Hansson Private Label HBS Brief Case 4021 Case Study

Pages: 13 (3683 words)  ·  Bibliography Sources: 0  ·  Level: Master's  ·  Topic: Business

Hansson Private Label

Hansson is faced with the decision of whether or not to pursue a $50 million expansion. The decision is risky. It concentrates the firm's business with a single major customer, and that customer is only willing to sign a three-year guaranteed contract. Hansson has built a successful business as a supplier of private-label personal care products. This decision will have a significant impact on the firm, not just in terms of finances but also in terms of the firm's broader strategy. While many other firms in private label manufacturing had enjoyed significant success tying their operations to a single retailer, this move was unusual for Hansson at the time. This case analysis will review Hansson's strategic position within the industry, and will work to calculate the net present value of the proposed project. Finally, a recommendation will be made with respect to the course of action that Hansson should take.

Background and Strategic Position

The personal care market is worth an estimated $21.6 billion, and is a mature industry with annual growth at less than 1%. In mature industries, firms typically compete intensely for market share. Private label products generally compete using a cost leadership strategy. Within this market, private label also has a steady share. The private label share of the market is 21.3%, up from 21.0% two years previous. This sluggish growth is mirrored in private label's dollar share of the industry, which is presently 16.1%, or approximately $3.4776 billion.

Hansson's annual revenues have been growing at a faster pace than those of the industry in general. The company's growth rate in 2007 was 7%, in 2006 it was 8.3%, in 2005 it was 8% and in 2004 it was also 8%. To calculate the firm's share of the market, the markup charged by its retailers would need to be known. However, the firm's current revenues are approximately 19.5% of the industry's revenues at retail. This indicates that the company probably has a total market share of private label in the 30-40% range.

For Hansson, the strongest growth comes from drug stores and mass merchants. These companies -- CVS, Walgreen's, Wal-Mart, Target -- are all dominant firms with strong bargaining power over their suppliers. They are also growing concerns that are increasing their market share over time. The second-largest customer group, club stores (i.e. Costco) also has similar characteristics. Mass merchants currently hold a 39.35% share of Hansson's business, compared with 33.6% share in 2003. Drug stores have an 11.7% share, compared with 10.9% in 2003.

Private label goods are a good investment for retailers. From the retailers' perspective, private label goods offered an opportunity to lower their cost of goods sold. Retailers could also offer private label goods at lower prices than branded goods. Given that most of Hansson's major customers compete on the basis of cost leadership, private label products have particular appeal because the retailer has greater control over the value chain. This allows the retailer to simultaneously offer the product at a lower price and for the retailer to earn more profit per unit on that product. Thus, retailers have a significant financial incentive to push private label products. In the past, consumer acceptance was a constraint on private label growth, but that constraint has eroded to the point where 99.9% of consumers purchased a private label product in the past year. However, with respect to personal care products, there has been minimal growth in private label share of the market. So while the retailers have significant incentive to push private label products on their customers, they have not demonstrated much success in recent years and the formerly powerful constraint on private label sales has already been removed. Thus, is it questionable how much more room for growth there is in private label personal products. Growth for Hansson therefore will only come from two sources. The first is dollar increases in price; the second is expansion by its retail partners. If Hansson's partners get bigger, Hansson's market share will increase.

Currently, Hansson is nearing its production capacity. The investment decision that it faces would not only allow it to serve the needs of this major customer, but it would also allow Hansson to meet growth demands from its other customers. In addition, some amount of expansion is probably likely for Hansson anyway, given that it is growing at a fairly steady rate around 8% annually. The decision would allow Hansson to increase its position within the private label industry. While it would increase its dependence on a single customer, this expansion may also give Hansson the opportunity to increase its bargaining power with other customers, as it would not be as dependent on their business. In an intensely competitive no-growth business environment, Hansson needs to consider the value of building out its own market share and economies of scale, in particular as it pertains to dealing with its massive and powerful retail partners.

Each of these retailers envisions itself as a dominant player for years to come, and envisions strong growth in the coming years. For Hansson, this investment represents an opportunity to strengthen its relationship not only with the retailer in question, but with other retailers of similar size and ambition. Hansson can establish itself as the main player in the private label personal care products business, and move itself into a position where it can capture increasing shares of business from all major private label retailers.

