inancial officer of Aurora Textile

hould install a new ring-spinning

n facility. A primary advantage of
er-quality yarn that would be used
finer-quality yarn would be sold
rease in the selling price of yarn,
he Zinser would provide increased
ora's operations management had
ncy would reduce operating costs,
expenses. Sales volume, however,
he cost of customer returns would
million installed cost, made the

vest in the new technology was

ormance as well as the difficult
rora, however, was competing in
to survive foreign competition,
also recognized that there was
er as its price had been increas-
agement team, however, agreed
arguing that it would be cheaper
e, which should keep the current
Aurora to postpone replacement

trademark CompACT3.

Barnhardt (Dean Emeritus of the CoJ!ege

by Lucas Doe (MBNME '04), under
scussion rut her than to illustrate effective
e case is bused on an actual company,
pedagogical purposes. Copyright © 2007
esville, VA. All rights reserved. To order
No part of this publication may be repro-
smitted in any form or by any mea11s-
ithout the permission of the Darden

283
 both domestic and international components, 90% of the company's revenue came
from the domestic textile market.
Yarn sales for the hosiery market accounted for 43% of Aurora's revenue. The
primary consumer products were athletic and dress socks, with white athletic socks
accounting for the majority of sales. In fact, Aurora was the largest volume pro-
ducer of all cotton yarns for white athletic socks in the United States, with nearly
half the U.S. population owning socks made with Aurora yams. Aurora had long
enjoyed supplying the hosiery market for several reasons. First, as a leader in the
market, Aurora was able to command attractive margins and maintain relationships
with some of the largest and most profitable hosiery companies in the world. Second,
hosiery was produced using bulky, heavy yarns. Aurora's plants were designed for
this type of manufacturing operation, which allowed the company to process large
quantities of yarn efficiently Thrrct, unlike other segments of the textile industry,
the hosiery market had successfully defended itself against global competition. The
heavy yarns and bulky products were costly to transport, making them less attrac-
tive for foreign producers. Moreover, this type of production was highly automated
in the United States such that labor costs had been reduced to the point that Asian
manufacturers did not have sufficient opportunity to provide significant cost savings
over U.S. manufacturers.
The knitted-outerwear market was the second-largest revenue source for Aurora,
accounting for 35% of sales. Aurora's customers within this market mainly produced
knitted cotton and polyester/cotton dress shirts for a· variety of major retailers. The
yarns produced were medium- to fine-count yarns (14/1 to 22/1 ring and rotorj.' This
quality yarn, however, was easily produced by other market participants, leaving very
little opportunity for suppliers to differentiate their products and creating an environ-
ment where there was constant price pressure on outerwear yarns.
Accounting for 13% of Aurora's business revenue, the wovens market was a rel-
atively small but important segment for the company. Most of these yarns were used
to produce denim for jeans. Although much of the production had shifted offshore to
lower-cost producers, most weavers continued to purchase U.S. yarns in order to avoid
the supply risks associated with sourcing yams from other countries. In addition, the
yams produced for the wovens market were coarse (5/1 to 14/1 ring and rotor) and

2The coarseness of a yarn was measured by the amount of yam it took to equal one pound: the more yams
per pound, the finer the yarn. One "hank" held 840 yards of yam. A count of 22/1 specified that 22 hanks
were needed to equal one pound. A count of 14/1 indicated a coarser yarn than a count of 22/1 in that one
pound of 14/1 yarn required only 14 X 840 yards.
 processes,. although rotor spin-
d constituted the majority of the ,
and 2 present Aurora's financial
ne in sales had led to manage-
in 2000 in an effort to rightsize
reduce manufacturing costs. In
ng: Hunter, Rome, Barton, and
process technology by plant).

matic changes over the years

icies, cheaper production costs
ustry, which had started in New
e advantage of cheaper produc-
per production costs had begun
pparel makers moved their pro-
U.S. yarn manufacturers were
competition from the influx of
lar had made it more appealing
essively, flooding the U.S. mar-
nufacturing base exclusively in ·
and modernize their operations

e market. The emphasis in the

e manufacturing as textile mills
entrating on manufacturing sys-
ds to be produced with minimal
ring goods to retailers and con-
on technology allowed retailers
mmunicate those needs through
nsumer preferences had moved
d those preferences were even

