What is the economic rationale for industry consolidation

Transcription

1 Feature Article Stein: The Economics of Outsourcing What is the economic rationale for industry consolidation and how can small remanufacturers take advantage of this trend? Generally, industries consolidate over time. The North American automotive industry went from hundreds of manufacturers to three to two over the course of the past 100 years. The computer industry had a similar consolidation pattern, although in a significantly shorter time period. Retail, banking, telecommunications, cable, agriculture, entertainment, health care, pharmaceuticals and a host of other industries have experienced similar consolidation trends. Industry Consolidation and Economies of Scale Industries consolidate due to economies of scale and competitive advantage. Not only is it frequently less expensive to produce products and services in larger volumes than in smaller volumes, but also larger companies often can develop significant competitive advantages over smaller companies. The manufacturing portion of the cartridge remanufacturing industry is no exception. A remanufacturer that produces 40,000 units per month can do so less expensively on a per cartridge basis than a remanufacturer that produces 1,000 units per month. Similarly, larger remanufacturers tend to have a wider selection of products, bring products to market faster, have higher quality products, and can devote more resources to process improvement. These factors favoring economies of scale and competitive advantage operate in a circular manner: the larger the manufacturer, the greater the economies of scale and the more significant the competitive advantage. As a result, the bigger remanufacturers tend to get bigger faster therefore, consolidation increases. While consolidation and outsourcing receive a fair share of negative attention from the press, these trends are natural and create opportunities for those who take advantage of the strategic pattern and find ways to adapt their business models to the new competitive environment sooner rather than later. The Economics of Outsourcing The strategic basis for outsourcing is, fundamentally, economic. Companies choose to outsource production or services because it is less expensive to do so. Almost every company outsources some process, and many processes have become so commonplace to outsource that managers do not even consider it outsourcing. Consider a company s payroll processing, health insurance or shipping. It is substantially less expensive for ADP to process millions of payrolls every week than it is for an individual company to oversee the process from beginning to end. Similarly, it is less expensive for Blue Cross/Blue Shield, Kaiser, or PacifiCare to offer health insurance to a larger employee population than for a single company to be responsible for all of its employees health care. Other examples are UPS, FedEx, DHL, Airborne and the US Postal Service. Any company would be challenged to hand deliver all of its products and invoices to its customers. Such outsourcing decisions have become so basic that rarely does a manager agonize over how to handle these daily decisions. Should Microsoft outsource its programming and software design? These are fundamental elements of each of these companies value proposition. Outsourcing the basic value proposition in these situations does not make sense because these companies do it better than anyone else. For many remanufacturers, the perspective is similar. Remanufacturing a cartridge goes hand-in-hand with selling the cartridges and servicing the printers. This decision becomes even more significant for a company that started remanufacturing a few cartridges in a garage and selling those cartridges to local businesses. In such instances, not only is production an integral part of the business, it is at the very core of the company s birth. How can an owner outsource such a critical element of the organization s business model and origination? From a cultural, organizational and strategic perspective, the answer is complex. However, in terms of economics, with the proper analysis, the answer is relatively simple. A Fictional Case Study: Anytown Laser Toner Recharge In the Beginning We can highlight the challenges of outsourcing through the history and economics of a generic remanufacturer, who, for lack of a better name, will be called Anytown Laser Toner Recharge. Let us suppose that Anytown Laser Toner Recharge was founded in 1992 by the husband and wife team of Lew and Karly Kurlander in Anytown, Iowa. Lew had