442 MCADAM

Written Analysis of the Case (WAC)

Prepared by: Adjarani, Alberto, Andalahao, Palma, Wee J., Yap
I. STATEMENT OF THE PROBLEM
In the light of the transfer of its operational headquarters from Calgary, Alberta to Toronto,
Ontario, what should 442 McAdam (the Company) undertake in order to maximize its expected
revenue while minimizing its total production cost for the next two fiscal years (2016 and 2017)?
II. OBJECTIVES
The primary objective of this paper is to recommend Sarah Shell, the owner and operator of 442
McAdam, a course of action that would optimize the companys profitability in the light of the
companys operational transfer to another Canadian city. Specifically, this paper seeks to:

Assess the effect of each possible strategy on the overall profitability of the Company.

Assess the level of inventory that should be produced given the parameters from
outsourcing options with the least possible cost (obsolescence, storage, etc.)

Identify potential problems that may arise from the recommendation.

III. AREAS OF CONSIDERATION

STRENGTHS

SWOT Analysis The Company

WEAKNESSES

Companys owner well oriented in the

fashion design and accessories industry.

Quality produced handbags, with a wide

production.

variety of unique, exclusive and

Low level of brand awareness for high-end

market

sophisticated designs and styles

Seasonal demand

Branding position of its products in the

The sophisticated design of the handbags

market.

Lack of resources to make large volume of

makes their production time consuming

Able to penetrate a good target market

Poor pricing schemes and discounts

for handbags.

Target market is confined to women only

Sales channels online and retail stores

OPPORTUNITIES

Attaining global prominence but

Larger brand competitors (e.g. Gucci,

preserving the uniqueness of the brand

Louis Vuitton, Chanel, Herms, Cline,

Availability of manufacturers for

Club Monaco)

outsourcing.

THREATS

Industrys seasonality business nature,

Suggestions in designs by the consumers

causing leftover bags to be sold with

(i.e. customization)

difficulty beyond six months.

Expansion to other market segments and

Counterfeiting

products (i.e. male luxury bags, children

bags, other accessories, etc.)

Sarah Shell, The Owner

Sarah Shell was very well equipped with experience in the fashion design industry. She
graduated with a degree in Fashion Design at a prestigious fashion design school in New York.
She worked as a designer at Club Monaco and as purchasing/merchandising at Gucci North
America. She also worked with other designers such as Catherine Melandrino, Yigal Azrouel,
and BCBG Alex Azria for a number of season of New York Fashion Week shows. She also
worked for the Forzani Group as a Purchase Analyst. These experience made her very well
oriented in the industry of fashion designing.
Unique Handbag Design
442 McAdam create handbags made of quality top-grain leather. Designs used were mostly
bohemian and equestrian designs which are unique for luxury handbags that are commonly sold
in stores around the Americas. No wonder women who love uniquely designed luxury bags
would prefer to buy these bags than the more popular brands. At times, suggestions are taken by
the owner herself from the consumers through the boutiques on their desired bag designs and are
incorporated in the next designs of the companys bags.
Branding Position
The McAdam bag lines are marketed with exclusivity and prestige. This line of womens
handbags are limitedly sold through a selection of boutiques and online. However, with this

market positioning, the brand associated with 442 McAdams products are not very well known
in the market.

Target Market
McAdams primary target market are women between the ages of 20 and 45. These women are
typically considered as young professionals and are capable and willing to spend slightly more
money for fashion items suited for their styles. With the price setting of the McAdam bags
(priced at the lower end of the luxury handbag market), the bags surely have attracted these
young professionals who are looking for their first real luxury fashion handbag. With the transfer
of the companys headquarters to Toronto, Ontario, Canada, this line of handbag may be
introduced to a larger market of women who would like to have a cheap top of the line luxury
bag.
Production Outsourcing
The transfer of the company headquarters from Calgary, Alberta to Toronto, Ontario, 442
McAdam recognized the possibility of an increased demand for the products. Due to the lack of
available resources to produce large volume of handbags (especially human resources), the
company would want to resort into outsourcing of the production of the bags from either a local
or an overseas manufacturer. This consideration, however, does not limit/prohibit the company
from hiring additional labor force to retain the production of the bags in-house to keep its design
secrets as secret.

Quantitative Considerations
Inventory Computations

Based on the case facts, the following are the projected demand and inventory requirements for
the Fiscal Years 2016 and 2017:
2016
Retail store sales (12 stores x 8 bags x 2 seasons)
Online sale
Total Projected Demand

192
24
216

2017
(@ 150% of 2016)
288
36
324

Desired Design volume by the company is stated as follows:

Number of designs desired
Number of colors per design
Number of style seasons
Total number of desired design volumes per year

5
4
2
40

Given that the company desires a minimum total number of design volumes of 40 per year, and
each manufacturer requires a minimum order quantity per design, the following will be the
projected minimum order quantity per annum for each producer:

Desired design volumes per year

Minimum order quantity per design
Total minimum order requirements per year

Local

Overseas

Manufacturer
40
10
400

Manufacturer
40
50
2,000

Based on this order requirement, the following are the projected order balances and ending
balances per year under the assumption of each manufacturer:

