Kls Steel Company

I. EXECUTIVE SUMMARY

As an additional incentive for our customers to patronize our steel products, we have chosen to provide them special services, one of which is the cold-drawn steel. However, certain equipments are necessary to be able to produce such a product. At present, we have in our hands a 57-year old draw bench which has a bad reputation of consuming too much energy, of producing a lot of rejects and of needing too many costly repairs.

While it may seem unnecessary for us to invest in a department that we do not specialize on, we must also consider that offering the Cold-drawn steel (CDS) is our competitive advantage; it is our differentiation strategy from our competitors. Giving up this service may displease our customers and sever ties that took us years to build. You, as president, have suggested buying from an outside and reselling the CDS. However, based on the comparative income analysis between these two alternatives, producing the CDS ourselves will yield $5,000 more income per year. It is then recommended that we continue our operations in the CDS department.

Thus, we need to address the production inefficiency problem of this department. As mentioned earlier, the roots of the problem are the aging equipment. At this point, we have to choose between repairing the equipment or replacing it with a new one, once and for all. An evaluation of the Net Present Value and Internal Rate of Return approach show that investing money on the acquisition of a new draw bench will yield greater returns than our cost of capital (10%). Moreover, the payback period approach shows that we would be able to gain back our initial investment at the end of 6 years and 2 months - a far cry from the equipment's total useable life of more than 50 years.

We also need to take a look at the qualitative factors that have an impact in our decision. First, we have to assess if the purchase of a new draw bench will contribute to our firm's future plans. Our long-term goal is to build strong, profitable customer relationships, and we can only do this by providing customer solutions, which are cold-drawn steel. It is therefore recommended that we purchase a new draw bench, as it is in line with our strategy to develop the CDS department. After all, we do not want to be branded as laggards in the industry, we must keep up with practical improvements in technology, for in the end, both our customers and our company benefit from it.

In lieu with this recommendation, it is also necessary for us to retrain our employees regarding the operation and maintenance of the new draw bench. Furthermore, we also have to exercise quality evaluation and control over production quality related to the proposed equipment in order to assess if our decision is indeed the right one.

II. CASE CONTEXT

1. Company

 An old company that has been in the steel industry for 30 years

 One of the larger regional steel service centers in the Midwest

 The CDS department is a "dog" in the BCG matrix, meaning it has a low market share and low market growth

 Their competitive advantage lies on differentiation - by offering additional customer benefits and features such as heat treating, cutting to length and light assembly.

2. Product

 Generic products, not differentiable

 Require highly specialized equipment for producing different kinds of steel

 Cold drawn steel (CDS) are offered to customers as a special service

 The main equipment used to produce CDS is already 57 years old.

3. Economy

 A sharp increase in inflation rates from 1986-1987.

 In October 1987, the US stock market crashed. It was the largest one-day percentage decline in stock market.

4. Point of View

 We are KLS Steel Company's Cold-Drawn Steel Department's Production Manager, and we are presenting our suggested decisions and recommendations to the company's President.

III. PROBLEM DEFINITION

As KLS Steel Company's president, we know that our 57-year old second-hand draw bench has been showing signs of inefficiency. It uses too much electricity, produces plenty of scrap and breaks down a lot. Moreover, this aging draw bench is a constant source of headache for us especially now that repair costs are increasing. On the other hand, this equipment is still useable, but a new one costs $500,000. The problem now is:

Should we purchase a new draw bench?

V. ANALYSIS

To determine whether it is profitable to continue our CDS Department, we compare the current income generated from our CDS operations with the possible income we would get if we buy CDS from a specialty producer and then resell it.

From CURRENT CDS Operations:

1987 Net income $90,000

Tons sold per year 17000

Income per ton $5.29

From the BUY-AND SELL Option:

Income per ton $5

Incremental income per ton, in favor of current operations $0.29

This analysis states that it is profitable to continue the CDS Department given that it will be contributing a net income of $5000 ($0.29 x 17,000 tons per year) more than the proposed Buy-and-sell option.

Also, since some of the equipment that KLS Steel Company owns still work and can be used for CDS operations, then the company might as well proceed extending its special service as an additional incentive for their customers.

As for the consultant's comment that "...you shouldn't invest in business where you have a low market share and low growth," we believe that the benefits of continuing with the CDS Department still outweigh the costs. KLS Steel Company started giving this special service as