been a copier service technician for 10 years, and he became interested in the growing and profitable remanufacturing industry after he read an article about it in a national magazine. He saw an opportunity to make some additional money and, if things worked out in the long run, to be his own boss. Anytown Laser Toner Recharge began modestly out of the Kurlanders garage. Lew maintained his day job, but he remanufactured some of the most popular Hewlett-Packard cartridges at night. Karly worked part time in the accounting department of a local Fortune 500 company, and she helped Lew with the books on the weekends. Out of the Garage By 1994,Anytown Laser Toner Recharge had developed a solid reputation for producing high quality remanufactured cartridges at competitive prices. Anytown had a loyal following of 25 to 30 customers who depended upon Lew for both supplies and services. Lew was now remanufacturing 200 cartridges per month out of his garage enough for Lew to quit his job and begin remanufacturing full time. Two years later in 1996, Anytown was producing twice as many cartridges, and Lew had hired a full-time production assistant to remanufacture the cartridges. The Kurlanders moved their company out of the garage and into a leased 1,500-square-foot office and warehouse space. Lew spent his days servicing printers and selling cartridges and, on some evenings, would assist with the remanufacturing to catch up on any back orders. Making the Decision to Outsource The challenging decision occurs when a manager needs to consider outsourcing a fundamental portion of the company s business. Should Wal-Mart outsource its distribution system or the management of its stores? Should Toyota outsource its production processes? Should Merck outsource its new product development? 2

2 A Full-Time Family Business By 1998, Anytown Laser Toner Recharge employed two production employees, two service technicians, and an office manager to assist with everything from marketing to taking orders to helping the service technicians with their driving directions. Lew spent all day servicing printers and all night taking care of the books. To free some time in the evenings and to save the business some money, Karly decided to leave her part-time job and join Anytown Laser Toner Recharge full time. Running the Numbers First, the Kurlanders looked at the HP 1200X (C7115X). The HP 1200X sold for approximately $80 at retail stores. To be competitive, Anytown would need to sell the cartridge for approximately $60, a 25 percent discount. When determining the cost of the cartridge, including labor, overhead, and material costs, Karly estimated that the HP 1200X would cost approximately $40 to remanufacture. Therefore, Anytown would make $20 from each cartridge sale. A Local Success Story Four years later, in 2002, Anytown Laser Toner Recharge was a success story by any measure. The company had grown to nearly $2 million in yearly sales and had been featured several times in the local press. The Kurlanders had even received an award from the local Chamber of Commerce for their strong growth. Anytown Laser Toner Recharge remanufactured approximately 1,000 laser cartridges per month and had relationships with a good 15 percent of the local small- and medium-sized businesses. The company produced 40 different types of toner cartridges, including the HP 4500 color toner, a few Canon fax cartridges, and several of the older Lexmark models. Anytown advertised in the Yellow Pages and by word-of-mouth. The company employed four service technicians, three production employees, an office manager, a customer service assistant, and Karly had promoted herself to the general manager. Lew and Karly were making more money than they had ever made in their lives. Overall, prospects looked good. The Economics of a New Product Launch Investing in new product development is a mandate for any remanufacturer, and Anytown Laser Toner Recharge was no exception. However, with the challenges of running a small and growing business, Lew and Karly had fallen a year or two behind in their new product introductions. The couple recognized that they would not be remanufacturing the HP 27X until they retired. More important, the Kurlanders were all too aware that a few local competitors were approaching Anytown s customers with products that Anytown did not yet offer. So, in 2002, Anytown decided to make a push into new products and, hopefully, leap frog their competition. Lew and Karly estimated that they would need to release at least 25 new products to get ahead of their competition. The new products