatives. Another opportunity for competitors was in the "Rustic" furniture segment. Total production in Mexico for this type of furniture was over US$100 million in 1997 and 60% was exported to the U.S. with sales increasing at 15% annually. Though inefficient, the leader of the Rustic furniture segment was Segusino S.A. This company in 1997 generated a revenue exceeding US$35 million. The Mexican furniture manufacturers' production amounted to US$2.9 billion at wholesale prices in 1997 an increase of 17% over previous year's levels. Around 13% of the firms produced upholstered furniture and only 7% produced kitchen furniture with an annual value of US$226 million and US$122 million, respectively. With an expected increase in wooden furniture by 17%, a competitor should be able to meet this increase in demand without encountering any retaliation by local companies. The Mexican market also consumed US$3.35 billion worth of home furniture in 1997. Bedroom and living room retail sales accounted for US$2.51 billion. However, the domestic demand was still only 80% of what it had been a decade earlier. Household furniture made up 74% of the import with the total by 1996 being US$250 million. As for export, which was worth US$1.7 billion, residential furniture accounts for 70% of which 18% was upholstered and 2% kitchen furniture. All these opportunities encourage a firm not to export its product to Mexico, but to actually build a manufacturing plant in Mexico and sell domestically as well as exporting into the U.S. Assuming that the junior-level team did an excellent job of estimating the costs and revenues of establishing a plant in northern Mexico, when will Palliser recover its investment and how fast will it grow? These are some of these questions that must be addressed. If the company cannot recover its investment, there is no point of building a plant. If the recovery process is too long, the company might undergo financial trouble that can only be resolved through liquidation.
Looking at the worst case scenario with the report generated by the junior-level team, the company should be able to recoup any initial investment by the end of the second year (Appendix 1). And if the growth rate continues, the company should be able to become a market leader in Mexico in no time. Once the decision to build the plant has been made, the next question is where? The criteria for determining the location of the plant are: excellent infrastructure; large labor market; close proximity to suppliers; stable government; and others. Saltillo meets these criteria. Another benefit to Saltillo is large pool of female workers that are willing to work for US$1.00-1.25/hour. Furthermore, the location is close to the U.S. border enabling the delivery tune to be low.
3. Establish a joint venture or some form of alliance with the Chinese company.
Ignoring the marketing strategy by the Chinese companies would be a huge mistake. They have gained grounds in producing a quality product. Because of shipping and handling charges, these companies, by using the principle of economies of scale and cheaper labor force, are able to mass-produce their products. As stated before, some of these companies are able to directly deal with the retailers rather than dealing with Palliser. However, they are still 70 companies willing to work with Palliser as an intermediary. But this could change depending on the aggressiveness of the retailers willing to make deals with the Chinese companies directly. Palliser must address this threat by the Chinese companies. Already Lacquer Craft's President indicated that he is interested in making a deal with Palliser. Palliser should consider this and pursue any other options that are in the horizon. Due to lack of information, the junior-level team should do more research before recommending any decision.
IV. Recommendation: as a consultant of this firm, my recommendation is for Palliser to expand into the Mexican market by building a manufacturing plant in the city of Saltillo (alternative number 2). [Explain why this is a superior alternative to those analyzed]
V. Plan of Action: As Arthur acknowledges that "the Mexican leather furniture industry is made up of small manufacturers with low sales volumes who do not have the capability of Palliser given our experience and financial strength. If we act now, Palliser could be the controlling force in the Mexican leather industry hi 10 years, precluding our competition from making a similar move." Because Palliser has the financial strength it must be willing to build this plant before other competitors move in. The paperwork of filing requests for government approval and obtaining the place to manufacture, and the logistics of hiring the people to work and establishing the layout of the plant must be done. Once the plant is in operation, the company should proceed with building leather furniture for exporting hi the U.S. This market grew at a rate of 15% to 18% between 1994 and 1997. Now with cheaper labor while maintaining the same Palliser quality, the company should be able to gain even greater grounds in this lucrative market. Afterwards, the company should turn to "Rustic" furniture that is doing exceptionally well especially upholstered furniture for both U.S. as well as Mexico. This product is very popular with those individuals with Mexican background, which includes many from southwest region of the U.S. Furthermore, this move should help Palliser form losing its market share to the Chinese companies. By speeding the process of manufacturing and delivery, without sacrificing any of the quality that Palliser is known for, the retailers in Mexico would be more than willing to make deals with Palliser. By establishing a strong presence in Mexico, other foreign competitors should shy away from direct competition. Using computer-aided design and computer-numeric-controlled machinery and JIT can create a high entry barrier for most companies. Later on the company might consider marketing then* products more aggressively into South America after doing extensive research to the demand for the products that Palliser manufacturers. As for Palliser World Trade, the company needs to gather more information before making any decision about what to do with the foreign competition from China.
VI. Contingency Plans: There are many assumptions that have been made in making this recommendation. First assumption is that the report generated by consultants working for Palliser and the junior-level team is accurate. The second assumption is that the positive trend in the upholstered furniture, the leather furniture, and the "Rustic" furniture will continue to hold. Third assumption is that Palliser would be the first furniture manufacturer company to be built in Mexico and others will back away from establishing a manufacturing plant of their own in Mexico. The last assumption is that the retailers in Mexico will purchase products from Palliser, even though it is Canadian owned. If the first assumption is not true, then this whole decision must be reevaluated in light of what is accurate. As consultants, we guarantee the accuracy of our report. As for the report generated by the junior-level team, this must be carefully examined. Inaccuracy can lead to either a benefit or a detriment. Benefit if the cost of establishing a plant is less than what was forecasted. This means less time is needed to recover all the investments. Detriment if the cost is more than what the company originally planned. If the cost is huge, it can force the company to rethink its willingness to build a plant there or it will take longer time to recover its initial investment in the plant. If the company cannot build a plant in Mexico, it must be willing to go elsewhere to produce quality products for less cost. If they cannot find a reasonable place, a joint venture or strategic alliance might be needed. If the second assumption proves to be misleading, instead of growth there is either a decline or stagnation, the company must not expand beyond the demand. If there is no growth, Palliser should still build a plant in Mexico, for Palliser is able to remove some market shares from other competitors. However, if the demand decreases to the point that Palliser has excess amount of supplies, it should not build a plant in Mexico. Instead the company should strengthen its distribution channels and be willing to make deals with retailers to keep its products out in the market. When the economy picks up again, many of the competitors have either consolidated into a different company or have filed for bankruptcy. This means fewer competitors, but those remaining behind are in better shape than before. Likewise those are some of the options that Palliser can pursue as well, but not recommended if Palliser wants to maintain its current management. If the third assumption is wrong, and other manufacturers do move in, Palliser must be able to "brand" its product through promotion to the retailers as well as to the consumers. Not only establishing a brand name, but also increasing the efficiency of the plant becomes very important. This will lower the cost of manufacturing, and the money saved can either be used to increase marketing or to lower the price of the product. Either case, Palliser must act quickly before some other company establishes its presence before Palliser does. If the last assumption is unfounded, then there is nothing Palliser can do until the Mexican retailers change their attitude. Providing them with offers and deals that they can't refuse can ease their unwillingness to distribute non-Mexican owned furniture. Meanwhile the plant should be built for exporting purposes. Appendix 1

