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Capstone. Computer Simulation. Objectives. Demonstrate effectiveness of multi-discipline teams working together. Use strategic thinking to an advantage. Learn financial fundamentals. Understand overall interaction and impact of various parts of a business on one another.

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capstone
Capstone

Computer

Simulation

objectives
Objectives
  • Demonstrate effectiveness of multi-discipline teams working together.
  • Use strategic thinking to an advantage.
  • Learn financial fundamentals.
  • Understand overall interaction and impact of various parts of a business on one another.
  • Grow an awareness of competition.
  • Take away practical know-how to improve the effectiveness of your business.
why simulate
Advantages

Risk Free

View Alternative Strategies

Compress Time (8 years in 8 weeks)

Disadvantages

Some players not serious

Selectivity and abstraction

Discrete time increments

Why Simulate?
disclaimers
Disclaimers!
  • These slides are not a substitute for reading the Team Member Guide 
  • They do not include all necessary information to make decisions 
  • In the event of a conflict between these slides, the Guide, and the simulation’s output; believe the output. 
the playing field
The Playing Field
  • $100M electronic sensor

manufacturer.

  • Market dominated by handful of firms.
  • No outside competitors or substitutes.
  • Benign environment.
market segments beginning shares annual growth rates nn
Market Segments Beginning Shares & Annual Growth Rates (nn%)

Share of units

Performance - 8.4% (19.8)

Low End – 39.3% (11.7%)

Traditional – 32.4% (9.2%)

High End – 11.2% (16.2)

Size – 8.7% (18.3%)

These values change.

Check manual.

perceptual map
Perceptual Map

Large

Size

Small

Fast

Slow

Performance

slide9

Perceptual Map

Large

Performance

Low End

Size

Traditional

Size

High End

Small

Fast

Slow

Performance

Defines five market segments.

perceptual map changes

Low

Perf

Trad

High

Size

Perceptual Map Changes

Large

  • Other characteristics:
  • Price
  • Reliability (MTBF)
  • Age (yrs since revised)

Size

Small

Fast

Slow

Performance

Customer expectations change to smaller and faster

each segment has a sweet spot
Each Segment Has a Sweet Spot

Large

Rough cut

Fine cut

Size

Sweet Spots

Not to scale

Small

Fast

Slow

Performance

high end sweet spot
High End Sweet Spot

Sweet Spot

See Guidefor exact position

two stage purchasing decision
Two stage purchasing decision
  • Select from among products that meet criteria based on
    • Performance
    • Size
    • Reliability
    • Price
  • Decide on quantity based on other factors.
functional areas
Functional Areas

Production

R&D

HR

Marketing

Finance

research development
Research & Development
  • Set Product coordinates (Position)
  • Set MTBF rating (Quality)
  • Drive Perceived age (Age)
  • Create new products
marketing
Marketing
  • Price
  • Promotion Budget
  • Sales Budget
  • Set Sales Forecast
  • Set Credit Policies AR/AP
production
Production
  • Set automation level
  • Buy or sell capacity
  • Schedule production
      • One year lag to add capacity or automate
human resources
Human Resources
  • Wages
  • Benefits
  • Profit Sharing
  • Wage Escalator
finance
Finance
  • Acquire Capital
    • Issue Stock
    • Short Term Debt
    • Issue Long Term Bonds
  • Set Dividend
  • Retire Long Term Bonds
  • Retire Stock
  • Emergency Loan
proformas
Proformas
  • Balance Sheet
  • Profit & Loss
  • Cash Flow
  • Financial Ratios
scoring the simulation
Profit

Market share

Return on Sales

Asset turnover

Return on Assets

Return on Equity

Stock Price*

Market capitalization*

Scoring the Simulation

You will establish your own success criteria. Capstone provides common financial performance measure that you can weight as you see appropriate to your success. Of course, the stock price is always looked at closely by the outside world.

* Ending only, others areweighted averages

skill mix needed
Skill Mix Needed
  • Teamwork—all members
  • At least one team member should have
    • Quantitative skills—spreadsheet useful
    • Organizing skills—get the team to meet and get decisions entered on time
    • Forecasting skills—anticipate future demand
    • Analytical skills—predict likely competitor actions
functions to cover
Functions to cover
  • Product managers (1 to 8, start with 5)
  • Segment managers (5)
  • Marketing
  • Production
  • Finance
  • Competitive Intelligence
  • General Manager

There are more functions than people. Each person will have multiple responsibilities.

team decision processes
Team Decision Processes

Review results

Compare to plan

R & D

decisions

Analyze competitors’ results.