included several of the latest HP cartridges such as the 1200X and the 9000X, a few more Lexmark cartridges, the new Canons and the Brother TN460, among others. Large vendors such as Static Control Components, Future Graphics, and Oasis were all in contact with the Kurlanders on a regular basis, helping them to decide which products to release first. The Kurlanders compiled the recommendations, conducted their own research, and then pulled together some financial projections on launching a few of the new products. Karly estimated that Anytown would need to invest approximately $1,000 in start-up costs to release the product. Start-up costs included an HP 1200 printer, two OEM cartridges to benchmark Anytown s remanufactured performance, labor and materials. Karly assumed that in the first month, Anytown would sell only 10 units of the 1200X. Within six months, she anticipated the 1200X would account for approximately 6 percent of Anytown s total business (60 cartridges per month). Table 1 illustrates Anytown s analysis with a $20 profit per ca Anytown would make its money back within three months and, cumulatively, would make approximately $10,000 on the new product launch by year s end. A 10 times return within one year looked very compelling. Lew and Karly both agreed that they should launch the product as soon as possible. At the other end of the spectrum was the HP 9000X (C8543X). The HP 9000X cartridge sold for approximately $250 at the street price. To be competitive, Anytown would need to sell its cartridge for approximately $190, a 25 percent discount. The Kurlanders were excited by the high selling price of each cartridge and knew that most of their customers would appreciate saving $60 per cartridge. They were even more excited once they figured out the profit per cartridge. Karly estimated that the total cost of the cartridge, including labor (very expensive for this cartridge), overhead and material costs would be $130. So, the company would make $60 from each cartridge sale. This would be the largest profit contribution from any cartridge that Anytown had ever produced. Lew was ready to release the 9000X right away. However, Karly was less sure. Karly estimated that Anytown would need to invest approximately $8,000 in start-up costs to release the product. Start-up costs included an HP 9000 printer, two OEM cartridges to benchmark Anytown s remanufactured performance, a splitting system, drill bits, jigs and a lot of labor. Table 1: 1200X Launch Economics January February March April May June July August Sept. October November December Monthly Units Sold Profit Per Cartridge $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 Monthly Profit $200 $400 $600 $800 $1,000 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 $1,200 Cumulative Units Sold Cumulative Profits $200 $600 $1,200 $2,000 $3,000 $4,200 $5,400 $6,600 $7,800 $9,000 $10,200 $11,400 $1,000 Initial Investment ($800) ($400) $200 $1,000 $2,000 $3,200 $4,400 $5,600 $6,800 $8,000 $9,200 $10,400 3

3 Table 2: 9000X Launch Economics January February March April May June July August Sep. October November December Monthly Units Sold Profit Per Cartridge $60 $60 $60 $60 $60 $60 $60 $60 $60 $60 $60 $60 Monthly Profit $600 $600 $600 $600 $600 $600 $600 $600 $600 $600 $600 $600 Cumulative Units Sold Cumulative Profits $600 $1,200 $1,800 $2,400 $3,000 $3,600 $4,200 $4,800 $5,400 $6,000 $6,600 $7,200 $8,000 Initial Investment ($7,400) ($6,800) ($6,200) ($5,600) ($5,000) ($4,400) ($3,800) ($3,200) ($2,600) ($2,000) ($1,400) ($800) Karly aggressively assumed that in the first month, Anytown would sell 10 units of the 9000X. With a savings potential of $60 per cartridge, Anytown should have success selling the 9000X, but Anytown knew of fewer than a half dozen businesses that had purchased the printer. Therefore, Karly assumed that the penetration for the 9000X would be limited and, at best, would probably capture less than 1 percent of the total market. After a year, Anytown would be lucky to have sold more than 120 units. Table 2 illustrates Anytown s analysis with a $60 profit per cartridge. With the 9000X, Anytown would not break even for over a year. While this was not an inordinate amount of time, it was quite a bit longer than for the 1200X. Lew and Karly moved the 9000X down to the bottom of their priority list for new cartridge releases. The Economics of Keeping Up With Every New Product As Karly and Lew mulled over their options, they decided to run a quick analysis on how much Anytown would need to invest in order to pursue all of the new products that they were considering. They