Taking the worst case scenario

Revenue: Annual Expenses: Travel & Entertainment Factory Operation (i.e. power) Inventory Accounts receivable Key Personnel Annual Wages: General Manager
Sales Manager Financial Manager
Plant Supervisor Sales Representative Clerical & Hourly Employees Projected number of workers:

Net Income before tax and initial cost

Initial Cost in Production Facility Refurbished Factory Space & Land Machinery & Equipment Office Equipment & Computers

Year 1 Year 2 Year 3
$10,800,000 $18,700,000 $31,400,000

|$ | 23,000 |$ | 23,000 |$ |23,000 |
|$ | 1,620,000 |$ | 2,805,000 |$ |4,710,000 |
|$ |1,080,000 |$ | 1,870,000 |$ |3,140,000 |
|$ |1,620,000 |$ | 2,805,000 |$ |4,710,000 |
|$ | 67,500 |$ | 367,500 |$ |367,500 |
|$ | 74,250 |$ | 89,250 |$ |89,250 |
|$ | 60,750 |$ | 66,750 |$ |66,750 |
|$ | 33,750 |$ | 36,750 |$ |36,750 |
|$ | 21,500 |$ | 208,500 |$ |335,500 |
|$ | 676,000 |$ | 1,253,000 |$ |2,100,000 |
| |104 | | 179 | |300 |
|$ |5,523,250 |$ |9,175,250 |$ |15,821,250 |
|$ |9,000,000 | | | | |
|$ |5,000,000 | | | | |
|$ |300,000 | | | | |

Accumulated profit before tax
$(8,776,750) $ 398,500 $16,219,750