Precision Worldwide, Inc.
In late May 2004, Hans Thorborg, the general manager of the German plant of Precision Worldwide, Ine. (PWI), scheduled an afternoon meeting with his sales manager, accountant, and development engineer to discuss the introduction by the French firm Henri Poulenc (a competitor) of a plastic ring substitute for the steel retaining rings presently used in certain machines sold by Precision Worldwide. The plastic ring, new to the market, not only had a much longer life than the PWI steel ring but also apparently had a much lower manufacturing cost. Thorborg’s problem stemmed from PWI’s large quantity of steel rings on hand and the substantial inventory of special steel that had been purchased for their manufacture. After a thorough survey, he had found that the special steel could not be sold, even for scrap; the total book value of these inventories exceeded $390,000. For nearly 90 years PWI had manufactured industrial machines and equipment for sale in numerous countries. The particular machines involved in Thorborg’s dilemma were made only at the company’s plant in Frankfurt, Germany, which employed more than one thousand people. The different models were priced between $18,900 and $28,900 and were sold by a separate sales organization. Repair and replacement parts, which accounted for a substantial part of the company’s business, were sold separately. As with the steel rings, these parts could often also be used on similar machines manufactured by competitors. The company’s head office was in Toledo, Ohio, U.S.A. In general, plants outside the United States were allowed considerable leeway in administering their own affairs; the corporate headquarters, however, was easily accessible by telephone, email, or during executive visits to the individual plants. In the late 1990s, competition had increased. Japanese manufacturers, with low-priced spare parts, had successfully entered the field. Other companies had appeared with lower-quality and lower-priced machines. There was little doubt that future competition would be more intense. The steel ring manufactured by PWI had a normal life of about two months, depending upon the extent to which the machine was used. A worn-out ring could be replaced in a few seconds, and although different models of the machines required from two to six rings, the rings were usually replaced individually as they wore out. The sales manager, Gerhard Henk, had learned of the new plastic ring shortly after its appearance and had immediately asked when PWI would be able to supply them, particularly for sale to customers in France, where Henri Poulenc was the strongest competition faced by PWI. Bodo Professor William J. Bruns, Jr. adapted this case from “Industrial Grinders N.V.” (HBS No. 175-246). HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 1997 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means=-electronic, mechanical, photocopying, recording, or otherwise-without the permission of Harvard Business School.197-103 Precision Worldwide, Inc. Eisenbach, the development engineer, estimated that the plastic rings could be produced by midSeptember. The necessary tools and equipment could be obtained for about $7,500. Eisenbach had initially raised the issue of the steel-ring inventories that would not be used up by September. Henk believed that if the new ring could be produced at a substantially lower cost than the steel ones, the inventory problem was irrelevant; he suggested that the inventory be sold, or if that was impossible, thrown away. The size of the inventory, however, caused Thorborg to question this suggestion. He recalled that the size of the inventory resulted from having to order the highly specialized steel in large amounts so that a mill would be willing to handle the order. Henk reported that Henri Poulenc was said to be selling the plastic ring at about the same price as the PWI steel ring; since the production cost of the plastic ring would be much less than the steel, he emphasized that PWI was ignoring a good profit margin if it did not introduce a plastic ring. As the meeting concluded, it was decided that the company should prepare to manufacture the new ring as soon as possible but that until the inventories of the old model and the steel were exhausted, the plastic ring would only be sold in those markets where it was offered by competitors. It was expected that the new rings would not be produced by any company other than Henri Poulenc for some time, and this meant that no more than 10% of Precision Woldwide’s markets would be affected. Shortly after this, Patrick Corrigan, from the parent company in Ohio, visited Frankfurt. During a review of company problems, the plastic-ring question was discussed. Although the ring was only a small part of the finished machines, Corrigan was interested in the problem because the company wanted to establish policies for the production and pricing of all such parts that, in total, accounted for a substantial portion of PWI’s revenues. Corrigan agreed that the company should proceed with plans for its production and try to find some other use for the steel; he then said, “If this does not seem possible, I would, of course, expect you to use this material and produce the steel rings.” A few days after Corrigan’s visit, both Eisenbach and Henk came in to see Thorborg. Eisenbach came because he felt that since tests had indicated that the plastic ring had at least four times the wearing properties of the steel ring, it would completely destroy demand for the steel ring. He understood, however, that the price of the competitive ring was high, and he felt that the decision to sell the plastic ring only in markets where it was sold by competitors was a good one. He observed, “In this way we will probably be able to continue supplying the steel ring until stocks, at least of processed parts, are used up.” Henk still strongly opposed sales of any steel rings once the plastic ones became available. If steel rings were sold in some areas, he argued, while plastic rings were being sold elsewhere, customers who purchased steel rings would eventually find out. This would harm the sale of Precision Worldwide machines-the selling price of which was many times that of the rings. He produced figures to show that if the selling price of both rings remained at $1,350.00 per hundred, the additional profit from the plastic rings (manufactured at a cost of $279.65 per hundred versus the $1,107.90 per hundred for steel rings) would more than recover the value of the steel inventory, and do so within less than a year at present volume levels. Thorborg refused to change the decision of the previous meeting but agreed to have another discussion within a week. Anticipating this third meeting and also having Corrigan’s concern in mind, Thorborg obtained the data displayed in Table A from the cost accounting department on the cost of both plastic and steel rings. Thorborg also learned that the inventory of special steel had cost $110,900 and represented enough material to produce approximately 34,500 rings. Assuming that sales continued at the current rate of 690 rings per week, without any further production, some 15,100 finished rings would 2Precision Worldwide, Inc. 197-103 be left on hand by mid-September. Thorborg then recalled that during the next two or three months the plant would not be operating at capacity; during slack periods, the company had a policy of employing excess labor (at about 70% of regular wages) on various make-work projects rather than laying workers off. He wondered if it would be a good idea to use some of this labor to convert the steel inventory into rings during this period.
Overhead was allocated on the basis of direct labor cost. It was estimated that the variable overhead costs included here were largely fringe benefits related to direct labor and amounted to 80¢ per direct labor dollar or about 40% of the departmental amounts.
What action should Hans Thorborg take? Why?