assumed that Anytown would need to release approximately 25 new products to catch up with and, hopefully, beat their competition in breadth of product offering. Conservatively, they estimated they would need to spend $50,000 for all of the new printers, the labor, the splitting machines, and miscellaneous materials. At $2 million in sales, this amount was 2.5 percent of their total sales and was a substantially larger portion of Anytown s net income. The investment was becoming much larger than the Kurlanders had anticipated. On the upside, while the 1200X seemed as if it would be a popular item, the Kurlanders were hard pressed to assume that the release of the 24 other new products, a 60 percent increase over their current 40 SKUs, would increase their supplies business by 60 percent. Rather, they assumed it would increase their total sales by 15 percent, given that new products took time to penetrate, that some of their older cartridge models were declining, and that many of the specialty printers had unique applications and were used only by a portion of their customers. Table 3 illustrates the Kurlanders analysis, assuming an average contribution of $25 per cartridge, 150 new unit sales per month, and a $50,000 investment. By the end of the year, Anytown would still be $5,000 behind. More important, what if the assumptions were wrong. What if Anytown made less than $25 per cartridge? What if they sold fewer than 150 new cartridges per month? The investment might not pay off for 18 to 24 months. At that time, there might be another 25 or even 50 new cartridges to release. The Kurlanders began to question their ability to finance new product development and wondered if they would always be behind in new product releases. Contemplating the Possibility of Outsourcing At a national trade show two years earlier, the Kurlanders met a large remanufacturer who was offering a wide selection of products and had a good reputation for quality. The Kurlanders decided to get a rough price estimate on the 25 cartridges they were considering releasing themselves, just to see how their prices compared to the large remanufacturer. Overall, the prices to purchase the products from the large remanufacturer were 10 percent higher than what it would cost the Kurlanders to make the product themselves. Initially, they were skeptical. Then, Karly ran the numbers with a similar set of assumptions: 150 new unit sales per month and $22.50 profit per cartridge, 10 percent less than Anytown s standard $25 contribution per cartridge. In contrast, though, the Kurlanders were not required to make any upfront investments themselves. At a minimum, the Kurlanders would save $50,000 in start-up costs. Table 4 illustrates the Kurlanders estimates. Table 3: Overall In-house New Product Launch Economics January February March April May June July August Sep. October November December Monthly Units Sold Profit Per Cartridge $25 $25 $25 $25 $25 $25 $25 $25 $25 $25 $25 $25 Monthly Profit $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 $3,750 Cumulative Units Sold ,050 1,200 1,350 1,500 1,650 1,800 Cumulative Profits $3,750 $7,500 $11,250 $15,00 $18,750 $22,500 $26,250 $30,000 $33,750 $37,500 $41,250 $45,000 $50,000 Initial Investment ($46,250) ($42,500) ($38,750) ($35,000) ($31,250) ($27,500) ($23,750) ($20,000) ($16,250) ($12,500) ($8,750) ($5,000) 4

4 Table 4: Overall Outsourced New Product Launch Economics January February March April May June July August Sep. October November December Monthly Units Sold Profit Per Cartridge $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 $22.50 Monthly Profit $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 $3,375 Cumulative Units Sold ,050 1,200 1,350 1,500 1,650 1,800 Cumulative Profits $3,375 $6,750 $10,500 $14,250 $18,000 $21,750 $25,500 $29,250 $33,000 $36,750 $40,500 $44,250 $50,000 Initial Investment $3,375 $6,750 $10,500 $14,250 $18,000 $21,750 $25,500 $29,250 $33,000 $36,750 $40,500 $44,250 Assuming that Anytown sold the same number of cartridges and made 10 percent less than if they had produced the cartridges in house, at the end of the year, Anytown would have a $44,250 profit instead of still being in the red $5,000. Anytown Outsources New Products Anytown was intrigued by the prospect of outsourcing their new products and decided to work with the remanufacturer. After a year, they had sold a total of 1,500 units from the new products less than they had anticipated. However, they were able to charge a higher price for a portion of their products because their competitors did not offer all the products