or yarn producers like Aurora

rns. For example, a dress shirt
of Aurora yarn. If the yarn was
the high-end market, the company's dollar liability per garment would increase. For
example, if Aurora supplied the yarn for a shirt that sold for $75 at Nordstrom, a cus-
tomer return would make Aurora liable for paying $75 to Nordstrom despite the fact
that Aurora would have received only $10 for the yarn used to make the shirt. Aurora's
production engineers were confident that the Zinser would yield such high-quality
yarn that the volume returned would drop to 1.0%.
The U.S. government's free-trade policies were implemented through the North
American Free Trade Agreement (NAFTA) and the Caribbean Basin Initiative (CBI).
These trade agreements had created a burden on the U.S. textile industry by encourag-
ing trade with Canada, Mexico, and Caribbean countries, which lowered the prices of
consumer goods in the U.S. market. This enriched trade also forced U.S. textile com-
panies to compete against cheaper labor, lower environmental standards, and government-
subsidized operations. The net-effect was substantially lower-priced goods for U.S.
consumers but a very difficult competitive environment for U.S.-based manufacturers.
For other parts of the world, the U.S. State Department had used textile quotas
and tariffs as a political bargaining tool to obtain cooperation from foreign govern-
ments. The United States and other countries also used quotas and tariffs as a mech-
anism to prevent the dumping of foreign goods into local markets and to protect the
domestic industry. Recently, however, the World Trade Organization (WT0)3 had
announced that, as the governing body for international trade, it would ban its mem-
bers from using quotas, effective January 1, 2005. This move would further open the
U.S. market to competition from countries beyond its immediate borders. Notwith-
standing this outlook, most research analysts believed that the U.S. textile industry
would grow around 2% in real terms, with prices and costs increasing at a 1 %. infla-
tion rate for the foreseeable future.

Production Technology
The production of yarn involved the processes of cleaning and blending, carding,
combining the slivers, spinning, and winding (Exhibit 4). Aurora used only rotor spinning
and ring spinning in its yam production. Ring spinning was a process of inserting twists
by means of a rotating spindle. In ring spinning, twisting the yarn and winding it on a
bobbin occurred simultaneously and continuously. Although ring spinning was more

3Established
through agreements and negotiations signed by the bulk of the members of the General Agree- ·
ment on Tariffs and Trade {GATI), the WTO replaced GATI in January 1995. The WTO was an interna-
tional, multilateral organization that laid down rules for global trading systems and resolved disputes
between member states. Of its 148 members, 76 were founding members, including the United States.
t, by eliminating the need
-end rotors produced yarn
eover, the yarn from open-
siderably weaker and had
cottons were desirable for

financially. The company

ronment, and had suffered
urrently, the company had
nt working capital. Since
States, and 200,000 indus-
manufacturing operations,
ies. Since 2000, the com-
million. These efforts had
cult financial environment
.

g machine in the Hunter

d was carried on Aurora's
machine could be sold for
by the time the machine
value. Management also
ne could continue to oper-
ed to have grown from its
pacity of 600,000 pounds

bility of a fiber sample. A sample

irflow and resulling in a lower
w ratio of surface area to mass.
the suitability of Hunter's ventilation, materials-flow, and inventory systems.
The cost structure of a textile plant was primarily composed of a materials cost
(the cost of cotton) and a conversion cost, which included the cost of labor, dyes and
chemicals, power, maintenance, customer returns for defects, and various other pro-
duction and overhead costs. In 2002, the Hunter plant's conversion cost was $0.43/lb.
Most of the conversion costs would not be affected if the Zinser replaced the exist-
ing spinning machine. For example, there would be no change in the work force,
although the current operators would need to be trained on the Zinser, at a one-time
cost of $50,000, during the installation year. A significant benefit of the Zinser, how-
ever, was that it was expected to reduce power and maintenance co_sts equivalent to
a savings of $0.03/lb. The cost of customer returns constituted $0.077/lb. of the con-
version costs for 2002. Based onengineering and marketing.projections, Pogonowski
estimated that the cost of customer returns would rise to $0.084/lb. for the higher-
quality yarn produced by the Zinser. As shown in Exhibit 5, the cost per pound was
influenced by the return frequency ( 1.0%), the liability multiplier (7.5), and the expected
increase in selling price per pound ($1.0235 X 110% = $1.126). Depreciation and
SG&A expenses were not included as part of conversion costs. SG&A was estimated
to remain at 7% of revenues for both the existing spinning machine and the Zinser.
Although the Zinser's reliability would reduce the inventory of unprocessed cotton,
buffer stocks would be necessary to hedge against the uncertainties surrounding the
cotton's timely delivery to the plant as well as slowdowns and shutdowns due to pro-
duction problems with the spinning machine. The Zinser was becoming widely used
by many U.S. yarn producers, and had proved itself a highly reliable machine, with
very few production delays, compared with earlier-generation spinning machines. This
dependability had allowed most manufacturers to reduce their cotton inventories to
20 days from the average of 30 days (see Exhibit 6 for cotton spot prices).6 When
asked about this benefit; the Hunter plant manager responded:
My job is making profits. I just happen to do it by spinning cotton yam. A big part of those
profits comes from controlling our cost of cotton. I do that by buying large quantities of
cotton when the price is right. If you look at my cotton inventory over the year, you will
see that it varies considerably, depending on whether I think it's a good time to buy cotton

5The installation cost included a building-modification cost of $115,000, an airflow-modification cost of

