Pack-A-Card Gift Card Packaging Company
Marriott School Of Management 2008

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Pack-A-Card GIFT CARD PACKAGING COMPANY "The possible benefits make this proposal very tempting," mused Mr. Craig Hunt, "but how would it affect the other areas of the business?" In a recent planning meeting held in July 2008, production manager, Ms. Ching, proposed that Pack-A-Card (PAC) Gift Card Packaging Company adopt a level-production strategy for the next year. PAC's sales were seasonal and the company, therefore, produced on a seasonal basis. By switching to level production, Ms. Ching hoped that production costs could be minimized. Pack-A-Card Gift Card Packaging Company designed and manufactured a variety of gift card packages with tin boxes for large retailers and department stores. Each year PAC produced from 15 to 20 formats of gift tin boxes in a broad range of designs. Dollar sales of a particular design varied by as much as 25 to 35% from year to year depending on fashion trends, color preferences, and consumer spending patterns during the Thanksgiving and Christmas Holiday season. The manufacture of gift card packaging was a highly competitive business. The manufacturing process was relatively simple and capital requirements were not large. Because design, price, and functionality were so important to consumers, competitive pressures on smaller firms were intensified by the existence of a number of large international manufacturers. These large manufacturers had ample financial resources to employ in elaborate product development, supplier support, and advertising programs. However, since the concept of packaging a “gift card” is relatively new PAC, being one of the few early movers in this industry, was able to obtain a few design and utility patents related to packaging gift cards in tin boxes. Holding these patents gave PAC an advantage that eliminated some of the competitive pressures in early years. In recent years, firms used alternative materials or packages and competition intensified. By accurately predicting fashion trends, a company was sometimes able to steal market share from its competitors for a short time. For example, PAC's introduction of the "Golden Bow Box" in 2006 had contributed substantially to sales and profits. In 2007, however, a large competitor, Hangzhou Xiaoshan Flydragon Tins Co., had followed with similar products and turned the bow box into a common fashion. Consequently, margins suffered that year. Appendix A illustrates some of PAC’s top selling gift card packages. The Pack-A-Card Gift Card Packaging Company was founded by Mr. William Ausman in 1998. Mr. Ausman had been employed as the production consultant of a large CD-ROM packaging manufacturer. As an enthusiastic entrepreneur, he had recognized the similarities between the manufacturing of CD sleeve cases and gift card packages. Mr. Ausman and his former assistant, Craig Hunt, established PAC Gift Card Packaging Company with their combined savings in 1998. In 1999, the firm was incorporated, with Mr. Ausman owning 75% of the stock and Mr. Hunt controlling 25%. Mr. Ausman had overall direction of company affairs and Mr. Hunt was over the production and logistics. Due to labor costs and what Mr. Ausman called “harassment” by the INS and EPA, PAC moved its production from the U.S. to the city of Shenzhen near Hong Kong in the Guangdong providence of China in 2001. Consequently, production costs were influenced not only by the cost of materials, but also by the cost of labor in China and potentially by the dollar-Renminbi exchange rate.1 The decision was made in 2002 that as long as the exchange rate remained stable, the company wouldn’t worry about trying to hedge against material or labor price changes in China. Appendix B provides some background information on China and
1

The Chinese currency is the Renminbi (RMB) and is commonly referred to by its base unit the Yuan. The RMB has been pegged at approximately 8.28 Yuan for a dollar since 1995. In 2005, it was revalued to 8.11. The RMB is now moved to a managed floating exchange rate based on market supply and demand with reference to a basket of foreign currencies. Most recently RMB is valued at 6.82 Yuan per dollar. This ratio has been maintained by active intervention by the Chinese government’s yearly purchase of billions of U.S. dollars which are then typically invested in Treasury Bills.

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Marriott School Of Management 2008