Anytown was now selling. As a result, Anytown had a higher profit than expected. Overall, they were satisfied with their decision not to produce the products in-house. (The Kurlanders spent $10,000 of the $50,000 they saved on a trip to Southern Italy after the Remax Show in Europe that year.) Anytown Considers Outsourcing Existing Products While 2002 was another successful year for Anytown Laser Toner Recharge, by the start of 2003, Anytown was beginning to feel the pressure of increasing competition. Several local competitors were aggressively growing their businesses, national players were coming into the scene and Internet companies were substantially lowering the price points for remanufactured products. Conducting A Break-Even Analysis On New Product Releases Releasing new products is a critical element in being successful in the remanufacturing industry. At today s pace, OEMs are releasing 40 to 50 new products per year, and the pace seems only to be increasing. It is of equal importance for a remanufacturer to evaluate the cost of a new product release as it is to determine the point at which the company will break even. The calculations are fairly simple when the following information is available: release a new product. All three scenarios assume 10 units per month with $25 profit per cartridge (see below.) With a $1,000 initial investment, this product breaks even by May. With a $2,500 initial investment, the product breaks even in November. And with a $5,000 initial investment, the new product does not break even until well into the second year. Cost to release the product Estimated units sold per month Profit per cartridge Successful remanufacturers will run their own analyses to determine where to make the best investments on new product releases. With this information, remanufacturers are able to run a basic analysis on when they can expect to break even on a new product release. Table A provides an example for a $2,500 investment for the release, an estimated 50 units sold per month a $20 profit per cartridge, and a January release. Based on this analysis, the remanufacturer breaks even within three months a pretty quick return. The higher the cost to release the product, the lower the units sold per month, and the lower the profit per cartridge, the longer it will take to break even. Table B shows three different break-even timelines for different upfront investments to Table A Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Monthly Units Sold Profit Per Cartridge $20 $25 $25 $25 $25 $25 $25 $25 $25 $25 $25 $25 Monthly Profit $1,000 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 $1,250 Cumulative Units Sold Cumulative Profits $1,000 $2,250 $3,500 $4,750 $6,000 $7,250 $8,500 $9,750 $11,000 $12,250 $13,500 $14,750 $2,500 ($1,500) ($250) $1,000 $2,250 $3,500 $4,750 $6,000 $7,250 $8,500 $9,750 $11,000 $12,250 5

5 As a result, Lew was spending more time out in the field selling and was requiring his service technicians to make at least 10 sales calls a day to new customers. Fortunately, Lew was very personable and was able to close many of his new prospects. He felt that if only he could spend more time selling, he would be able to keep the business at its historically high growth pace. Table 7: In-House Versus Outsourced Production Costs - 1st Attempt In-house Production Outsourced Production Average Units/Month 1,300 Average Units/Month 1,300 Average $/Unit $65.00 Average $/Unit $65.00 Avg. Material Cost/Unit $25.64 Avg. Material Cost/Unit $38.46 Meanwhile, Karly was having problems managing the warehouse. Two experienced production workers had left, the new hires were not as productive and had more quality issues, and Anytown was contemplating how to handle its lease, which was expiring in several months. Once again, the question of outsourcing came up for the Kurlanders. If outsourcing made sense on new products, might it make sense on existing products? However, given that the up-front investments had been made long ago, the investment return analysis that Karly had pulled together the prior year was not feasible. Anytown had to analyze its income statement and balance sheet in order to fully understand the impact of this decision. Excluding the new products it already outsourced, Anytown produced 1,300 cartridges a month. The company employed four production employees, five service technicians, an office manager, a customer service representative, plus Karly, the general manager, and Lew, the president. Total revenues for 2003 were forecast to be $2.4 million with approximately $1 million coming from supplies (again, excluding the new products), $1 million coming from service and $400,000 coming from hardware. Given that Anytown was not considering changes to its service or hardware business, the Kurlanders focused their analysis on the supplies side of the business. Lew and Karly ran numbers quickly just to see how things might look if they were to outsource the entire production. Table 5 illustrates Anytown s projected 2003 income statement for the supplies business. Table 5: Anytown s Supplies Segment Profit and Loss Statement Revenues Amounts Percentage Costs $1,000, % Materials $400,000 40% Labor $150,000 15% Overhead $60,000 6% Gross Profit $390,000 39% SGA $150,000 15% Net Profit $240,000 24% Table 6 illustrates the financial metrics per cartridge. 6 Table 6: Anytown s Per Cartridge Financial Metrics Average Units/Month 1,300 Average $/Unit $65.00 Average Cost/Unit $40.00 Average Profit/Unit $25.00 The Kurlanders decided that they were unwilling to outsource production unless they could negotiate a situation in which their average cost per unit was the same for outsourced product as for product produced in-house. After receiving prices back from several remanufacturers, the Kurlanders were disappointed to see that the price per unit actually increased (Table 7). The material cost per cartridge increased from $25.64 to $38.46 per unit, a $13 or more than 50 percent increase. Lew immediately wanted to stop discussing outsourcing and felt that he would just need to work harder. Karly was not willing to give up on the analysis. Something must be wrong; she had heard so much about outsourcing over the past two years. After a few days of running different scenarios, Karly realized that she had neglected to reduce Anytown s labor and overhead expenses. Clearly, Anytown would not need the same amount of product labor, space or overhead as it would when the company was producing cartridges inhouse. Karly had not been comparing apples to apples, but had been comparing the aggregate cost from the potential outsourcing partners to Anytown s material costs. Karly ran the numbers again and the per unit comparison was much more compelling (Table 8). The average profit per unit did decline by $0.40, roughly 1.3 percent of the average sales price per unit. Table 8: Further Analysis of Production Costs In-house Production Outsourced Production Average Units/Month 1,300 Average Units/Month 1,300 Average $/Unit $65.00 Average $/Unit $65.00 Average Material Cost / Unit $25.64 Average Material Cost / Unit $38.46 Average Labor Cost /Unit $9.62 Average Labor Cost /Unit $0.64 Average Overhead/Unit $3.85 Average Overhead/Unit $0.38 Total Average Cost/Unit $39.10 Total Average Cost/Unit $39.49 Average Profit /Unit $25.90 Average Profit /Unit $25.51 Table 9: In-house vs. Outsourced Production In-house Production % Outsourced Production % Revenues The income statement comparison between Anytown s costs in-house Revenues Costs $1,000, % Costs $1,000, % Materials $400,000 40% Materials $600,000 60% Labor $150,000 15% Labor $10,000 1% Overhead $60,000 6% Overhead $6,000 1% Gross Profit $390,000 39% Gross Profit $384,000 38% SGA $150,000 15% SGA $150,000 15% Net Profit $240,000 24% Net Profit $234,000 23%

6 Anytown s total material costs increased from $400,000 per year to over $600,000 per year. As a result, the average material cost per unit increased from $25.64 to $38.46, almost a 50 percent increase, as Karly had seen before. However, after more detailed examination, labor and overhead both dropped significantly. Anytown presumed it would still need space to store the cartridges as well as someone to receive and inspect the incoming cartridges. In the end, it appeared that the overall price per cartridge did not increase significantly. Costs were simply reallocated from Anytown s labor and overhead expense directly into the price of the cartridges from the outsourced manufacturer. An additional advantage occurred on the balance sheet as Anytown was now able to put its labor expenses and overhead directly into accounts payable. Although modest, the outsource model did make some additional working capital available to Anytown. Volume Lowers Costs for Outsourcers As the Kurlanders contemplated this new analysis, they became concerned that perhaps they were being quoted an inferior product from the outsourcing partner. How could the large-scale remanufacturer sell product at roughly the same price that it cost Anytown to build the cartridge? After some consideration, the Kurlanders realized that large-scale remanufacturers are able to create a cost savings for two primary reasons: