BACKGROUND 2 THE CAPSTONE COURIER 5 THE PURCHASE DECISION 7 ADVANCED MODULES 17 PROFORMAS & ANNUAL REPORTS 18 EXECUTIVE SUMMARY 19 OPERATIONS 11

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1 Cases in Strategy and Business Policy CAPSTONE BUSINESS SIMULATION

2 BACKGROUND 2 YOUR CUSTOMERS 2 BUYING CRITERIA 2 POSITIONING 3 PRICE, AGE AND RELIABILITY (MTBF) 4 SEGMENT CRITERIA 4 THE CAPSTONE COURIER 5 FRONT PAGE, STOCK & BOND SUMMARIES, FINANCIAL ANALYSIS AND PRODUCTION ANALYSIS 5 SEGMENT ANALYSES 5 MARKET SHARE, PERCEPTUAL MAP AND HR/TQM REPORT 6 THE PURCHASE DECISION 7 THE ROUGH CUT 7 POSITIONING IN THE ROUGH CUT 7 PRICE IN THE ROUGH CUT 7 RELIABILITY IN THE ROUGH CUT 7 THE FINE CUT 7 POSITIONING IN THE FINE CUT 8 RELIABILITY IN THE FINE CUT 8 AGE IN THE FINE CUT 8 PRICE IN THE FINE CUT 9 BUYER S & SELLER S MARKETS 9 MARKET SIZES AND GROWTH 10 OPERATIONS 11 R&D 11 REPOSITIONING 11 MTBF ADJUSTMENT 11 PRODUCT INVENTION 11 PROJECT MANAGEMENT 11 A PRODUCT'S AGE 12 MARKETING 12 PRICE 12 PROMOTION (PROMO BUDGET) 12 PLACE (SALES BUDGET) 13 PRODUCT 13 SALES FORECASTING 14 PRODUCTION 14 PURCHASING CAPACITY 14 SELLING CAPACITY 14 DISCONTINUING A PRODUCT 14 AUTOMATION 14 CHANGING AUTOMATION 15 FINANCE 15 CURRENT DEBT 15 BONDS 16 STOCK 16 EMERGENCY LOANS 17 CREDIT POLICY 17 ADVANCED MODULES 17 PROFORMAS & ANNUAL REPORTS 18 BALANCE SHEET 18 CASH FLOW STATEMENT 18 INCOME STATEMENT 18 EXECUTIVE SUMMARY 19 R&D 19 MARKETING 19 PRODUCTION 19 FINANCE 20 GETTING STARTED 21 DOWNLOAD CAPSTONE.XLS 21 REHEARSAL SIMULATION 21 PRACTICE ROUNDS 21 COMPETITION ROUNDS 21 INDEX 22 For detailed information, see the Online Manager Guide -1

3 1. BACKGROUND IN THE NEXT EIGHT YEARS, THE SENSOR MARKET WILL SEE A 165% INCREASE IN UNIT DEMAND. GROWTH RATES VARY AMONG THE SUB MARKETS, OTHERWISE KNOWN AS MARKET SEGMENTS. SOME SIMULATIONS USE ADVANCED MODULES. THE WEBSITE WILL NOTIFY YOU IF ADVANCED MODULES HAVE BEEN ACTIVATED. Your company manufactures electronic sensors. Last year, global demand for sensors surged more than 12%. Unprecedented opportunities exist for companies that adopt a leadership role in the market, either through a superior product offering or aggressive pricing. Although its financial results have been respectable, your company currently markets an aging product line. To become a market leader, you must improve your products, increase productivity and remain profitable despite downward price pressure. Your company needs to revamp the management structure while coordinating strategy and tactics across all functional areas: Research & Development (R&D) Marketing Production Finance Your company uses a Microsoft Excel spreadsheet called Capstone.xls to formulate and transmit corporate decisions. To download Capstone.xls, login at and click the Making Decisions link. Managers have an opportunity to learn how to use the spreadsheet by playing the Rehearsal Simulation. The spreadsheet will teach you step by step the decision making process. Your company selected you and your fellow managers because of your strategic vision and tactical skills. During the next eight years, the company expects you to make it a market leader. Careful study of the remaining sections will help greatly in this effort. Best of luck in running your company! YOUR CUSTOMERS Your customers are Original Equipment Manufacturers. They put your sensors into a range of products, from bio hazard neutralization to security systems to manufacturing controls. Because so many products depend upon your sensors, the sensor industry is growing and evolving fast. Even the oldest designs are less than eight years old. Customers fall into five categories or market segments: Traditional Low End High End Performance Size BUYING CRITERIA Each market segment demands sensors that fits its needs or criteria. Therefore, sensors for each segment vary in their physical dimensions (size), and the speed with which they respond to changes in physical conditions (performance). Combining size and performance creates a product attribute called positioning. 2- Capstone Manager Guide