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Shenzhen. In 2006, at Mr. Ausman's retirement, Mr. Hunt assumed the presidency of PAC Gift Card Packaging Company. As president, Mr. Hunt hired Ms. Ruby Ching to coordinate the production facilities. Ms. Ching, a recent graduate of a prominent technical institute, worked in the tin factory of a large diversified hardware company and thus had a basic knowledge of tin production processes. Ms. Ching’s ability to speak Mandarin (Putonghua), willingness to live close to the industrial area in Shenzhen, China, and her technical education and experience made her an ideal COO. PAC Gift Card Packaging Company grew rapidly since its founding in 1998, and was profitable in most years. On the strength of its 2009 holiday product line, sales were forecasted at $7.69 million, a substantial increase over its 2008 sales of $6.994 million. Under seasonal production with a 43% tax, the coming year’s profits were projected at $254,000, compared to $197,000 profits in 2008. The latest financial statements are presented in Exhibits 1 and 2. The cost of goods sold averaged about 80% of sales in the past, and was expected to remain that percentage under seasonal production this year. Operating Expenses would be incurred evenly throughout the year, as they were in the past, under either level or seasonal production. PAC's working capital position was somewhat strained due to the expansion of operations in recent years. A cash balance of $125,000 was considered an absolute minimum necessary for operating the business. Any available cash beyond $125,000 was immediately invested in marketable securities earning 3.75% annual interest. There was no year-end balance on PAC’s unsecured line of credit from First National Trust Company. First National assured Mr. Hunt that it would extend up to $2.0 million in credit in 2009, with the stipulation that the loan would be repaid and "off the books" for at least four months during the year. A 5.5% interest rate was charged on the outstanding balance, and any advances beyond $2.0 million were subject to further negotiations. Gift card packages sales were highly seasonal. Exhibit 3 shows a breakdown of monthly sales in 2008 and monthly sales projections for 2009. Almost 80% of dollar sales volume occurred between August and November, when large department stores and retail chain stores made purchases for the year-end holiday season. Most customers took 60 days to pay in spite of company-quoted terms of net 30-days. Collection experience had been slow but steady in the past with virtually no bad debt. The manufacture of gift card tin boxes was not extremely complex. In Shenzhen China, the tinplate was printed and coated according to the design, then was pressed against the embossed mold and the edges were curled. The boxes were then trucked to Hong Kong where non-stamped or painted decorations (i.e., stickers and material) were added for export reasons before being loaded into cargo containers for shipment to Long Beach California. By doing some production in Hong Kong, even token activities such as adding stickers, PAC avoided higher import tariffs associated with products imported directly from mainland China. Most tariff and quota exemptions for products from Hong Kong continued even after the “hand over” of Hong Kong from the British to the Chinese government in the spring of 1997. Virtually no work in process inventory existed. Weekly purchases were made on net 30-day terms in amounts necessary for the estimated production of the forthcoming week. For 2009, total purchases were forecast at about $3.307 million. All trade credit was paid promptly as it came due. Indeed, prices and payment policy were dictated by a few key and very large tin suppliers, mainly Indonesia’s PT Timah Tbk. and China’s Yunnan Tin Co. Ms. Ching, the production manager, believed that the company could hold capital expenditures to $40,000 per month in 2009. Depreciation would amount to $30,000 per month throughout the coming year. Ms. Ching warned, however, that this year's projected volume would approach the full capacity of PAC's equipment in China. In particular, the forecasted sales of $2 million in September of 2009 would push PAC’s capacity to its extreme limits. Since PAC Gift Card Packaging Company’s founding, it produced in response to customer orders.

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Marriott School Of Management 2008

