The first part involves the development and implementation of the STRATEGY to change PVC Pipe Plant losses (over $1.1 million) to a profit (minimal) in one year.
When CDC acquired BirdTech, Inc. out of bankruptcy they received the following assets:
- A PVC Pipe plant in Louisiana that was the last of the PVC pipe operations BirdTech owned. At one time BirdTech was a major competitor in the production of PVC pipe, and in addition the company held several patents on the gaskets used in large diameter PVC pipe. Details on the PVC Pipe Plant follow.
- An overfunded pension plan valued at $3.4 million. It took the management of CDC over two years to work through the IRS regulations to liquidate the pension plan and collect the $3.4 million. The IRS stipulated that the PVC plant must continue operating until the overfunded pension plan was closed.
- A Gulfstream jet. This gave CDC two corporate airplanes, one a turbo-prop from the previous major stockholder and the Gulfstream. Both planes were sold by the CDC management team. We used the turbo-prop a couple of times, but after looking at the condition of the PVC Pipe Plant, we decided that the maintenance on the Gulfstream might be suspect, so we let it set in the hanger until the sale.
- Several season tickets to the professional football team in Houston, which were sold to one of the partners of the CPA firm. Like good auditors, they covered their increased expenses by billing CDC a few extra hours.
The PVC Pipe Plant
The PVC Pipe plant was a 24/7 operation and produced PVC pipe for the construction industry in sizes from 1"-14" diameter and in standard lengths. The pipe was formed in an extrusion machine, where PVC pellets were fused by heat and then extruded over a mandrel to produce to appropriate diameter pipe. The time required to change the extrusion head, which determined the PVC pipe diameter, was close to 24 hours. So, to achieve maximum efficiency/lower costs it was desirable to run the extrusion machines for as long a period as possible (say on the 1-1/2" PVC pipe which is a standard for residential plumbing).
The alternative to changing the machinery on a frequent basis was to have long runs in excess of current demand and put the finished pipe in inventory. The pipe could be stored in racks, and the pipe had a very extensive shelf life. Then when the construction project for the new shopping center needed the drain pipe (larger diameters/often colored blue) tomorrow (general contractors are notoriously poor planners), the pipe would be in inventory and it would be loaded on a truck and taken to the job site the next day.
Note the problem. If management wanted to have pipe on hand (in inventory) when the customer placed an order, then the cost of carrying the inventory would be high. If management wanted to minimize inventory (maximize cash flow), then PVC Pipe would be at a disadvantage when a company with more production lines (50 lines was the norm for a medium sized plant and some companies had over 150 lines on average in production) and greater sales was able to carry the inventory and/or have the capability to switch out a line for a special order.
Another limiting factor in the PVC pipe industry is the distance you can transport a load of pipe on an 18 wheeler. The shipment is light in weight and a great portion of the volume of the shipment is air. The larger the pipe diameter, the more air is being shipped. The customer does not pay for the air, only the pipe on the truck. Hence, PVC pipe plants were located close to large metropolitan centers, where there was a lot of construction.
The competition was fierce. The pipe producers usually employed their own salesmen, who sold to distributors who maintained contact with the contractors. Since there is almost no product differentiation between suppliers, the sales effort became a 'good ol'boy' network between the sales staff and the pipe distributors.
The industry is similar to the USMC Aviation motto-'On Target. On Time'. The product had to be at the job site when the trench was dug and at the lowest price
Obviously, the larger producers (many parallel production lines at one location) had an advantage of the smaller producers. All of the BirdTech pipe companies operations had been sold before the acquisition of the bankrupt BirdTech, and the remaining plant in Louisiana was left to compete with the big boys-with only 3 production lines!
A significant competitor is The Evansville Pipe Company in Indiana. Evansville Pipe has several plants in the Midwest and in the Mississippi-Texas corridor. Evansville Pipe is a well-managed mid-sized competitor and along with the larger producers makes life difficult for the PVC Pipe Plant.
The Status of the Company in 1987
The structure of PVC Pipe Plant is as follows:
- The organization chart is as follows:
- General Manager. Compensation $65,000. Company car.
- Sec to GM. Compensation $16,000.