4 A product with a size of 12 and a performance of 8 is positioned here. Figure 1.1 Perceptual Map POSITIONING Positioning is such an important concept that marketers developed a tool to track the position of their products and those of their competitors. This tool is called a perceptual map. Note that the perceptual map in Figure 1.1 measures size on the vertical axis and performance on the horizontal axis. A product with a size of 12 and a performance of 8 is plotted at the point where the two lines intersect. That is the product s position. Market segments have different positioning preferences. Therefore, each segment clusters in a different part of the map. Low End customers want slow performing products that are large in size. They want products that fall inside the upper left circles in Figure 1.2. High End customers want products that are fast performing and small in size. They want products that fall within the circles to the lower right. Over time, customers want products that are smaller and faster. This causes the segments to move or drift a little every month. As the years progress, the drift becomes significant. Figure 1.3 shows the location of the market segments at the end of the fourth year; Figure 1.4, at the end of the eighth. High End, Performance and Size customers demand greater product improvement than Traditional and Low End customers. Therefore, the High End, Performance and Size market segments drift at a faster rate. As time goes on, the overlap between the segments decreases. YOU AND YOUR MANAGEMENT TEAM MUST ENSURE THAT YOUR PRODUCT LINE KEEPS UP WITH CHANGING CUSTOMER DEMAND. TO DO THIS, PRODUCTS MUST BE REPOSITIONED TO STAY WITHIN THE MOVING SEGMENT CIRCLES. PRODUCTS MUST BE REDESIGNED SO THAT THEY ARE SMALLER IN SIZE AND FASTER IN PERFORMANCE. Low End Performance Figure 1.2 Traditional Size High End Beginning Segment positions. As the years progress, the segments will move or drift at different speeds towards the lower right. Figure 1.3 Low End Traditional Size Performance High End Segment Positions at the end of Year 4. Segment overlap decreases. Figure 1.4 Low End Traditional Size Segment Positions at the end of Year 8. Very little overlap remains. Performance High End MARKET SEGMENTS WILL NOT MOVE FASTER TO CATCH UP WITH A PRODUCT THAT EXCEEDS THEIR EXPECTATIONS. FOR EXAMPLE, HIGH END CUSTOMERS WILL REFUSE TO BUY A PRODUCT TO THE LOWER RIGHT OF THE CIRCLES. CUSTOMERS ARE ONLY INTERESTED IN PRODUCTS THAT FALL WITHIN THEIR SEGMENTS ON THE PERCEPTUAL MAP. For detailed information, see the Online Manager Guide -3

5 EACH MARKET SEGMENT EXPECTS DIFFERENT: POSITIONING AGE RANGE PRICE RANGE LEVELS OF RELIABILITY, MEASURED IN HOURS AS MEAN TIME BETWEEN FAILURE, OR MTBF PRICE RANGES IN ALL SEGMENTS DROP $0.50 PER YEAR. FOR EXAMPLE, THIS YEAR, THE TRADITIONAL PRICE RANGE WILL BE $19.50 $29.50, NEXT YEAR IT WILL BE $19.00 $ POSITIONING CRITERIA WILL CHANGE IN FUTURE YEARS! AGE AND RELIABILITY (MTBF) CRITERIA REMAIN THE SAME YEAR AFTER YEAR. PRICE, AGE AND RELIABILITY (MTBF) In addition to position, each segment has different criteria for: Price: The cost of the sensor; Age: The length of time since the sensor was invented or revised; Reliability or MTBF (Mean Time Between Failure): The number of hours the sensor is expected to operate. TRADITIONAL SEGMENT CRITERIA Traditional customers seek proven products using current technology. Last year s buying criteria were: Age, 2 years 47% of decision; Price, $20.00-$ % of decision; Positioning, performance 5.0 size % of decision; Reliability (MTBF), 14,000-19,000 9% of decision. LOW END SEGMENT CRITERIA Low End customers seek proven products, are indifferent to technological sophistication and are price motivated. Last year s buying criteria were: Price, $15.00-$ % of decision; Age, 7 years 24% of decision; Positioning, performance 1.7 size % of decision; Reliability (MTBF), 12,000-17,000 7% of decision. HIGH END SEGMENT CRITERIA High End customers seek cutting-edge technology in both size and performance. Last year s buying criteria were: Positioning, performance 8.9 size % of decision; Age, 0 years 29% of decision; Reliability (MTBF), 20,000-25,000 19% of decision; Price, $30.00-$ % of decision. PERFORMANCE SEGMENT CRITERIA Performance customers seek high reliability and cutting edge performance technology. Last year s buying criteria were: Reliability (MTBF), 22,000-27,000 43% of decision; Positioning, performance 9.4 size % of decision; Price, $25.00-$ % of decision; Age, 1 year 9% of decision. SIZE SEGMENT CRITERIA Size customers seek cutting edge size technology. Last year s buying criteria were: Positioning, performance 4.0 size % of decision; Age, 1.5 years 29% of decision; Reliability (MTBF), 16,000-21,000 19% of decision; Price, $25.00-$ % of decision. 4- Capstone Manager Guide

6 2. THE CAPSTONE COURIER Customer purchase and sensor company financial results are reported in an industry newsletter called The Capstone Courier. The Courier is available from two locations: Login to the website and click the Reports link; From Capstone.xls, click Last Year s Reports in the menu bar. Figure 2.1 Selected Financial Statistics from the front page of the Courier. FRONT PAGE, STOCK & BOND SUMMARIES, FINANCIAL ANALYSIS AND PRODUCTION ANALYSIS The Front Page of the Courier delivers a snapshot of last year s results (Figure 2.1). Be sure to compare your company s sales, profits and cumulative profits with the competition s. Page 2, Stock and Bond Summaries charts stock price and reports bond ratings. Page 3, The Financial Analysis, surveys each team s cash flow, balance sheet and income statement. Use the Financial Analysis to check the financial health of your competition. Page 4, The Production Analysis, reports detailed information about each product in the market, including sales and inventory levels, price, material cost and labor cost. The Production Analysis also reports plant capabilities and utilization. SEGMENT ANALYSES The Market Segment Analyses, pages 5-9 of the Courier (Figure 2.2), review each market segment in detail. The Statistics table in the upper-left corner of each analysis reports Total Industry Unit Demand, Actual Industry Unit Sales, Segment % of Total Industry and the segment s Growth Rate. The Customer Buying Criteria table ranks in order of importance the customer criteria within each segment (these are the criteria listed on page 4): Positioning: The preferred product location as of December 31 of the previous year, also called the ideal spot ideal spots drift with the segments, moving a little each month; Price: Every year on January 1, price ranges drop by $0.50; Age: Age preferences stay the same year after year; Reliability: MTBF requirements stay the same year after year. The perceptual map shows the position of each product in the segment as of December 31of the previous year. The Accessibility Chart (Figure 2.3 on page 6) rates each company s level of accessibility. Accessibility is determined by the Marketing Department s sales budget the higher the budget, the higher the accessibility. Accessibility is measured by percentage, 0 to % accessibility means every customer has the ability to locate your product. Figure 2.2 Traditional Market Segment Analysis. Segment Statistics and Buying Criteria display in the upper-left corner of each segment analysis. For detailed information, see the Online Manager Guide -5