Free Cash Flows

Robert Gates has provided estimates and assumptions that can be used to estimate the free cash flows associated with this project. These free cash flows are going to be necessary in order to calculate the net present value of the project. Among the estimates Gates has provided, he has been conservative in his estimates of capacity utilization. He is clearly counting on expanding beyond the needs of the immediate contract. He assumes that revenues from the contract will last beyond the three years. This is a reasonable assumption -- he is counting of the firm to perform to the retailer's expectations. This is something that the firm can control, so the assumption is reasonable.

His assumption that this increased capacity will require four new managers at the outset, expanding to eight, is conservative. The point of expanding for an existing customer is to generate greater efficiencies flowing from economies of scale. Additional managers should not be required to produce addition goods. However, these costs are relatively inconsequential to the project's total financial outcome. His estimates for increased labor are probably also higher than they should be, as are his estimates for increased SGA expenses. They are still selling to a single customer, and the contract would have already been signed. The current SGA expense to revenue is 7.2%, so an estimate of 7.8% for this project is too high. It would likely be lower than the current 7.2% because the contract has already been signed and the volumes are all coming from a single customer. Gates is also estimating that total COGS (including labor, management and cost of materials) will be 84.2% of revenues in 2009. The current rate is 82%, so again Gates has probably overestimated these costs. Thus, the primary weakness in Gates' assumptions is that he has overestimated costs associated with the project. Where they should go down on a per unit or per dollar of revenue basis, Gates has them increasing. However, it is reasonable to be conservative when undertaking a capital budgeting decision. If Gates has underestimated these expenses, that would be a far greater fault. Overestimating expenses is reasonable and allowable, especially since the overestimates are relatively minor. If the project's NPV cannot overcome these estimates to show a positive value, then it may be too risky a project anyway.

It is unknown in Gates' assumptions if manufacturing overhead expense is incremental to the expansion decision. It is reasonable that it would be, since the manufacturing facility will be significantly expanded, but Gates' specific assumptions with regards to this cash flow are unknown. With that said, Gates' assumptions are generally reliable, and because of his conservative approach, it is reasonable to adopt his numbers. These numbers deliver a free cash flow for the life span of the project as follows:

Hansson Private Label

discount rate

Year

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Year

0

1

2

3

4

5

6

7

8

9

10

Initial Cost

-5

Revenue

0

84960

93881

103124

112700

122618

132887

135545

138256

141021

143681

Raw Materials

0

-45120

-49400

-53760

-58200

-62720

-67320

-68000

-68680

-69360

-70040

Mfg Overhead

0

-3600

-3708

-3819.24

-3933.82

-4051.8

-4173.39

-4298.6

-4427.5

-4560.4

-4697.2

Maintenance

0

-2250

-2317.5

-2387.03

-2458.64

-2532.4

-2608.37

-2686.6

-2767.2

-2850.2

-2935.7

Management

0

-160

-165.6

-171.396

-177.395

-183.6

-190.03

-196.68

-203.56

-210.69

-218.06

Hourly Labor

0

-18000

-19570.9

-21814

-24190.2

-26706

-29368.2

-30396

-31460

-32561

-33701

SGA

0

-6626.9

-7322.72

-8043.67

-8790.6

-9564.2

-10365.2

-10573

-10784

-11000

-11207

Free Cash Flow

-5

11396.3… [END OF PREVIEW]

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Hansson Private Label HBS Brief Case 4021.  (2010, November 20).  Retrieved January 15, 2019, from http://allstarrchiro.net/subjects/paper/hansson-private-label-hbs-brief-case/972701

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"Hansson Private Label HBS Brief Case 4021."  20 November 2010.  Web.  15 January 2019. <http://allstarrchiro.net/subjects/paper/hansson-private-label-hbs-brief-case/972701>.

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"Hansson Private Label HBS Brief Case 4021."  Essay.  November 20, 2010.  Accessed January 15, 2019.
http://allstarrchiro.net/subjects/paper/hansson-private-label-hbs-brief-case/972701.