- Sales Manager. Compensation $50,000
- Two salesmen. Compensation $40,000 each + car
- Operations Manager. Compensation $45,000
- 5 Supervisors for 5 shifts. 24/7. Compensation $25,000
- Warehouse Manager. Compensation $26,000
- 3 shift supervisors for warehouse. Compensation $19,000
- Accounting Manager. Compensation $38,000
- Three accounting clerks. Compensation $18,000
- Purchasing clerk. Compensation $17,000
- Fringe benefits at 32% of salary
The other costs are detailed on the P&L statement for 1987-1989. The division, a wholly owned subsidiary of CDC, has losses that range in the $1.1 million annually.
That was the problem that I inherited as CEO of CDC. We had two years of losses at the $1.1 million figure, and we had taken the steps to re-organize the facility with a new sales manager, new general manager, trimming expenses and trying to get an understanding of the business. We were in the last steps of re-capturing the $3.4 million in the over-funded pension plan. The most memorable things about the town of Slidell was the great food one could get in the local restaurants. There was nothing memorable about the PVC Pipe Plant.
We had contacted our competition in the industry to see if we could arrange a sale of the facilities. There were no takers and we could not sell the company due to the IRS regs. We had developed a good relationship with the Evansville Pipe executive team, but they did not have the financial resources to purchase a PVC pipe plant.
During a dinner one night in Slidell, crayfish and beer, with the Evansville management, we developed a strategy that offered the only way to reverse the $1.1 million dollars of loss to a small operating profit in one year. What we had to do was to turn the strategy into an operating plan and make it happen. We did this, and the next year the PVC Pipe Plant had a $36,000 profit at the operating income level. Your assignment is to develop a strategy that puts the company in the black. I am sure that no one will be able to duplicate the successful strategy. In fact, I am so confident that there will be a 1 point bonus for the first person who develops the appropriate strategy. In addition to reversing the loss, we were able to reverse the negative cash flow.
You can do research on the PVC pipe industry, you will find nothing of value to assist in developing the correct strategy. If you want to do research I would do the following.
- Find out who the producers of PVC pipe are in the US and call up the plant and talk to the plant manager or the sales manager.
- Analyze the structure, giving special attention to the plant locations, size of plant (# of operating lines), range of product produced, market served (customers and geographic) and suppliers of the raw material.
- See if you can get an idea of the disadvantage a 3-line plant would have in the market. Find out about the suppliers of the resin and the stability of the price of raw material. Discuss the 24/7 operation and the problem of line changes (from one diameter of pipe to another).
- You will probably find that the raw material is 75-78% of the COGS and there is no chance of a price reduction. There are a limited number of suppliers and they are not willing to negotiate price.
- Discuss the importance of having the right inventory at the pipe distributor when the customer calls in with an order.
- GM% and operating income %.
- Price stability. Discounts offered to suppliers for quantity purchases.
- Unions. Not a significant factor, since most of the plants are in the southern US.
- Any financial information which can be reduced to ratios, such as gm%,
- Approximately 74% of the industry employees were laborers, operatives or service workers.
- Approximately 14% were officials, general managers and professionals.
- Approximately 12% were technicians, salespeople or office workers.
- The average hourly earnings of production workers were $15.78/hour in 2005.
- PVC pipe and other plastic piping is part of SIC 3079: Miscellaneous Plastics Products in 1972, and the workforce figures were calculated on the 1972 SIC basis.)
- 75-78% of sales price is material. See if you can gather data as to the stability of the raw material price as a % of sales. If the price is relatively stable as a % of sales, then another way to reduce costs and achieve profitability is eliminated.
- You cannot exist as a supplier of PVC by only producing a few sizes of pipe. You must produce all sizes and maintain some inventory to be competitive.
The answer to how the deal was structured over crayfish and beer is in the Deal Structure Lecture. The answer to fine tuning the operation to maximize income and cash flow is in playing 'what if' with the pro-forma year after you develop the appropriate strategy.
You do not need a complete financial statement. You can play what if with the existing balance sheet and the numbers established for assets and liabilities. Once you develop the strategy, the financials will all into place.
Attachment:- Plant Financials Base.xlsm