7 Figure 2.3 Segment Analysis Accessibility and Market Share Actual vs. Potential Charts. USE THE CUSTOMER SURVEY AS A QUICK COMPARISON TOOL WHEN CONDUCTING A COMPETITIVE ANALYSIS. The Market Share Actual vs. Potential Chart (Figure 2.3) displays two bars per company. The actual bar reports the market percentage each company attained in the segment. The potential bar indicates what the company deserved to sell in the segment. If the potential bar is higher than the actual, the company under produced and missed sales opportunities. If the potential is lower than the actual, the company picked up sales because other companies either under produced or marketed products that were unacceptable to the segment. Top Products in Segment: This table ranks the products selling in the segment, and reports: Market Share Units Sold to Segment Revision Date Stock Out (whether the product ran out of inventory) Performance and Size coordinates Price MTBF The product s Age on Dec.31 Promotion and Sales Budgets The Segment Analyses have two more important columns: Customer Awareness The December Customer Survey Customer Awareness (Figure 2.4) is determined by the Marketing Department s Promo Budget the higher the budget, the higher the awareness. Awareness is measured by percentage. 100% awareness means every customer knows about your product. The December Customer Survey (Figure 2.4) indicates how customers perceive the products in the segment. The survey evaluates the product against the buying criteria. 0% indicates the product meets none of their criteria. A perfect score of 100% results in part when the product: Is priced at the bottom of the expected range; Is perfectly positioned (because the segment moves each month, this can occur only once each year); Has an MTBF specification at the top of the expected range; Has the ideal age for that segment (because the product ages each month, it can only have the ideal age once a year). MARKET SHARE, PERCEPTUAL MAP AND HR/TQM REPORT Three pages follow the segment analyses: Market Share Report, which details sales across all market segments; Perceptual Map (Figure 2.5), which displays all five segments and every sensor in the industry; HR/TQM Report, which displays investments and results when the optional TQM, Human Resources and/or Labor Negotiation modules are activated. Figure 2.4 Customer Awareness reports the percentage of customers who know about your product. The December Customer Survey reports what customers think about your product; the higher the score, the better they like it. Figure 2.5 Page 11, Perceptual Map, displays the positioning of all the sensors in every segment. 6- Capstone Manager Guide

8 3. THE PURCHASE DECISION Customers go through two stages as they make their purchase decisions, the Rough Cut and the Fine Cut. THE ROUGH CUT The outer circle indicates the positioning rough cut. The inner circle indicates the positioning fine cut. In the rough cut, buyers focus on four product characteristics: Performance: The sensor s speed in measuring and reporting conditions; Size: The sensor s dimensions and weight; Reliability: Expressed in terms of Mean Time Between Failure, or MTBF, the number of hours the sensor will last; Price: Different price ranges are associated with each market segment, and distinguish one customer type from another. Each segment sets its own standards for performance, size, reliability and price. Products must fall within segment guidelines to survive a customer s rough cut. POSITIONING IN THE ROUGH CUT On the perceptual map, the circles represent the market segments, the groups of customers with similar purchasing concerns. Products that plot within 4.0 units from the center of the segment circle survive that segment s positioning rough cut. When products plot more than 4.0 units away, they fail the segment s rough cut (Figure 3.1). A product within the outer circle but outside the inner fine cut circle has reduced sales potential. Potential drops in a linear fashion. Just beyond the fine cut circle, potential drops 1%; halfway between the fine and rough cut circles, potential drops 50%; potential drops 99% for products that are just inside the rough cut circle. Figure 3.1 Positioning Rough Cut / Fine Cut circles. The outer Rough Cut circle has a radius of 4 units. The inner Fine Cut circle has a radius of 2.5 units. PRICE IN THE ROUGH CUT Each segment sets price guidelines, which further differentiate the segments. For example, Traditional customers will not pay High End prices. Segment price expectations correlate loosely with the segment s position on the perceptual map. In general, as performance increases or size decreases, price ranges go higher. RELIABILITY IN THE ROUGH CUT Reliability is measured with Mean Time Between Failure (MTBF). The MTBF conveys the number of hours a product is expected to function. Each segment has a different range of expected MTBF (see page 4). THE FINE CUT THE SEGMENT ANALYSES OF THE CAPSTONE COURIER REPORT THE BUYING CRITERIA FOR EACH SEGMENT. In the Fine Cut, customers evaluate products against the four buying criteria listed on page 4: Positioning Age Price Reliability (MTBF) Each segment assigns different importance to each criteria. For detailed information, see the Online Manager Guide -7

9 Figure 3.2 The arrows indicate each segment s ideal spot, the location where positioning demand is highest. Ideal spots drift with the segment circles. POSITIONING IN THE FINE CUT The product s exact position now increases in importance. Each segment s fine cut circle has an ideal spot (arrows, Figure 3.2). The ideal spot indicates the location where positioning demand is highest. Customers in the high technology segments (High End, Performance and Size) want cutting-edge products. The ideal spots for these segments are located towards the lower-right edge of the circles, where size is smaller and performance is faster. Low technology customers (Traditional and Low End) want proven technology. The Low End ideal spot is located towards the upper left, where products are bigger and slower. The Traditional ideal spot is in the center of the circle. Ideal spots drift with the circles. RELIABILITY IN THE FINE CUT Customers prefer high MTBF ratings to low ones. However, if a product s MTBF is beyond the expected range, customers ignore the additional reliability. AGE IN THE FINE CUT In the Fine Cut, customers assess each product s age and award a score based upon their preferences. For example, Traditional customers prefer products that are 2 years old. Products with that age are given a score of 10 (see Figure 3.3). Age assessments vary from segment to segment (see Figures 3.4 through 3.7). The Buying Criteria on the Courier s Segment Analyses report the age preference and its overall importance to the purchase decision. Figure 3.3 Traditional customers prefer products in the 2 year range. Figure 3.4 Low End customers want products in the 7 year range. Figure 3.5 High End customers demand new products. Figure year-old products score highest with Performance customers. Figure 3.7 Size customers prefer products that are 1.5 years of age. 8- Capstone Manager Guide