Predict strategy

Marketing

decisions

Forecast sales

Production

decisions

Reassess

plans

Cash flow

decisions

Capital

decisions

log into capstone
Log into Capstone
  • http://www.capsim.com
  • Tour website
  • Download starting conditions
    • Operating note: If you see a quantitative conflict between the manual or these slides and the software, use the software numbers; e.g., segment growth rate or size.
internal company operations
Internal Company Operations
  • Research and Development
  • Marketing
  • Production
  • Labor Relations
  • Finance

Decision making should start with R & D and go down the list. Iterate until the entire team is satisfied with the decision.

research and development
Product R & D improves the product characteristics

New products

Positioning

Age (perceived)

Quality (mean time between failure, MTBF)

Process R & D improves production

Automation—covered in Production segment

Research and Development
product r d
Reposition products’ Performance and Size. Any change cuts perceived age in half.

Increase MTBF to improve quality

Create new products

Repositioning and quality improvements affect material cost.

Automation increases time required to reposition product.

Product R & D
new product development

+

New Product Development
  • One year minimum
  • Development time driven by distance from existing product
  • Requires new production capacity
factors affecting r d cycle time
Factors affecting R&D cycle time
  • Automation level of production line
  • Number of R & D projects underway
  • Degree of change (distance moved on perceptual map)
    • Big moves (>4 units) take 2.5-3.0 years regardless of automation

See Guide page 20 for details

process r d
Automation reduces labor cost

E.g., $11.20/unit at level 1; linear to $1.20 at level 10

Automation costs $4 per level per million units production capacity. E.g., 2 levels x 600 cpy x $4 = $4,800.

Automation increases time to revise a product (nonlinear).

Process R & D
r d notes
R & D notes
  • You can add or delete products; min=1, max =8.
  • Projects started must be finished before new projects can be started on that product.
  • All projects start on January 1.
  • Products not repositioned will eventually become obsolete (segment drift)
  • New products require new production facilities. One year minimum to complete (typical 1.1 to 2.3 years).
  • New production capacity takes one year.
marketing s four ps
Marketing’s four Ps
  • Price—quick response, easily copied
  • Promotion—Cumulative effect with diminishing returns
  • Place—Have the product where the customer needs it.
  • Product—The result of R & D efforts (prior slides).
    • All are described ceteris paribus but that is never the case!
two stage purchasing decision1
Two Stage Purchasing Decision
  • Stage One: Which products meet the customer’s requirement?
    • Performance and size are within 4 units of center
    • Reliability and age within expectations
    • Price does not exceed maximum
  • Stage Two: How many units to buy from among those that pass stage one?
    • How close to ideal is each product on each characteristic?
two stage purchase decision

Able

Price

Segments

Two Stage Purchase Decision

Stage 1 - Match Product to Market

Size

1. Product must plot within the segment.

Able

2. Product must fall within

price guidelines.

Performance

Able

Quality

(MTBF)

3. Product must fall within quality and age guidelines

Segments

two stage purchase decision1
Two stage purchase decision

Stage 2 - Rank Best Product

Quality

1. Positioning

2. Age

3. Quality

4. Price

Position

3

Sweet Spot

0

Yrs

1

Age

Price

20000

25000

HIGH END

$30

$40

age effects
Age Effects
  • Product age does not affect rough cut
  • Demand is normally distributed around ideal age (with truncation)
  • Sensitivity to age varies by segment

Gary Whitney

sellers markets
Sellers’ Markets
  • When there is insufficient inventory to meet aggregate demand, there is a “sellers’” market. Buyers relax their criteria to meet needs.

Sellers’ market slope—precipitous!

Buyers’ market slope 20%/1K hours

Demand

22K

27k

MTBF Guidelines

segment criteria
Segment Criteria

Traditional

Low End

High End

Perform

Size

Age

Price

Position

Quality

Price

Age

Position

Quality

Position

Age

Quality

Price

Quality

Position

Price

Age

Position

Age

Quality

Price

See Guide for exact criteria

price
Price
  • Low price alone is not a strategy

Prices have been dropping about $.50/year in each segment. Therefore, holding price will reduce demand.

Price

Estimate this curve for your segment to find optimal prices.

