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EXHIBIT 2 DairyPak—A “Value Chain”
Projected Manufacturing Costs (11 1/2“ Pads) Perspective on Product Line Strategy
This case is set in I988 in a consumer goods packaging division of a major forest products company.
The product is the polyethylene coated paper enrtonfar milk or orange juice.
Variable Costs
Material
Earle Bensing has some very tough decisions to make in the Summer of 1988. As Vice President for
Labor
the Dairy-Pak Division of Champion International he faces:
Total
- Declining market share in the growing “branded juice" segment of the domestic paperboard carton
Fixed Factory Overhead '
market.
@ 360% of direct labor
- A technological y outmoded manufacturing system in terms of the expanding markets.
Total manufacturing cost $148.12
- Avery limited output capability which has not grown in lo years.
- A dramatical y expanding international market which the corporation has seen as fraught with
e withPu haseof 5 000 l‘ ewToolin more problems than op ortunit es.
Variable Costs The capital spending and strategic positioning decisions he must make in 1988 will shape the
Material $15.64 future of the DairyPak division for many years to come.
Labor 1 1.64
Total 27.28 I. LIQUID PACKAGING AND THE PURE-PAK CARTON
Mil ions of Americans, Europeans, Asians and South Americans start their day with milk or juice
Fixed factory overhead ‘
poured from a paperboard carton. Worldwide, paperboard is still the dominant forth of milk and juice
@ 360% of direct labor 41.29
packaging today. But the industry has changed dramatically since the “gabled top" Pure-Pak carton
Total manufacturing cost $69.18
rose to prominence in the 19505.
The Plastic ubstitute. Polyethylene replaced parafin to coat paperboard in l961. it didn’t
‘ Fixed Manufacturing Overhead for the company as a whole was 57.6 mi on in 1992.
take long afler that before someone in the oil industry thought of making plastic canons instead of
360% of direct labor. Of the total. $2.4 mil ion was engineering and development on plastic coating for paper cartons. Shell Chemical and Hoover lntemational (now Johnson Controls)
new automotive exhaust valve products. The balance of $5.2 related to plant operations. changed the liquid packaging industry overnight in 1965 when they combined to introduce the plastic
The plant was currently operating at about 60% of capacity, but all fixed costs were resin pellet and the “blow molding" machine to manufacture plastic jugs. The blow molding machine
being charged to current production. was, and still is, so easy to use that paper packaging dropped from 82% of the milk market in 1971 to
37% in 1985.
But the interesting story here is that although plastic captured 100% of the gallon size carton
market, it has not climtnated the other sizes of paper carton as many had predicted it would. Plath. is
more economical when resin prices are low. When the price rises, paper looks good. Guessing future
levels of ethylene gas prices (the basic driver of polyethylene price) is a notoriously difficult task.
And the dairy owner also has important non—fmancial reasons for staydng with the paper
carton. First, the dairy does not want to be at the mercy of oil companies. By using dual suppliers—
paper and plastic—the dairy creates a hedge against volatile input prices. Also, as new uses of the
plastic resin are created (industrial and consumer uses of plastic containers), the input price will not go
lower since the plastic isjust a by-product of ethylene gas. Second, the dairy believes that paper isthe
best product nutritionally. University studies have shown that paper protects milk vitamins and flavor
much better than translucent plastic. Also, recent legislation prohi mg the dumping of plastic in
Suffolk County on Long Island has created doubt about the long run viability of plastic.
31% Exhibit 1isa global overview
of the paperboard packaging business. There are five
players in the domestic Prue-Pak industry - International
Paper, Champion, Potlatch, Westvaco and Weyerhaeuser.
All of these companies are vertically integrated producers
of the carton all the way back to the wood chip. Also,
because of the scale and integation economies of these
firms, new vertically integrated entrants are efl'ectively
shut out. In fact, because of the scale economies in
producing a Pure-Pal: carton, it is more likely that a small
current player would drop out of the industry - as
Georgia Pacific did in 1981 or as Weyco' did in the
Eastern US. in 1982. _
lntemational Paper is the industry leader. IP is
considued to be the low cost producer. achieving
sigrificant economies with a large and diverse extruding
and converting capacity. 11’ is also the technological
leader, with significant investment in aseptic (germ free)
packaging and rotogravure printing (smte-of-thc-art
technology). I? has continued to expand capacity,
aggressively growing in the non-dairy segments by
emphasiz'ng their aseptic, hot fill. and other extended life
packages, and aggres ively pursuing their own off-shore
converting operations (e.g. Korea and Japan). Along with
these strategies, 11’ continues to price aggres ively. But
ofien IP isconsidered an unreliable supplier mm
because of their wil ingness to leave a customer when
neces ary to grow their off-shore converting operations.
Champion is currently a strong number 2, with
more domestic volume than the other three players
combined (see Exhibit 1).
Potlatch, Westvaco, and Weyerhaeuser all rank
in a third tier of competition. All three face dif iculties
related to quality and inefficient scale. Weyerhaeuser and
Potlatch have responded by looking increasingly to export
markets while trying to maintain selected domestic niches.