10 PRICE IN THE FINE CUT Price plays a role in both the Rough Cut and Fine Cut. For products that survive the Rough Cut, demand for a product follows a classic economic demand curve: as price goes down, demand goes up. Customers, however, also are concerned with the product s position, age and reliability. A better product creates higher demand, and this can be traded for a higher price. Suppose that the position, age and reliability for product Able is superior to Baker s. If they were priced the same, Able would outsell Baker. But as Able raises its price, at some point its unit demand will be equal to Baker s demand. Able will trade off some of its potential demand for a higher price on fewer units. In general, the high technology segments (Performance, High End, and Size) are sensitive to design and can command a higher price. The low technology segments (Low End and Traditional) are less sensitive to design and place more emphasis on price. BUYER S & SELLER S MARKETS In a buyer s market there are plenty of units available to meet demand within a segment. In a seller s market there are too few units available to meet demand within a segment. CUSTOMERS ARE INDIFFERENT TO PRODUCTS WITH MTBFS ABOVE THE GUIDELINE. BUYER S MARKET In a buyer s market, products priced $1 above or below the segment guideline lose about 20% of their sales potential. Products continue to lose approximately 20% of their potential for each dollar above or below the guideline, on up to $5, at which point they lose all sales potential. Products with an MTBF 1,000 hours below the segment guideline lose about 20% of their sales potential. Products continue to lose approximately 20% for every 1,000 hours below the guideline, on up to 5,000 hours, at which point they lose all sales potential. SELLER S MARKET In a seller s market, products can be priced up to $4.99 above the price range without losing any sales potential. customers dislike the price, but they must have something. However, at $5 above the range products lose all sales potential; customers refuse to pay the price. Products can have MTBFs 4,900 hours below the range without losing sales potential. However, at 5,000 hours below the range, products lose all sales potential. For detailed information, see the Online Manager Guide -9

11 Table 3.1 Last year s unit sales percentage MARKET SIZES AND GROWTH Traditional Low End High End Performance Size 32.4% 39.3% 11.2% 8.4% 8.7% Table 3.2 Segment growth rates Traditional Low End High End Performance Size 9.2% 11.7% 16.2% 19.8% 18.3% Table year unit sales percentages Traditional Low End High End Performance Size % 12.9% 11.3% 11.0% THE LOW END CUSTOMERS ARE MOST CONCERNED ABOUT THE SENSOR S PRICE, WHILE HIGH END AND SIZE CUSTOMERS ARE LEAST CONCERNED ABOUT PRICE. MARKET SIZE BY UNIT The low technology segments (Traditional and Low End) dominated last year s sensor market in units sold (Table 3.1). However, the Traditional and Low End growth rates trail the growth rates for High End, Performance and Size (Table 3.2). Five years from now, High End, Performance and Size will command a greater percentage of the overall market (Table 3.3). MARKET SIZE BY DOLLAR The low technology segments (Traditional and Low End) dominated last year s sensor market in dollars (Table 3.4). Unlike unit demand, the five-year dollar value of each segment is impossible to predict. Aggressive price cutting in the Low End segment could significantly reduce its dollar value percentage in five years. Aggressive pricing in the High End and Size segments could increase their dollar value. Table 3.5 estimates the dollar percentage for each segment, assuming there are no aggressive pricing tactics. Table 3.4 Last year s dollar percentages Traditional Low End High End Performance Size 32.3% 31.0% 15.6% 10.4% 10.7% Table year dollar forecast (assumes current prices will not change) Traditional Low End High End Performance Size 27.6% 28.2% 17.7% 13.4% 13.1% 10- Capstone Manager Guide

12 4. OPERATIONS YOUR R&D DECISIONS ARE FUNDAMENTAL TO YOUR MARKETING AND PRODUCTION PLANS. IN MARKETING, R&D ADDRESSES: THE POSITIONING OF EACH PRODUCT INSIDE A MARKET SEGMENT ON THE PERCEPTUAL MAP; THE NUMBER OF PRODUCTS IN EACH SEGMENT; THE AGE OF YOUR PRODUCTS; THE RELIABILITY OF EACH PRODUCT (ITS MTBF RATING). IN PRODUCTION, R&D AFFECTS OR IS AFFECTED BY: THE COST OF MATERIAL; THE PURCHASE OF NEW FACILITIES TO BUILD NEW PRODUCTS; LEVELS OF AUTOMATION FOR A PRODUCT (AND ITS LABOR COST). IMPROVING POSITIONING AND RELIABILITY WILL MAKE A PRODUCT MORE APPEALING TO CUSTOMERS, BUT DOING SO INCREASES MATERIAL COST. IF YOU DON T BUY THE PRODUCTION LINE THE YEAR PRIOR TO ITS INTRODUCTION, YOU CANNOT MANUFACTURE YOUR NEW PRODUCT! WHEN PRODUCTS ARE CREATED OR MOVED CLOSE TO EXISTING PRODUCTS, R&D COMPLETION TIMES DIMINISH. THIS IS BECAUSE YOUR R&D DEPARTMENT CAN TAKE ADVANTAGE OF EXISTING TECHNOLOGY. Each company starts the simulation with five products. Your company has one product for each segment. You have one assembly line per product. Products can be terminated or added. Your company must have at least one product and cannot have more than eight. You and your fellow managers make business decisions on January 1 of each year. They are then executed by your employees. Industry results are published in The Capstone Courier, which can be viewed from the website s Reports link and from the Last Year s Reports menu in Capstone.xls. R&D The Research & Development Department invents new products and changes specifications for existing products. Changing size and/or performance repositions a product on the perceptual map (see Figure 1.1 on page 3). Improving performance and shrinking size moves the product toward the lower-right on the map. All R&D projects begin on January 1. If a product does not have a project already underway, you can launch a new project for that product. However, if a project begun in a previous year has not finished on January 1, you will not be able to launch a new project for that product (the decision entry cells on the R&D spreadsheet in Capstone.xls will be locked). REPOSITIONING A repositioning project moves an existing product from one location on the perceptual map to a new location, generally (but not always) down and to the right. Repositioning requires a new size attribute and/or a new performance attribute. To keep up with segment drift, products must be made smaller (that is, decrease its size) and better performing (that is, increase its performance). MTBF ADJUSTMENT The reliability rating, or MTBF, for existing products can be adjusted up or down. Lowering an MTBF decreases material cost. PRODUCT INVENTION New products are assigned a name (the first letter of all new products should match the first letter of the company name), size, performance and MTBF. Of course, these specifications should conform to the intended market segment. All new products require a production line. The Production Department must order equipment one year in advance. Invention projects take 1.3 to 2.3 years to complete. PROJECT MANAGEMENT Segment circles on the perceptual map move at speeds ranging from 0.7 to 1.3 units each year. You must plan to move your products (or retire them) as the simulation progresses. Generally, the longer the move on the perceptual map, the longer it takes the R&D Department to complete the project. Project lengths can be as short as three months, or as long as three years. R&D project lengths will increase when For detailed information, see the Online Manager Guide -11

