Case #1 - Filter Innovations Inc.

Critical Issues 1.) How to comply with government regulations so that FII can sustain their corporate goals and vision of being an innovative leader within their industry. 2.) How to effectively brand FII with the MBR technology within the scope of their current market so that they can sustain their existing customer centric competitive advantage. 3.) FII is behind innovation due to managerial decision of only allocation 5% of EBIT towards R&D.
Analysis
The waste water management industry is experiencing significant growth around the world and expected to be worth $348 billion by 2010. The opportunities in North America are growing due to rising population, government regulations and the “Green” movement; therefore there will be a much higher demand for MBR technology. While the government regulations help drive demand, they can also hinder operations by making existing product lines obsolete.
New government regulations are being implemented which is putting pressure on FII to invest in newer technology that is in compliance with these regulations. This is evident due to the fact that their income has reduced by $97,899. A new opportunity to invest in Membrane Biological Reactors (MBR) would allow FII to meet these government regulations. The new technology would be replacing some of their existing product lines. MBR would be able to treat biological wastewater in addition to ground and industrial process water, which would give FII a larger customer base. John Dragasevich, President of FII, predicts that investing in MBR will increase his company’s sales by several million dollars.
The wastewater filtration industry is dominated by two major organizations, Zenon and Siemens, which cater to the larger municipalities and industry contracts. This means that FII will have to position their company to target the market that is below what the major organizations consider to be profitable. This range is between 10,000 and 1,000,000 litres of wastewater per day. FII’s direct competition in this “niche” market range for MBR systems is only two companies, Eviroquip and Sanitherm. Both companies are geographically distanced from one another, and from FII, which allows each company to capture the regional markets in their relevant areas. The Porter’s Five Forces analysis in Exhibit 4 states that the “Market is growing and due to barriers of entry there seems to be enough customers for the competing firms, hence lowering the competition intensity.”
Looking at FII’s current financial position, they have the capability to begin their expansion into MBRs going forward into 2009. Their current ratios as compared to industry standards are shown in exhibit 1. For every dollar of liabilities that FII has, they have $2.19 of current assets to counter it which is much higher than the industry standard of $1.20. This means that they have enough current assets to cover their liabilities comfortably, and of that $2.19 of current assets, $1.72 of it is already cash. This means they would not have to try to liquefy their assets to cover their current liabilities, they already have enough cash to cover them.
Also, FII carries no long term debt, so they do not have to try and cover those obligations. This is portrayed in their debt ratio as for every dollar of assets FII has there is only $0.45 of liabilities. In this respect, they can easily afford to incur more debt as they have enough assets to cover it. In terms of the actual gross margin that FII receives from their sales, their profit is 37% of their sales as opposed to the 29% that is the industry standard.
In order for FII to be successful with implementing the MBR systems they will need to become very knowledgeable in all aspects of MBR, and brand itself as a reliable supplier of MBR. In order for FII to fit its MBR expansion with its existing “customer-centric outlook” they will need to have the knowledge to not only install the new MBR system but also provide the same level of customer service that they do with their existing product line. This is very important to their competitive advantage as ongoing service and support will allow them to win contracts. FII will need to hire a technology expert that already has experience in MBR systems and for this they may look to Europe because Europe is more advanced in this technological aspect.
A decrease in net income had an adverse effect to R&D because 5% of EBIT is allocated towards further research and due to the decline in net income, FII’s R&D budget decreases as well. Therefore, FII is losing their innovative edge within the industry. This is evident as they are currently behind in the MBR technology.
Options
A.) Status Quo
If FII were to go into 2009 without investing into MBR technology, they will continue to lose revenue due to the new government regulations making some of their products and services more obsolete. FII will lose even more clientele because they will not pass future regulations. Based on their decline in profit in 2008¹ and if FII’s product line were to remain the same, FII would continue to see a loss in the coming years. Dragasevich’s vision for the company is to be a leader in innovations and the company’s corporate goal is to be socially and environmentally responsible. Neither the vision or cooperate goals will be met if FII continues its current product line. B.) Investment and launching MBR products in 2009
Investing in the MBR technology would give FII the ability to serve clients with biological wastewater, and obtain a new market of clientele in different sectors such as mining. FII should look to brand this new technology so that it aligns with their customer centric competitive advantage. To coincide with the launch in 2009, FII can take up to 6 months for employee training. The training will cost $12,950. The following three scenarios outline the potential impact to FII’s financial position regarding the MBR systems.
Best Case
The best case scenario is predicted to have $500,000 in sales of MBR systems, $87,500 in installation revenue and an overall incremental profit of $222,612 (see exhibit 2a). This scenario would give FII an ROI of 61%. The overall cash flow generated by the MBR systems in the best case scenario is $296,370 with an initial $110,000 cash investment (5a).
Worst Case
If FII is only able to generate $100,000 in revenue they would incur a loss of $62,388, with an ROI of -35% (see exhibit 2b). The overall cash flow generated by the MBR systems in a worst case scenario is $19,266 with an initial $110,000 cash investment (see exhibit 5b).
Break Even
FII would need to have system sales of $177,261 to generate incremental revenues of $208,282 to break even, thus leaving them a margin of error of $322,739 in sales (see exhibit 2c). C.) Launching MBR products in 2010 If FII was to delay one more year in launching their new line of MBR products they would delay their chance to build their reputation up as a MBR leader in the industry. Delaying one more year may minimize the risk of launching a new product line too quickly and damaging their reputation due to product failure or poor service. However, FII would also have to consider their competitors in the MBR industry as the longer they delay getting their product to the market the more market share Sanitherm and Enviroquip will obtain. D.) Maintaining R&D investments
Due to the loss in net income over the last two years, R&D investments have substantially decreased. FII could maintain fixed costs associated with R&D to prevent an innovative lag. Based on FII’s expenses for 2008 they can afford to invest a minimum of $20,000 each year to R&D.
Recommendations/ Action Plan
Based on the above analysis and options provided, we recommend Filter innovations launch the MBR systems in March 2009 as this will allow a 6 month training period (option A) & maintain a minimum of $20,000 investment in R&D costs (option D). This recommendation will address the issues of government compliance, lags in innovation due to decreased R&D, as well as sustaining their competitive advantage. The action plan will outline the steps required for FII to take in order to successfully implement the recommendation. Please see exhibit 6.
Exhibit 1- FII vs. Industry Ratios Ratios | FII | *Industry ratios from SME Benchmarking Canada
"SME Benchmarking Tool - Home." Industry Canada | Industrie Canada. Web. 21 Sept. 2011. <http://www.ic.gc.ca/eic/site/pp-pp.nsf/eng/home>.
Industry Average | Current ratio | 2.19 | 1.2 | cash ratio | 1.72 | 1.18 | Debt Ratio | 0.45 | 0.7 | Debt/Equity Ratio | 0.81 | 2.5 | Gross Profit Margin | 37% | 29% |
Exhibit 2- Scenarios
a) Best Case ($500,000 in system sale) b) Worst Case ($100,000 in system sale)