First, the outsourcers buy components, toner, drums and cores at such large volumes that they save 10 to 20 percent on their material costs. Second, they are more efficient with their labor, and, therefore, have lower labor costs. Both of these dynamics afford the large remanufacturer enough of a margin to produce the product for Anytown and still be profitable. New Product Development for Large- Scale Versus Local Remanufacturers While the initial investment to release a new product is generally consistent for both large-scale and local remanufacturers, the large-scale companies are at a distinct advantage in releasing new products when the following is considered: The probability of higher return The speed of the return The investment as a total proportion of sales Consider the example of a local remanufacturer producing 1,000 units per month versus a large-scale remanufacturer producing 40,000 units per month. Both are considering releasing 25 new products at an aggregate cost of $50,000. The local remanufacturer anticipates making $20 profit per cartridge; the large-scale remanufacturer anticipates 50 percent of that amount or a $10 profit per cartridge. A quick look at the break-even returns reveals several interesting trends (see table below). Even if the local remanufacturer assumes that the new products will account for a 15 percent increase in company sales, the company still does not break even for an entire year. For the large remanufacturer, sales only have to increase by 2.5 percent (1,000 units divided by 40,000) for the company to break even within five months. It is powerful to consider that the large-scale remanufacturer is making 50 percent less than the local remanufacturer, growing sales at one-sixth the amount and yet is able to break even in a third of the time. If the large-scale remanufacturer made the same amount of profit per cartridge and grew sales by the same percentage as the local remanufacturer, it would break even in two weeks on a $50,000 investment. Additionally, the local remanufacturer is investing a considerably larger portion of the company sales (and net income) into new product development. $50,000 could represent some 5 to 10 percent of total supplies sales, whereas the large-scale remanufacturer is investing somewhere between 0.1 to 1.0 percent of sales. For these reasons, many local remanufacturers are relying on national, large-scale remanufacturers for their new product development needs. Local Remanufacturer Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Monthly Units Sold Profit Per Cartridge $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 $20 Monthly Profit $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 $3,000 Cumulative Units Sold Cumulative Profits $3,000 $6,000 $9,000 $12,000 $15,000 $18,000 $21,000 $24,000 $27,000 $30,000 $33,000 $36,000 50,000 ($47,000) ($44,000) ($41,000) ($38,000) ($35,000) ($32,000) ($29,000) ($26,000) ($23,000) ($20,000) ($17,000) ($14,000) Large-Scale Remanufacturer Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Monthly Units Sold 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 1,000 Profit Per Cartridge $10 $10 $10 $10 $10 $10 $10 $10 $10 $10 $10 $10 Monthly Profit $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 $10,000 Cumulative Units Sold Cumulative Profits $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 $80,000 $90,000 $100,000 $110,000 $120,000 50,000 ($40,000) ($30,000) ($20,000) ($10,000) $0 $10,000 $20,000 $30,000 $40,000 $50,000 $60,000 $70,000 7

7 Evaluating Three Different Future Scenarios Now that the Kurlanders had answered their most important concern cartridge cost they began to have some reservations about what to do with their current production employees. While the production department had experienced some transition and the current employees were not as experienced as the prior employees, neither Lew nor Karly had the appetite for a staff reduction. Instead, they considered moving the personnel into inside sales positions to make outbound calls. If this could generate enough leads, Lew could close more business and grow Anytown Laser Toner Recharge s supplies and service business. The Kurlanders recognized that not everyone could transition from production into sales, so there might be one or two production employees who had to be laid off, but Anytown could certainly use more help in growing the sales. Lew and Karly ran the numbers and came up with three potential scenarios: 1. Stay the same: Do not outsource and grow at 20 percent. 2. Outsource, but do not grow: Eliminate production, do not invest in sales and continue to grow at 20 percent. 