13 IF THE PROJECT LENGTH TAKES MORE THAN A YEAR, THE CHANGES WILL NOT APPEAR IN THE NEXT CAPSTONE COURIER. THIS IS BECAUSE THE PRODUCT IS STILL IN R&D, AND THE OLD PRODUCT ATTRIBUTES WILL BE REPORTED. THESE NUMBERS CHANGE WHEN THE ADVANCED MARKETING MODULE IS ACTIVATED. SEE ADVANCED MARKETING IN THE ONLINE MANAGER GUIDE FOR COMPLETE INFORMATION. THE SEGMENT ANALYSES REPORT AWARENESS. SEE FIGURE 2.4 ON PAGE 6. companies put two or more products into R&D at the same time when this happens each R&D project takes longer. It is important to verify completion dates after all decisions have been entered. Usually you want repositioning projects to finish in less than a year. For example, consider breaking an 18 month project into two separate projects, with the first stage ending just before the end of the current year, and the second ending halfway through the following year. A PRODUCT S AGE It is possible for a product to go from an age of 4 years to 2 years. How can this be? When repositioning projects conclude, customers do not perceive the modified product to be new, but they do not perceive the product to be the same age as it was prior to modification. As a compromise, customers mentally cut the age in half. Age criteria vary from segment to segment. For example Traditional customers prefer an age of 2 years. This accounts for 47% of the Traditional customers purchase decision. If a Traditional product s age approaches 3 years, customers will begin to turn away (see Figure 3.3 on page 8). Repositioning the product will drop the age from 3 to 1.5 years, and customers become interested again. MARKETING Marketing is concerned with the 4 Ps: Price Promotion Place Product Figure 4.1 Increases in Promotion Budget have diminishing returns. The first $1,500,000 buys 36% awareness; Spending another $1,500,000 (for a total of $3,000,000) buys approximately 50%. The second $1,500,000 buys only 14% more awareness. PRICE Price was discussed in PRICE IN THE ROUGH CUT on page 7 and PRICE IN THE FINE CUT on page 9. To review, demand falls to zero when prices go $5.00 above or below the expected price range. Price drives the product s contribution to profit margin. Dropping the price increases demand but reduces profit per unit. Segment price ranges fall at a rate of $0.50 per year. For example, last year Traditional customers expected a price between $20.00 and $ This year, the Traditional price range will be $19.50-$29.50, next year it will be $19.00-$29.00, etc. This puts pressure on companies to improve their cost structures. PROMOTION (PROMO BUDGET) A percentage of your customers know about your product. This is called awareness. 50% awareness indicates half of the customers know your product exists. From one year to the next, a third of those who know about your product forget about it. If a product ended last year with an awareness of 50%, this year it will start with an awareness of approximately 33%. This year s promotion budget builds from 33%. A $1,500,000 promotion budget would add 36% to the starting awareness, for a total awareness of 69% (33% + 36% = 69%). A $3,000,000 budget would add 50% to the starting awareness, only 14% more than the $1,500,000 expenditure (33% + 50% = 83%). This is because further expenditures tend to reach customers who already know about the product (see Figure 4.1). 12- Capstone Manager Guide