$55,000, and freight and testing costs of $30,000.
6In
addition to cotton inventories, plants often carried large finished-goods inventories. Textile manufacturers
preferred to ship soon after completing production, but large buyers had increasingly been requiring produc-
ers lo hold their finished-goods inventories to reduce the buyers' carrying costs.
 d purchase the Zinser
is specific investment
st interest to invest in
g to lose money. This
textile market would
the ban on quotas in
ondition and its credit
nowski was also con-
r returns in the high-
mple, if the frequency
t would compromise
lly attracted the com-

ur years, shareholders
a share to its cun-ent
might prefer to see the
ssets for Aurora. Nev-
end of Aurora's stock
Aurora used a hurdle
felt confident that the
years, but he was less
er that time span.
 Net sales $245,908 $229,787 $182,955 $147,503
Raw-material cost 132,812 122,461 98,536 64,982
Cost of conversion 83,454 · 84,2i2 67,822 61,912
Gross·margin 29,641 23,114 16,597 20,609
SG&A expenses 14,603 14,218 11,635 10,305
Depreciation and amortization 15,241 13,005 11, 196 9,859
Operating profit (203) (4,109) (6,234} 445
Interest expense 6,777 6,773 5,130 3,440
Other income (expense) 1,143 (1,232) (409)
Asset impairments1 4,758 7,5(b4
Earnings before income-tax provision (6,980) (9,739) (17,354) (10,968)
Income-tax provision @ 36% tax rate (2,513) (3,506) (6,247) (3,949)
Net earnings ($4,467) ($6,233) ($11,106) ($7,020)

1Costs
associated with the shutdown of plants,
 4 2,516 2,505
9 30,308 30,427
5 197,889 190,410
8 230,713 223,342
4) (146,302) (154,658)
4 84,411 68,684
0 1 ,180 1,180
9 2,824 2,430
0 $143,023 $135,991

3 9,667 10,835
2 4,176 4,730
90 961 929
4 3,881 3,657
30 0 0
9 $18,685 $20, 151
1 58,000 58,000
1 1 i ,776 10,297
1 $88,461 $88,448

50 50 50
8 15,668 15,668
1 38,845 31,825
9 $54,563 $47,543
0 $143,023 $135,991
 BIT 4 I Industrial Yarn Production

Opening/Cleaning/ Carding Combining the Slivers Spinning Winding

Blending Line (Drawing/Combing/Roving)

!ning/Cleaning/Blending Line
on was shipped to the mills in bales and still contained vegetable matter. An automated process, designed to
small tufts of-fibers from the tops of a series of 20 to 40 bales, opened or separated the fibers into small
nps," removed any foreign particles in the tufts, and blended the tufts for a more homogeneous product. There
a continuous flow of fibers from the Opening Line to the Card.
ding
Card received the small tufts of fibers from the Opening Line and, through a series of metallic wire-covered
iders, separated the tufts of fibers into. individual fibers, which were parallelized, cleaned to remove smaller
ign particles, and formed into a strand of parallel fibers, called a sliver. The strand resembled a large, un-
ted rope.
wing
Drawing Process combined six to eight slivers to allow greater uniformity of the drawn sliver.
nbing
Combing Process was an optional process for ring-spun yarns. Combing removed short fibers (8%-12% of
weight of a sliver), eliminated practically all remaining foreign particles, and further blended the stock.
ring
Roving Process reduced the weight of a drawn silver to the point that a small amount of twist was needed to
tide the tensile strength required for ring spinning.
g Spinning .
;:i Spinning further reduced the weight (linear density) of the strand of roving, added more twist, and created a
111 package weighing Jess than half a pound.
1ding
,ding was a process that simply took multiple packages of ring-spun yarn and "spliced" them together into one
tinuous strand, resulting in a package of yarn weighing three to four pounds.
 (5 x i.5%)
(7.5% X $1.0235/lb.)

Calculation, . ·

5/iO)

5 X i.0%)
5% x $1 .0235/lb. x ii 0%)
 0
~ SOl------~------\::~..._,----='----;-----------1
Q)
0
·~ 401---~-~~--------~----------.------.r-----1
a.
+"'
g_
(I)
30~-~-------------------------~,
201---------~~~-~--~----~--~----1
....... ····--·--·;0-1-----------------------------1

1Source:
Bloomberg Database.

EXHIBIT 7 I Interest-Rate Yields: January 2003

U,Sr G"overnment, (% yield)'.

Treasury bill (i -year) i.24
Treasury note (1 a-year) 3.98
Treasury bond (30-year) 4.83

Prime rate1 4.25

AAA (i 0-year) 4.60
AA (i 0-year) 4.66
A (10-year) 4.87
BBB (10-year) 5.60
BB (i o-ysar) 6.90
1The
prime rate was the short-term interest rate charged by large U.S.
banks for corporate clients with strong credit ratings.