c) Breakeven

Exhibit 3- SWOT Analysis Strengths | Weaknesses | * Company has been around since 1992 * Reputable in the industry * Profitable * Member of Calco Group allows FII to have: * a shared knowledge of network and resources * manufacturing alliances * exclusive suppliers * extended terms to pay for components * Due to FII’s access to many resources, FII can be flexible to their customer’s needs * Sales in North America and Europe * Served over 500 clients, 1500 business sites * High working capital with total assets at $1,433,732 * 5% of profit spend on R&D | * Can only target smaller contracts with under 1million L per day due to Zenon and Siemens * Low profit margin after expenses at only 4% * Obsolete product lines that does not pass government regulations * Customers are on 90 day terms to pay (affects cash on hand) * Components for their systems come from suppliers which would require transportation costs of 5% * Lack of knowledge in the MBR technology (behind two companies) * Income went down $110,016 in 2008 (2007 Income: R&D is $13,504/5% = $270,080) * Will have less money for R&D in 2009 based on 2008’s IBIT if FII continues with the 5% investment ($8,609 compared to 2008’s $13,504) | Opportunities | Threats | * Growing industry * Market for water and wastewater market increasing * Green movement – companies taking more initiatives to water filtering * Developing nations demand for safe drinking water increasing * Newer regulation increases the demand for water treatment systems * 40% increase in water consumption by 2025 * Opportunity to invest in MBR technology: * allows to pass newer regulations * can service a larger market as MBR can treat biological wastewater | * Industry dominated by oligopolies: Zenon and Siemens * Current change in provincial government regulations meant that existing wastewater treatment designs did not meet the new guidelines * New technological advances in the industry * Reputable can be damaged as word of mouth is critical in the business * Sanitherm and Enviroquip already in the MBR market and ahead | Summary: The current industry of water filtration is at a growth and demand is rising. However, FII faces the threat of ongoing government regulation which has made their product lines obsolete and causing their sales to go down. They have an opportunity to develop a new line of product using MBR technology which will allow them to meet with the newer government regulations. FII’s lack of knowledge puts them at a risk of damaging their current strength in reputation if the product and services does not meet with customer expectations. |
Exhibit 4- Porter’s Five Forces

Exhibit 5- Cash Flow Analysis
BEST CASE

WORST CASE

Exhibit 6- Action Plan | Task | Timeframe | Start Date | Finish Date | 1. | Start Training Program | 130 days | Mon 03/10/11 | Fri 30/03/12 | 2. | Hire MBR Tech Expert | 25 days | Mon 03/10/11 | Fri 04/11/11 | 3. | Acquire MBR Equipment Inventory | 11 days | Mon 03/10/11 | Mon 17/10/11 | 4. | Plan out Marketing Strategy | 60 days | Mon 03/10/11 | Fri 23/12/11 | 5. | Evaluate Plan and performance | 11 days | Fri 14/09/12 | Fri 28/09/12 |

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[ 1 ]. Calculated by taking 2008 R&D and dividing it by the 5% annual R&D investment figure (gives you EBIT from 2007), then subtracting EBIT from 2008. Calculation: ($13,504/.05)-$172,181= $97,899 drop in EBIT
[ 2 ]. 906,456 /14 employees = $64,746.86 average annual salary. We assume to takes 20% of this time will spend on MBR training (20% is based on Dragasevich’s time spend on MBR). $64,746.86 x 20% = $12,950.