14 THE $250,000 FEE AND THE 50% AWARENESS WILL NOT BE REFLECTED IN THE MARKETING SPREADSHEET IN CAPSTONE.XLS. THEY WILL APPEAR IN THE NEXT CAPSTONE COURIER AND ANNUAL REPORT. YOUR COMPANY ALLOCATES A SALES BUDGET FOR EACH PRODUCT. THE SALES FORCE DRUMS UP DEMAND FOR THE PRODUCT IT REPRESENTS. FOR EXAMPLE, SUPPOSE A CUSTOMER IS CONSIDERING TWO IDENTICAL PRODUCTS. YOUR COMPANY HAS A SALESPERSON PRESENT, YOUR COMPETITOR DOES NOT. YOU WILL MAKE THE SALE TWO OUT OF THREE TIMES. IF YOUR COMPETITOR S SALESPERSON IS PRESENT AND YOURS IS NOT, YOUR COMPETITOR WILL MAKE THE SALE TWO OUT OF THREE TIMES. THE SEGMENT ANALYSES REPORT ACCESSIBILITY. SEE FIGURE 2.3 ON PAGE 6. THESE NUMBERS CHANGE WHEN THE ADVANCED MARKETING MODULE IS ACTIVATED. SEE ADVANCED MARKETING IN THE ONLINE MANAGER GUIDE FOR COMPLETE INFORMATION. Once your product achieves 100% awareness, you can scale back the product s promotion budget to around $1,400,000. This will maintain 100% awareness year after year. When new products are invented, they are considered newsworthy events. Awareness is created quickly with a public relations campaign. At launch you automatically are charged a $250,000 fee for marketing rollout and public relations. This fee earns a new product a starting awareness of 50%. Suppose no team promotes their products and all have 0% awareness. Customers would rely upon their own research. Sales would be distributed based upon the merits of those products that pass the fine cut. Suppose all products enjoyed 100% awareness. Again, sales would be distributed based upon the merits of those products that pass the fine cut. Now suppose your product has not been promoted for many years while competitors have aggressively promoted their products. Your awareness is 0%, their awareness is 100%. Your product would achieve about half the demand it would have received if it also had 100% awareness. PLACE (SALES BUDGET) Place operates in a similar fashion to Promotion. The sales budget creates relationships with customers and establishes distribution channels. In the short term, your sales force promotes your products, which increases demand. In the long term, your sales budget builds distribution channels. Each market segment has a distinct sales channel (a Traditional channel, a High End channel, etc.). The strength of your sales channel is measured by accessibility, on a scale of 0 to 100%. If your product exits the segment, it leaves the old segment s accessibility behind. When it enters the new segment, it inherits the accessibility present in that segment. If you drop your sales budget to zero, you lose one third of your accessibility each year. Like awareness, 0% accessibility does not imply zero sales. Instead, sales potential might be half what it could be because it is more difficult for customers to find your product or interact with you. Unlike awareness, accessibility applies to the segment, not the product. This has three important implications: 1. Customer access to the product depends on the accessibility strength in the segment. 2. The more products you have in a segment, the stronger your distribution channels, support systems, etc. This is because each product s sales budget contributes to the strength of the segment s accessibility. 3. Achieving 100% accessibility is difficult. Teams must have two products inside the segment. Each product experiences diminishing returns at a sales budget of $3,000,000. However, the segment s overall diminishing return is not reached until the two budgets total $4,500,000 (for example, two products with sales budgets of $2,250,000 each). Once you reach 100% accessibility, you can scale back the segment s total sales budget to around $4,000,000 to maintain 100%. Think of awareness and accessibility as before and after the sale. The Promo Budget drives awareness, which persuades the customer to look at your product. The Sales Budget drives accessibility, which governs everything during and after the sale. The Promo Budget is spent on advertising and public relations. The Sales Budget is spent on distribution, order entry, sales budgets, customer service, etc. PRODUCT Product is the primary concern of your R&D Department. It controls the three factors that affect design: Positioning Age Reliability (MTBF) For detailed information, see the Online Manager Guide -13

15 SALES FORECASTING Accurate sales forecasting is a key element to team success. Manufacturing too many units results in extra time/ material costs and inventory carrying costs. Manufacturing too few units means stock outs and lost sales, which can be even more costly. See Sales Forecasting in the Online Manager Guide for complete information. PRODUCTION The Production Department schedules manufacturing runs for each sensor product. Your production plant has five lines with room for three more. Each assembly line is unique to the product it manufactures. You cannot move a product from one assembly line to another because automation levels vary and each product requires special tooling. CAPACITY First shift capacity is defined as the number of products that can be produced on an assembly line (that is, without a second shift) in a single year. Assembly lines can produce up to twice their first shift capacity with a second shift. For example, an assembly line with a capacity of 2,000,000 units per year could produce 4,000,000 units with a second shift. However, second shift wages are 50% higher than the first shift. PURCHASING CAPACITY Each new unit of capacity costs $6 for the floor space plus $4 times the automation rating. The production spreadsheet in Capstone.xls calculates the exact cost. SELLING CAPACITY Capacity can be sold at the beginning of the year for $0.65 on the dollar value of the original investment. You can replace the capacity in later years, but you have to pay full price. If you sell capacity for less than its depreciated value, you lose money, which is reflected as a write-off on your income statement. If you sell capacity for more than its depreciated value, you make a gain on the sale. This will be reflected as a negative write-off on the income statement (see INCOME STATEMENT on page 18). LABOR COSTS INCREASE EACH YEAR BECAUSE OF THE ANNUAL RAISE IN LABORʹS CONTRACT. OPTIONAL LABOR NEGOTIATIONS AND THE HUMAN RESOURCE MODULE ALSO AFFECT LABOR COSTS. DISCONTINUING A PRODUCT If you sell all the capacity on a production line, Capstone interprets this as a liquidation instruction and will sell your remaining inventory for half the average cost of production. Capstone writes off the loss on your income statement. If you sell all but one unit of capacity, your inventory will not be liquidated and it can be sold for full price. AUTOMATION Automation levels are given a scale of 1.0 to is the lowest automation, 10.0 the highest. At the beginning of the simulation all assembly lines have an automation level between 3.0 and 5.0. As automation levels increase, the number of labor hours required to produce each unit falls. At an automation rating of 1.0, labor costs are highest. At a rating of 10.0, labor costs fall about 90%. Each additional point of automation decreases labor costs approximately 10%. 14- Capstone Manager Guide

16 IF YOU REDUCE AUTOMATION, YOU WILL INCUR A RETOOLING COST. THE NET RESULT IS YOU WILL BE PAYING MONEY TO MAKE YOUR PLANT LESS EFFICIENT. WHILE REDUCED AUTOMATION WILL SPEED R&D REDESIGNS, BY AND LARGE IT IS NOT WISE TO REDUCE AN AUTOMATION LEVEL. Despite its attractiveness, two factors should be considered before raising automation: Automation is expensive: At $4 per point of automation, raising automation from 1.0 to 10.0 costs $40 per unit of capacity; As you raise automation, it becomes increasingly difficult for R&D to reposition products short distances. At an automation level of 1.0 it is possible to move a product 1.7 units on the perceptual map in a single year. At 10.0 it takes 1.1 years to move a product 0.1 units. This relationship does not apply to long moves on the map. You can move a product a long distance at any automation level, but the project will take between 2.5 and 3.0 years. CHANGING AUTOMATION For each point of change, up or down, the company is charged $4 per unit of capacity. For example, if a line has a capacity of 1,000,000 units, the cost of changing the automation level from 5.0 to 6.0 would be $4,000,000 Reducing automation does not have the same effect as selling capacity. You will not receive cash for lowering your automation, but will be billed instead. FINANCE Your Finance Department is primarily concerned with five issues: 1. Acquiring the capital needed for company activities. Capital can be acquired through: Current Debt Stock Issues Bond Issues (Long Term Debt) Profits 2. Establishing a stock dividend policy that maximizes the return to shareholders. 3. Setting credit policies for customers and suppliers (which are set on the marketing spreadsheet). 4. Driving the financial structure of the firm, its relationship between debt and equity. 5. Selecting and monitoring performance measures that support your strategy. AS A GENERAL RULE COMPANIES FUND SHORT TERM OBLIGATIONS LIKE ACCOUNTS PAYABLE, INVENTORY EXPANSIONS OR INCREASES IN ACCOUNTS RECEIVABLE POLICY WITH CURRENT DEBT. CURRENT DEBT Your bank issues current debt in one year notes. The finance spreadsheet in Capstone.xls displays the amount of current debt due from the previous year. The company can roll that debt by simply borrowing the same amount again. There are no brokerage fees for current debt. Interest rates are a function of your debt level. The more debt you have relative to your assets, the more risk you present to debt holders and the higher the current debt rates. Current debt amounts are limited to 75% of the value of Accounts Receivables (A/R) plus 50% of the value of your inventory. Banks will look at the combined value from your proforma balance sheet, which is the forecast for the current year, and the annual report balance sheet from last year. Banks will allow the larger of the two amounts when calculating the limit (see PROFORMAS & ANNUAL REPORTS on page 18). For detailed information, see the Online Manager Guide -15