Westvaco is holding on to its domestic niche. Exhibits 1
and 2summarize the estimated competitive situation for
1988.
Outside of the US. there are three major
manufacturers supplying Pure-Pak cartons:
' - inlan - They profess to be the
World's No. 1 exporter and the World's second
largest producer of liquid packaging board-
342,000 tons of liquid packaging and fast-food
board was supplied during 1987.
Bil grgd - Sweden - Paperboard production of
224,000 tons in 1988. This corresponds to a
world market share of 14 percent. Most of the
WM Given the cost
“lame and changing environment already outlined,
Champion su'll believes that the domestic dairy market
will continue to be the principal area of profits, even with
the contraction due to plutic. Champion will attempt to
defend its dominant position, but cannot expect
improvement in current volume unless one of the major
competitors (IP, Westvaco, Weyerhaeuser cr Potlatch)
leaves the business. For example, in 1982 Weyerhaeuser
exited the paperboard carton industry in the East when
their paper mill in North Carolina was convened from
board to disposable diapers. it is estimated that
Champion picked up 30,000 to 40,000 tons a year of
Weyerhaeusers old business.
Overall, Champion recognizes its strengths as:
Large and efficient board machine
Eflicient and geographical y wel -located
extrusion facility
5 competitive and strategically located canon
converting plants
Suc es ful ovenable board convening plant (in
the Midwest)
Very suc es ful position in the dairy market east
of the Rockies
Excellent service reputation among domestic
dairies
Knowledgeable operating people throughout the
system
But Champion also recognizes its weaknes es:
Limited extrusion capacity
Lack rotoyavure printing
Champion has been unable to respond efficiently
to the diverse needs of the non-dairy segment
Although tremendous progress has been made,
there are still nagging problems with the quali t y
of the board (see Exhibit 5)
Lack roll wrapping and labeling capability of
competitors at the extruding plant
Reputation of uncertain commitment in export
markets
Given the above, the Champion strategy has
been, and still is, to be the low cost producer in the
commodity dairy segment, to try to make inroads in the
dif erentiated juice segment, to cautiously upgrade its
infrastructure but not to invest in latest printing and roll-
wrapping equipment, and to view export and special end-
use segments as
ancil ary (no need for major
commitments).
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Dai Pak 111
Dai Pak — Note on VCA 119
{mammal structural cost driver. driver concept is a way to understand cost Can we increase value (revenues) in this activity, and other cuts, and boxing the pieces at the plant,
H Executional Cost Drivers. The second category behavior in each activity in the value chain. holding costs constant? which further reduced transport charges by removing
of cost drivers, “executional” drivers [Riley, 1987], are Thus, ideas such as ABC are only a subset of the Can we reduce assets in this activity, holding excess weight.
those determinants of a firm's cost position which hinge value chain framework. costs and revenues constant? The company has fought tenaciously to hold down
on its ability to execute successful y. Whereas For strategic analysis, volume is usually not the labor costs. Though some of its plants are unionized,
“snucmraf’ cost drivers are not monotonically sealed with most useful way to explain cost behavior. By systematical y analyzing costs, revenues, and it refused to pay the wages called for in the United
performance, “executional drivers" are. That is, for each What is more useful in a strategic sense is to assets in each activity, the fum can achieve Food & Commercial Workers' expensive master
of the structural drivers, more is not always boner. There explain cost position in temts of the structural difer ntia on—cumcost advantage~something which agreement, which the elders of the industry have been
are diseconornies of scale, or scope. A more complex choices and executional skil s which shape the Japanese manufacturers have been able to achieve. An tied to for 40 years. Iowa Beef's wages and benefits
product line is not necessarily better or necessarily worse fum's competitive position. For example Porter effective way to accomplish difer ntia on-cmcost average half those of less hard-nosed competi ors.
than a less'complex line. Too much experience can be as [1986] analyzes the classic confrontation advantage is to compare the value chain of the fu'm with
bad as too little in a dynamic environment. Texas between General Electric and Westinghouse in the value chains of one or two of its major competitors Calculati rial culti s
Instruments emphasized the learning curve and became steam turbines in 1962 in temis of the structural and identifying the actions needed to manage the firm’s We do not wish to imply that constructing a value chain
the world's lowest cost producer of obsolete microchips. and executional cost drivers for each firm. value chain better than those of its competitors. In short, for a firm is easy. There are several thorny problems to
Technological leadership versus fol owership is a Not all the strategic drivers are equally important relative. What matters is
competitive advantage is purely confront: calculating value (revenues) for intermediate
legitimate choice for most firms. all the time, but some (more than one) of them not how fast the firm runs but whether or not the firm is products, isolating key cost drivers, identifying linkages
In contrast, for each one of the “executional” are very probably very important in every case. nrnning faster than its competitors. The dynamics of across activities, and computing supplier and customer
drivers, more is always better. In other words, better For example, Porter [1986] develops a strategic automatically lead to continuously shifting
competition margins, and constructing competitor's cost structures.