3. Outsource and grow: Eliminate production, reinvest in sales and grow at 40 percent. The results for all three scenarios were quite different (Table 10). Table 10 Stay the Same 20% Growth Revenue $1,000,000 $1,200,000 $1,440,000 $1,728,000 $2,073,600 Gross Margin 24% 24% 24% 24% 24% Gross Profit $240,000 $288,000 $345,600 $414,720 $497,664 SGA Expense $150,000 $150,000 $150,000 $150,000 $150,000 Cumulative Net Income $90,000 $138,000 $195,600 $264,720 $347,664 $1,035,984 Outsource, But Do Not Grow 20% Growth Revenue $1,000,000 $1,200,000 $1,440,000 $1,728,000 $2,073,600 Gross Margin 23% 23% 23% 23% 23% Gross Profit $230,000 $276,000 $331,200 $397,440 $476,928 SGA Expense $150,000 $150,000 $150,000 $150,000 $150,000 Cumulative Net Income $80,000 $126,000 $181,200 $247,440 $326,928 $961,568 Outsource and Grow 40% Growth Revenue $1,000,000 $1,400,000 $1,960,000 $2,744,000 $3,841,600 Gross Margin 23% 23% 23% 23% 23% Gross Profit $230,000 $322,000 $450,800 $631,120 $883,568 SGA Expense $230,000 $230,000 $230,000 $230,000 $230,000 Cumulative Net Income $- $92,000 $220,800 $401,120 $653,568 $1,367,488 Analyzing the Results In reviewing the scenarios, losing some margin points definitely had a direct impact on Anytown s profitability. Outsourcing without reinvesting, on the surface, cost more money and resulted in overall less profits for Anytown. However, if Anytown chose to focus its time and attention on growing the business instead of producing product, the payoff was substantial. Over five years, 40 percent growth rather than 20 percent growth would produce almost two times the net income from supplies in The Kurlanders found the numbers compelling, but it did require a commitment on their part to push the business forward. After discussing the potential options, the Kurlanders believed they could free up so much additional time not worrying about production that they would easily be able to grow their business. To Outsource Or Not To Outsource The story of the Kurlanders and their experiences with Anytown Laser Toner Recharge is fictional, of course, but represents a common experience among many remanufacturers in North America over the past five years. Remanufacturers, collectively, have had a very successful 15 to 20 years in the industry. Many have grown, prospered and provided customers with a great value proposition. Going forward, remanufacturers have much to look forward to, including overall industry growth, technological advances, increasing market share for remanufactured cartridges, and, if executed properly, the economic advantages of outsourced production. Remanufacturers should be cautious about outsourcing new products, a portion of their products or all of their products. They have much to lose if they make a bad decision. However, they can gain so much more by recognizing the fundamental changes taking place within the industry. Those who respond first will be in the best position to benefit the most. How To Profit By Outsourcing Production Outsourcing is advantageous to the local remanufacturer for the following reasons: Increases breadth of product offering Reduces investment requirement in new products Increases speed to market with new products Frees up time and attention to focus on growing the business Reduces inventory carrying costs and working capital needs Simplifies purchasing because materials are now supplied by one vendor However, there are many stories of outsourcing situations becoming a complete disaster for both the local remanufacturer and the largescale remanufacturer. If quality is inconsistent, product is out-ofstock, credit is tight, shipping is expensive, customer service is unresponsive, products are late to market or any of a number of other factors, the outsourcing decision can seem like the worst decision a local remanufacturer has ever made. On the other hand, those who have made, or will make, the decision to outsource should take full advantage of the new business model: Be first to market in the local geographic area with new products Develop a strong marketing campaign Open a new office Create an alliance with a remanufacturer in another metropolitan area that will strengthen both businesses without causing competition Increase core collection capabilities Expand product offering into inkjets, thermal fax, paper and other imaging supplies Consolidation is a natural part of an industry s evolution. Those that choose to remain on the cutting edge and find a way to modify and maximize their business model will have many years of success in the future. 8