17 AS A GENERAL RULE, BOND ISSUES ARE USED TO FUND LONG TERM INVESTMENTS IN CAPACITY AND AUTOMATION. A BOND WITH A FACE AMOUNT $10,000,000 COULD COST $11,000,000 TO REPURCHASE EARLY BECAUSE OF FLUCTUATIONS IN INTEREST RATES AND YOUR CREDIT WORTHINESS. IF THE FACE AMOUNT OF BOND 12.6S2009 WERE $1,000,000, THE $1,000,000 REPAYMENT IS ACKNOWLEDGED IN YOUR REPORTS AND SPREADSHEETS IN THE FOLLOWING MANNER: YOUR ANNUAL REPORTS FROM DECEMBER 31, 2009 WOULD REFLECT AN INCREASE IN CURRENT DEBT OF $1,000,000 OFFSET BY A DECREASE IN LONG TERM DEBT OF $1,000,000. THE 2009 SPREADSHEET WILL LIST THE BOND BECAUSE YOU ARE MAKING DECISIONS ON JANUARY 1, 2009, WHEN THE BOND STILL EXISTS. YOUR 2010 SPREADSHEET WOULD SHOW A $1,000,000 INCREASE IN CURRENT DEBT AND THE BOND NO LONGER APPEARS. AS A GENERAL RULE, STOCK ISSUES ARE USED TO FUND LONG TERM INVESTMENTS IN CAPACITY AND AUTOMATION. DIVIDENDS ARE PAID TO STOCKHOLDERS IN QUARTERLY INSTALLMENTS AT A RATE PER SHARE THAT YOU ESTABLISH AT THE BEGINNING OF THE YEAR. FOR EXAMPLE, IF YOU SET A DIVIDEND POLICY OF $2.00 PER SHARE, THE DIVIDEND WOULD BE PAID DURING THE YEAR IN FOUR $0.50 INSTALLMENTS. 16- Capstone Manager Guide BONDS All bonds are ten year notes. Your company pays a 5% brokerage fee for issuing bonds. The first three digits of the bond, the series number, reflect the interest rate. The last four digits indicate the year in which the bond is due. The numbers are separated by the letter S which stands for series. For example, a bond with the number 12.6S2009 has an interest rate of 12.6% and is due December 31, Bondholders will lend total amounts up to 80% of the value of your plant and equipment (the Production Department s capacity and automation). Each bond issue pays a coupon, the annual interest payment, to investors. If the face amount or principal of bond 12.6S2009 were $1,000,000, then the holder of the bond would receive a payment of $126,000 every year for ten years. The holder would also receive the $1,000,000 principal at the end of the tenth year. Each year your company is given a credit rating that ranges from AAA (best) to D (worst). In Capstone, ratings are evaluated by comparing your short term interest rates with the prime rate. If your company has no debt at all, your company is awarded a AAA bond rating. As your debt-to-assets ratio increases, your short term interest rates increase. Your bond rating slips one category for each additional 0.5% in interest. For example, if the prime rate is 10%, and your short term interest rate is 10.5%, then you would be given a AA bond rating instead of a AAA. When issuing new bonds, the interest rate will be 1.4% over the current debt interest rates. If your current debt interest rate is 12.1% then the bond rate will be 13.5%. You can buy back outstanding bonds before their due date. A 1.5% brokerage applies. Buying back bonds reduces interest payments. These bonds are repurchased at their market value or street price on January 1 of the current year. The street price is determined by the amount of interest the bond pays and your credit worthiness. It is therefore different from the face amount of the bond. Bonds are retired in the order they were issued: The oldest bonds retire first. There are no brokerage fees for bonds that are allowed to mature to their due date. If a bond remains on December 31 of the year it becomes due, your banker borrows current debt to pay off the principal. This, in effect, converts the bond to current debt. This amount is combined with any other current debt due at the beginning of the next year. STOCK Stock issue transactions take place at the current market price. Your company pays a 5% brokerage fee for issuing stock. Stock price is a function of: Book Value Earnings Per Share (EPS) Dividend Policy Book value is equity divided by shares outstanding. Equity is common stock plus retained earnings. Shares outstanding is the number of shares that have been issued. For example, if equity is $50,000,000 and there are 2,000,000 shares outstanding, book value is $25 per share. EPS is calculated by dividing net profit by shares outstanding. Dividend is the amount of money paid per share to stockholders. Stockholders do not respond to dividends beyond the EPS. They consider them unsustainable. For example, if your EPS is $1.50 per share, and your dividend $2.00 per share, stockholder s would ignore anything above $1.50 per share as a driver of stock price. All of these factors are profit dependent. You need to make sufficient profit to increase the book value of your company and pay a dividend. Improving profit also improves EPS.