execution always contributes to performance. The list of as es ment of Dupont's position in Titanium benclunarks. The firm can be resr assured that its average The analysis starts by segmenting the chain into
basic executional drivers includes at least the following: dioxide based primarily on scale and capacity competitors will be smarter tomor ow than they are today. those components for which some f'um somewhere does
Work farce involvement ("participation") - the util 7ation issues. is crucial to
As such, on-going competitor cost analysis make a market, even if other firms do not. This will catch
concept of work force commitment to continuous For each cost driver, there is a particular cost developing and sustaining competitive advantage. the segments outlined in Exhibit 1 for the paper industry,
improvement (Kaizeu in Japanese). analysis framework which is critical to Reconfigure the Value Chain. While for example. One could start the process by identifying
Total quality management (beliefs and understanding the positioning of a fum. continuing the focus on managing the fum's existing every point in the chain at which an external market
achievement regarding product quality). The Dif erent value activities in the value chain are value chain better than competitors. greater efforts need to exists. This gives a good first cut at identifying the value
manner in which quality is implemented in the usually influenced by dif erent cost drivers. For
be spent on redefining the value chain where payoffs chain segments. One can always find some narrow
factory will affect the cost structure. instance, the relevant cost driver for advertising could be even more significant. For instance. in the enough stage such that an external market does not exist.
Capacity utilization (given the scale choices on is market share whereas promotional co:’s are
mature and tough meatpacking industry, Iowa Beef An example would be the progress of a roll of paper from
plant construction). usually variable. Coca Cola, for example, can
Proces ors has performed exceptionally well by the last press section of a paper machine to the first dryer
Exploiting linkages with suppliers and/or realize economies of scale in advertising because
control ing their processing, distribution, and labor costs. section on the same machine. There is obviously no
customers, per the firrn's value chain. of its large market share. A price-off, by contrast
They ac omplished these cost reductions by redefinrng external market for paper halfway through a continuous
Operationalizing each of these drivers also (an example of a sales promotion activity), is
the traditional value chain in this industry. To quote flow paper machine! Thus, seeing the press section and
involves specific cost analysis issues. Many strategy strictly avariable cost per unit.
Stuart (1981, pp. 67-73): the dryer section of the paper machine as separate stages
consultants maintain that the SCM field is moving very
Cost drivers are discus ed in more depth in Chapter 9. Earnings per share (of Iowa Beef Processors) have in the value chain is probably not operational.
quickly toward “execufional” drivers because the insights
soared at a compound annual rare of over 23 percent Part of the “art” of strategic analysis is deciding
from analysis based on “structural” drivers are too often
hat” taina Ie Corn etitive Advanta e since 1973 The company has achieved this which stages in the value chain can meaningful y be
“old
As of this writing, there is no clear agreement on remarkable record by never wavering from its decoupled conceptuall,~ and which cannot. Unless some
Once the firm has identified the value chain and
the list of “fundamental” cost drivers. For example, two strategy and obses ion - to be the low-cost producer furn somewhere has decoupled a stage by making a
diagnosed the cost drivers of each value activity, the firm
difl'emt lists are proposed in one single publication of beef. market at that stage, one cannot independently asses the
can gain sustainable competitive advantage in one of two
[8002, Allen, Hamilton, 1987]. However, those who see To that end, economic profit earned at that stage. But the
it rewrote the rules for kil ing, chil ing,
ways:
cost behavior in suategic terms are clear that output and shipping beef. It built plaan on a grand scale, opportunities for meaningful analysis across a set of firms
volume alone does not typically catch enough of the automated them to a fare-the -wel , and now spends that have defined dif erently what they make versus what
richness. How unit cost changes as output volume
(0 By control ing those cost drivers better than
they buy and what they sell are often very significant.
up to $20 mil ion a year on renovation to keep them
competitors; or
changes in the short run is seen to be a less interesting operating efficiently. The old-line packers shipped Despite the calculational problems. we contend
question than how cost position isinfluenced by the firm’s
(ii) By reconfiguring the value chain.
live animals to the abattoirs at such rail centers at that every fum should attempt to estimate its value chain.
comparative position on the various drivers that are Chicago, but Iowa Beef brought the plant to the cattle Even the process of performing the value chain analysis,
Control Cost Drivers Better Than
relevant in its competitive situation. in the sprawling fecdlots of the High Plains and in and by itself, can be quite instructive. Such an exercise
Competi ors. For each value activity, the key questions
Whatever items are on the list of cost drivers, the Southwest. This saved on transportation and avoided forces managers to ask ‘how does my activity add value to
to ask are:
key ideas are as fol ows: the weight loss that commonly occurs when live the chain of customers who use my product (service)?
I. Can we reduce costs in this activity, holding
1. Value chain is the broader framework; the cost animals are shipped. Iowa Beef also led the industry and ‘how does my cost structure compare with those of
value (revenues) constant?
in cleaving and trimming carcas es into loins, ribs, my competitors?‘

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