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Only a small fraction of capacity, 4-10%, was used during the first six months of the fiscal year, due to the seasonal demand. Once the orders for the upcoming holiday season started coming in at the beginning of July, the workforce was expanded and put on overtime. All equipment was used 16 hours a day during these peak months, and in September and October, some equipment was occasionally used around the clock. For the past year, overtime premiums had amounted to $180,000. Based on seasonal production, 2009 pro forma balance sheets and income statements was prepared and presented to Mr. Hunt for examination. These are shown in Exhibits 4 and 5. After experiencing her first production season at PAC, Ms. Ching was impressed by the many problems associated with the company's seasonal production scheduling. Overtime premiums reduced profits. Seasonal expansion and contraction of the work force resulted in recruiting difficulties and high training and quality-control costs. For six months machinery stood almost idle, and then was subjected to heavy use. Accelerated production during the peak season resulted in frequent setup changes on machinery, and wasted time and money. Seemingly unavoidable confusion in scheduling runs resulted. Short runs and frequent setup changes caused inefficiencies in assembly and packaging. In peak production months, even slight disruptions of tin deliveries could have serious consequences. Shipments in October and November were typically late and often partial orders were sent from Shenzhen to Hong Kong and from Hong Kong to Long Beach. The cost of shipping two partial orders was almost twice the cost of shipping one full order. Ms. Ching was also concerned about maintaining an adequate seasonal work force. The growth of manufacturing in Shenzhen, combined with the government’s restrictions on migrations from rural to urban areas, made hiring difficult. Especially the large lay-offs in January, prior to Chinese New Year, put Ms. Ching “out-of-favor” with local Party officials. For these reasons, Ms. Ching had urged Mr. Hunt to adopt a level-production schedule for 2009. She pointed out how reliable estimates of sales volume had been in the past; Ms. Ching cited for evidence the fact that PAC had rarely ended a year with unwanted inventory. The elimination of overtime wage premiums would result in substantial savings, estimated at $177,000 for the coming year. Ms. Ching firmly believed that additional direct labor and shipping savings of about $208,000 would result from orderly operations. A portion of the savings would be offset, however, by higher storage and handling costs estimated at $96,000 annually. These additional costs included warehouse space near Long Beach since real estate prices were lower in southern California than in Hong Kong and domestic storage would lead to better customer service. Mr. Hunt speculated upon the effect that level production would have on the company this year. Shortly after Ms. Ching submitted her recommendation, Mr. Hunt received a statement from one of PAC’s largest retail customers, Wal-Mart, indicating that starting in 2009 seasonal suppliers were required to buy back any unsold holiday inventory at cost if sales did not reach a specified target. Mr. Hunt remembered how the recent sub-prime mortgage crisis caused falling home prices which hurt first Wall Street and then Main Street. The exact effects of Wal-Mart’s new unilateral policy were unclear, but if the resulting recession proved worse than expected, any returned inventory would be physically and financially problematic. To simplify the problem, Mr. Hunt decided to assume that gross margin percentages would not vary during the year under either method of production; that is, cost of goods sold would be 80% of sales in each of the 12 months under seasonal production, and would be 75% of sales in each of the 12 months under level production.2 The increased storage and handling costs of $96,000 would be included in operating expenses. After developing monthly pro forma financials (income statements, balance sheets, and a cash budget), Mr. Hunt planned to weigh the costs and benefits to the company of level production. Then he would develop a complete and detailed plan of implementation based on his findings.
2

Note that $385,000 ($385,000 = $177,000 + $208,000) savings is just another way of saying that the cost of goods sold would drop from 80% to 75% of sales.

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Marriott School Of Management 2008

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Appendix A

Pack-A-Card Gift Card Packaging Product Lines

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Marriott School Of Management 2008

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Appendix B
China China is roughly the same size as the United States (China controls 3.7 million square miles and the United States controls 3.6 million). However, China has a much larger population (1.34 billion people in China and 0.31 billion in the U.S.) with a significantly lower per capita GDP ($6,000 GDP per capita in China and $47,000 in the U.S.) China is the second largest economy in the world after the U.S., after adjusting GDP for purchasing power parity. China’s economy is growing at an impressive rate as is shown in Figure A. China’s GDP average annual growth rate between 2000 and 2008 is 9.7% as compared with 2.4% for the U.S. in the same time period. Much of this growth is due to economic reforms and a gradual move towards a market economy initiated by Deng Xiaoping in 1976 after the passing of Chairman Mao Zedong.

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Marriott School Of Management 2008

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12 10

Figure A - Annual Percentage Change in GDP

GDP Growth (%)

8
U.S. GDP Growth

6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008

As a result of China’s economic reforms, U.S. and other international corporations have invested heavily in China. Figure B shows the amount of foreign direct investment (FDI in dollars) in China from 1999 to 2008. Much of that investment has been in manufacturing facilities often located near Hong Kong.

Figure B Foreign Direct Investment in China
Utilized FDI ($ Billions)
100 90 80 70 60 50 40 30 20

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Marriott School Of Management 2008

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Shenzhen Shenzhen was a small town in the Guangdong province of China that bordered Hong Kong in 1979. With the help of the Chinese government and Deng Xiaoping’s 1980 selection of Shenzhen as a “special economic zone,” the city—and its business sector—blossomed and continues to grow at a phenomenal rate. Today its population exceeds 9 million (including floating residents), and has become one of China’s most prosperous cites. The Shenzhen area (including surrounding cities) makes up roughly 10% of China's economy, 30% of Chinese exports, and has attracted 33% of China’s total foreign direct investment. Its economy grew by 16.3 percent yearly from 2001 to 2005 on average. The city is also the headquarters for one of China’s largest stock exchanges. Created in 1990, the Shenzhen Stock Exchange has a market capitalization around RMB 1 trillion (US$ 122 billion). On a daily basis, around 600,000 deals, valued US$ 807 million, trade on the SSE.