18 You are charged a 1.5% brokerage fee to retire stock. EMERGENCY LOANS CAUSE STOCK PRICE TO FALL, EVEN WHEN YOU ARE PROFITABLE. STOCKHOLDERS TAKE A DIM VIEW OF YOUR PERFORMANCE WHEN THEY WITNESS A LIQUIDITY CRISIS. THE TOTAL AMOUNT APPEARS IN THE DUE THIS YEAR CELL ON THE FINANCE SPREADSHEET IN CAPSTONE.XLS. CUSTOMER AND SUPPLIER CREDIT POLICIES ARE SET ON THE MARKETING SPREADSHEET IN CAPSTONE.XLS. EMERGENCY LOANS Financial transactions are carried on throughout the year directly from your cash account. If you manage your cash position poorly, Capstone will give you an Emergency Loan to cover the shortfall. The loan comes from a gentleman named Big Al, who arrives at your door with a checkbook and a smile. Big Al gives you a loan exactly equal to the shortfall. You pay one year s worth of current debt interest on the loan, and Big Al adds a 7.5% penalty fee on top to make it worth his while. For example, suppose the current debt interest rate is 10%, and you are short $10,000,000 on December 31. You pay one year s worth of interest on the $10,000,000 ($1,000,000) plus an additional 7.5% or $750,000 penalty. The emergency loan is combined with any other current debt due at the beginning of the next year. You do not need to do anything special to repay it. However, you need to decide what to do with the current debt (pay it off, re-borrow it, etc.). The interest penalty only applies to the year in which the emergency loan is taken, not to future years. CREDIT POLICY Your company determines the number of days between transactions and payments. For example, your company could give customers 30 days to pay their bills (accounts receivable) while holding up payment to suppliers for 60 days (accounts payable). Shortening the A/R (accounts receivable) lag from 30 to 15 days in effect extracts a loan from customers. Similarly, extending the A/P (accounts payable) lag from 30 to 45 days extracts a loan from your suppliers. The accounts receivable lag impacts sales. If your company offers no credit terms, sales potential falls to about 65% of maximum. At 30 days, sales potential is 92%. At 60 days, sales potential is 98.5%. At 120 days there is no reduction. The longer the lag, the more cash is tied up in receivables. The accounts payable lag has implications for production. Suppliers become concerned as the lag grows and they start to withhold material for production. At 30 days, they withhold 1%. At 60 days, they withhold 8%. At 90 days, they withhold 26%. At 120 days, they withhold 63%. At 150 days, they withhold all material. Withholding material creates shortages on the production line, workers stand idle and per-unit labor costs rise. 5. ADVANCED MODULES Instructors can activate four advanced modules: Advanced Marketing Human Resources Labor Negotiations Total Quality Management The website will notify you if the modules are active. If they are, you will find complete documentation in the Advanced Module section of the Online Manager Guide. For detailed information, see the Online Manager Guide -17

19 6. PROFORMAS & ANNUAL REPORTS TO ACCESS PROFORMAS, CLICK THE PROFORMAS MENU ITEM IN CAPSTONE.XLS; TO ACCESS THE ANNUAL REPORTS, CLICK THE LAST YEAR S REPORTS MENU ITEM IN CAPSTONE.XLS OR THE WEBSITE S REPORTS LINK. Proformas and Annual Reports include: Balance Sheet Cash Flow Statement Income Statement What s the difference between proformas and annual reports? Proformas are projections of results for the upcoming year, Annual Reports are the results from the previous year. The Proformas allow you to assess the projected financial outcomes of the company decisions entered in Capstone.xls. BALANCE SHEET The balance sheet identifies what is owned by the company, and by whom. Assets always equal liabilities & owners equity. Liabilities & owner s equity represent who owns those assets. Creditors have claim to the accounts payable (suppliers), current debt (bankers), and long term debt (bondholders). Stockholders have claim to the common stock. Management controls retained earnings, the portion of profits that is not returned to shareholders as dividends. CASH FLOW STATEMENT The cash flow statement indicates the movement of cash through the organization, including operating, investing and financing activities. The annual report cash flow statement shows how much cash was on hand at the end of last year. The proforma cash flow statement indicates how much cash is expected at the end of this year. Figure 6.1 Proforma Balance Sheet. This is a projection of the results of the upcoming round based upon the company s decisions. REMEMBER, THE PROFORMA REPORTS ARE ONLY AS ACCURATE AS THE MARKETING SALES FORECASTS. YOU MIGHT WANT TO PRINT YOUR PROFORMA INCOME STATEMENT AFTER FINALIZING YOUR DECISIONS, THEN COMPARE IT TO THE ACTUAL RESULTS IN THE ANNUAL REPORTS. SG&A, OR SALES & GENERAL ADMINISTRATION COSTS INCLUDES R&D, PROMOTION, SALES AND ADMIN COSTS. INCOME STATEMENT The income statement is an indispensable tool. Your company can quickly diagnose problems with excess inventory, insufficient profits or excess interest payments. The income statement provides a record of profits and losses by comparing revenues and expenses on a product by product basis. Sales are reported in dollars (not the number of products). Subtracting variable costs from sales determines the contribution margin, which generally should be 30% or more. Inventory carry costs are driven by the number of products in the warehouse. If your company has $0 inventory carry costs, you stocked out of the product and most likely missed sales opportunities. If your company has excessive inventory, your carry costs will be high. Sound sales forecasts matched to reasonable production schedules will result in a modest inventory carry costs. Period costs are the sum of deprecation and SG&A costs. Period costs are subtracted from the contribution margin to determine the net margin. Depreciation is an accounting principle that allows companies to reduce the value of their capacity and automation. Each year, some of the value is used up. It decreases the firm s tax liability by reducing net profits, and provides a more accurate picture of a company s value. Depreciation is reflected as a gain on the cash flow statement, but is expensed on the income statement. Net Profit impacts many of the financial measures associated with business success, including earnings per share, which drives stock price and market capitalization. Figure 6.2 Annual Report Income Statement. This shows the results from the previous year. 18- Capstone Manager Guide

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