2001

2000

Quantity demanded

price drives margins
Price drives margins
  • Hint!
    • In Capstone, a good variable margin target is about 38%!
  • Variable margin =

Price – (Direct labor + Direct Mat’ls + Inventory carrying cost) Price

    • See page 2 of your annual report
price1
Price
  • Credit policy is a form of price competition; it affects the capital structure of the buyer and seller
    • One million dollars in A/R costs you $100,000 at interest rates of 10%
promotion
Promotion

%

aware

Example only

Promotion expense

Note: half of those not made aware will do their own research to find the product.

promotion 2
Promotion (2)
  • Only products that pass the rough cut are affected by promotion. You cannot sell an unsuitable product with high promotion.
  • About half of the customers who have NOT seen your promotions will find it through their own research.
  • Promotion can explain no more than about half of the demand for your product compared to competitors; less if all promote about equally.
    • E.g. if all 6 companies achieve 80% awareness, then other factors become the driving forces.
place
Place
  • Sales force budget gets the product placed where the customer can buy it.
  • The relationship of expense to sales is the same as promotion but:
    • It applies to all of your products in that segment. This is an opportunity for economies of scale.
    • Products moving between segments get the benefit of the sales budget from the segment when they are in it.
customer survey in courier
Customer Survey (in Courier)
  • Index from 0 – 100 of how well each product met criteria in December
    • Lowest Price #
    • Perfect Position *
    • Top MTBF #
    • Ideal age *
    • 100% Awareness
    • 100% Accessibility
  • * Changes monthly so customer
  • survey score of 100 is
  • nearly impossible. However,
  • this can be useful information
  • for sales forecasting.
  • # Competitors may change your
  • ranking for the following year
  • on these.
production1
Production

Andrew’s Factories

  • Scheduling (short term) up to 200% of capacity at time and half
  • Automation (see Process R & D)
  • Capacity (long term)
  • Vendor relations (A/P)
    • Slow payments cause raw material to be withheld creating shortages and idle workers

Able

Acre

Adam

Aft

Agape

Space for additional factory

Space for additional factory

Space for additional factory

30 days--1%, 60 days—8%, 90 days—26%, 120 days—63%, 150 days—100%

inventory is money
Inventory is money
  • Hint!
  • In Capstone, a conservative target for end-of-year inventory is 10% of annual sales (36 days of inventory).
  • The perfect end-of-year inventory is 1 unit.
capacity changes
Capacity changes
  • Adding capacity
    • $6 per unit (floor space) + $4 * automation level (machines) per million per year.
    • Available for production the year after purchase
  • Reducing capacity
    • Sell equipment at 65% of price paid. May be more or less than depreciated value on balance sheet. Shown as gain or loss in write-off part of income statement.
    • Sell all capacity for one product to terminate that product
      • Unsold inventory is liquidated at half of cost!
graceful product termination
Graceful Product Termination
  • First Year
    • Sell all production capacity but one unit
    • Reduce promotion and sales budgets to clear existing inventory
    • Continue selling products
  • When all inventory is sold
    • Sell the last unit of capacity
labor relations
Labor Relations

The summary page says when negotiations are scheduled. No other notice!

  • Contract expires!
  • Labor will produce a set of demands.
    • 10% above current contract.
  • Management will establish negotiation range.
    • Not less then 80% of current contract.
    • Not more then 150% of current contract.
  • See Capstone Labor presentation for complete details
labor strategy issues
Labor strategy issues
  • The low cost producer must keep wages low
  • The high margin producer may be less sensitive to labor cost
  • Firms with inventory can weather a strike more easily
  • Firms with high automation are less sensitive to labor cost
  • All of these should be considered in relation to your competitors.
finance1
Finance
    • You must plan for each of these in the short run (using capstone.xls) and long run (using your strategic plan and spreadsheet)
  • Ending cashCash flow statement
  • ProfitsIncome statement
  • Capital StructureBalance sheet
pessimistic optimistic brackets
Pessimistic & optimistic brackets
  • Worst case scenario
    • Enter lowest sales forecasts on marketing spreadsheet
    • Enter highest production schedules on production spreadsheet
    • Check projected ending cash to avoid emergency loan
  • Best case scenario
    • Enter highest sales forecast
  • Results should be in between
cash flow
Cash flow
  • Every year must end with a positive cash balance or you are technically bankrupt. In Capstone, you will get an emergency short term loan to prevent liquidation. You will pay the short term rate plus 7.5%.
bracket pessimistic optimistic
Bracket pessimistic & optimistic
  • Worst case scenario
    • Enter lowest sales forecasts on marketing spreadsheet
    • Enter highest production schedules on production spreadsheet
    • Check projected ending cash to avoid emergency loan
  • Best case scenario
    • Enter highest sales forecast
    • Check projected inventory to avoid stock outs
  • Actual results should be in between
cash keeps creditors away
Cash keeps creditors away
  • Hint!
  • In Capstone, a conservative target for end-of-year cash is 10% of annual revenue (a 36 day supply).
  • The perfect end-of-year cash balance is 1 dollar.
income statement
Income statement

Keep your pro forma

income statement after

finalizing decisions to

compare with results achieved.

  • The “bottom line” is profit. It is the ultimate measure of success.
  • Investors look for return (profit) on their investments—Earnings per Share (EPS)
    • EPS trends drive stock prices
    • P/E ratio is awarded based on expectations
  • The income statement shows results of operations for the entire year.
balance sheet
Balance sheet

Assets

  • Sources of capital are:
    • Liabilities
      • Accounts payable
      • Current debt
      • Long term debt
    • Equity
      • Common stock
      • Retained earnings (accumulated profit)
  • The balance sheet is a “snapshot in time” that shows the capital structure of the firm at the end of the year.

=

changing capital structure
Changing capital structure
  • Short term debt is used to manage yearly fluctuations in cash needs.
    • One year at a time, paid back automatically.
  • Bond Issues are used to manage long term cash needs.
    • Once issued, remain until called
  • Stock Issues are used to manage long term cash needs.
interest rates
Interest rates
  • Are a function of your debt to asset ratio. Your bond rating is on page 2 of the Capstone Courier.
    • Short term rates are prime plus .5% for each category below AAA. (AAA, AA, A, BBB, BB, etc). They change every year.
    • Long term rates are short term plus 1.4%
      • Rate remains the same after bonds are issued.
leverage
Leverage

ROE= +30%

ROA=10%

Assets

Debt

Equity

ROE= -30%

  • Leverage=Assets/Equity=3
  • Return on Assets=10%
  • Return owners’ Equity=30%

Gary Whitney

interest rates1
Interest Rates
  • Reminders:
    • a=d+e
    • leverage= a/e
    • leverage = d/e+1
    • d/a=1-e/a
    • d/a=1-1/leverage
  • BUT an emergency loan will immediately reduce your bond rating
  • Long term rates are short term plus 1.4%
capital budget limit
Capital Budget Limit
  • Your bankers will not allow companies to raise more money than they could reasonably spend on capital improvements.
    • See Guide for specifics
issuing bonds
Issuing bonds

14.6S04

  • Pay a 5% brokerage fee to issue
    • Limited to 80% of factory value
  • Retire at market plus 1.5% fee.
  • Pay annual interest payment only.
  • Pay principle in 10th year.
  • Designation:

Series due

2022

Interest

Rate 14.6%

14.6S022

issuing stock
Issuing stock
  • Sell at market less a 5% brokerage fee.
    • Limited to 20% of current issue.
  • Buy at market plus 1.5% fee.
short term debt revolving credit line
Short term debt (revolving credit line)
  • No fees
    • Limited to 75% of A/R + 50% of projected inventory.
  • Interest rates fluctuate
driving stock price
Driving stock price
  • Book value
  • EPS trend
  • Dividends but do not exceed EPS and
  • Emergency loans will drive it down

Never borrow money to pay dividends!

summary
Summary
  • Bracket to verify cash and inventory
  • Use leverage consistent with your risk profile and industry volatility
  • Earnings trend dominates stock price
  • And finally, watch out for Whitney’s Top Ten Tribulationnext two slides.
whitney s top ten tribulations
Whitney’s Top Ten Tribulations
  • Insufficient margins
    • Target 30%+
  • New product w/o factory
    • One year lead time
  • Prices >$4.90 out of range
    • Fail rough cut
  • Unrealistically optimistic sales forecast
    • Hope is not a plan
  • Plant upgrades ordered w/o cash plan
    • Look at Proforma before submitting decisions

Gary Whitney

whitney s top ten tribulations1
Whitney’s Top Ten Tribulations
  • Failure to check proforma
    • Look for cash buffer of 10% of revenue
  • Plant capacity beyond needs
    • Wait until 100% use
  • Insufficient use of leverage
    • Earn profits on OPM (other people’s money)
  • Excessive cash
  • Excessive inventory
    • Target about 4- 6 weeks sales (each product)

Gary Whitney