Beginning inventory
Minimum order
Units available for sale
Sale
Ending inventory

Local Manufacturer
2016
2017
0
184
400
400
400
584
216
324
184
260

Overseas Manufacturer
2016
2017
0
1,784
2,000
2,000
2,000
3,784
216
324
1,784
3,460

Looking into this computation, making orders through overseas manufacturer would cost the
company large carrying cost and would cost larger losses on the part of the entity given the
expected demand.
Contribution Margin Under Each Production Outsourcing Strategy
The following shall be the estimated contribution margin for both retail store and online sale in
case the production shall be outsourced locally and overseas:
Local Manufacturer
Retail Store
Online
$ 198
$ 440
120
120
$ 78
$ 320

Sales Price
Production Cost
Contribution Margin
Contribution Margin Ratio

39.39%

72.73%

Overseas Manufacturer
Retail Store
Online
$ 198
$ 440
80
80
$ 118
$ 360
59.60%

81.82%

Thus, in case unit sales will be attained as projected, the following total contribution margin will
be expected per year:

Selling Price
Cost
Contribution
Margin per unit
Demand (in
units)

Outsource to Local
Manufacturers
2016
2017
Retail Onlin Retail
Store
e
Store Online
198
440
198
440
120
120
120
120

Outsource to Overseas
Manufacturers
2016
2017
Retail
Retail
Store Online Store Online
198
440
198
440
80
80
80
80

78

320

78

320

118

360

118

360

192

24

288

36

192

24

288

36

Projected
Contribution
Margin

14,976

Total CM

7,680

22,464

22,656

11,520

22,656

33,984

8,640

33,984

31,296

12,960
46,944

Due to the fact that the overseas manufacturers charge smaller production cost than the local
manufacturers, the contribution margin will be larger when production is outsourced through
them compared when the production is locally outsourced. Thus, setting other things aside, it can
be inferred that the production shall be better when outsourced overseas than locally.
However, due to the order requirement of the manufacturers and the seasonality of the bag
designs, the tendency for excess orders that will not be sold at the original price should be
considered. The following table summarizes the effects of excess orders on the Companys
profitability assuming the scenario that such excess orders is sold at 95% of cost:

Excess Orders
Discounts on
excess orders
(5% of cost)
Loss on sale
at below cost

Local Manufacturer
2016
2017

Overseas Manufacturer
2016
2017

184

76

1,784

1,676

6.00

6.00

4.00

4.00

1,104

456

7,136

6,704

Finally, we compute the projected 2-year margins net of expected discounts due to excess orders
for local and overseas manufacturers:

Contribution margins for 2016

and 2017
Loss on sale at below cost for
2016 and 2017
Contribution margins for 2016
and 2017, net of loss on sale
of excess orders

Local manufacturers

Overseas manufacturers

56,640

78,240

(1,560)

(13,840)

55,080

64,400

Note that in spite of the larger figures for expected excess orders and an assumption of sale at
below cost (95% of cost), contribution margin figures are higher if production is outsourced to
overseas manufacturers.
IV. ALTERNATIVE COURSES OF ACTION (ACOAs)

ACOA #1 Outsource production of bags from local manufacturers only. Increase market
share through intensifying marketing campaigns of the products online via social media
advertisements and other internet platforms.
Pros:

Smaller quantities of production order can be made compared to outsourcing the

production at overseas manufacturers, enabling the company to better control the
inventory levels.

There is a more likely possibility that a repeat order of each color of the design can be
made compared to the overseas production.

Risk and time associated with the shipment of products can be reduced.

Easier monitoring since the Proprietor can access the production sites

Increased marketing can bring increased awareness of the products especially to the
companys target market members.

Allows the Proprietor to focus more on marketing the products and creating new designs

Cons:

Higher production costs are charged to the company than international manufacturers,
thus leading to a lower contribution margin per unit.

Sale of the remaining inventory is not assured.

ACOA #2 - Outsource production of bags from overseas manufacturers only. Partner with
more boutiques for a larger market of the bags. Enter into a contract with the distribution
channels that enables an automatic sale of the products to the boutique within a specific
period (say, three months after initial delivery of the bag).
Pros:

The cost of production charged is low, enabling a higher unit contribution margin for
every product sold.

In the long run when the companys market is already well established and its brand is
already well known, the overseas outsourcing will enable large profit for the company
(i.e. long-run approach)

The payment terms of net 60 enables the company to use the cash intended for payment
of production cost to be invested initially into a profitable short-term financial
investments within the given time period.

Outsourcing manufacturing overseas is a great initial step towards obtaining international

prominence

Allows the Proprietor to focus more on marketing the products and creating new designs

Cons:

Risk associated with quality maintenance of the products is high.

High order requirements for the manufacturers can lead to excessive inventory orders.
Due to the seasonality of the designs, there is the possibility that such excess orders will
be sold at cost or even at below cost.

Travel time and shipping costs will be higher.

It would be timely for the Proprietor to look for qualified and trusted manufacturers
overseas since the Companys brand is not yet well-established in the global market.

ACOA # 3 Maintain production in-house by hiring two to three additional direct

laborers, paying them at a minimum wage of $11.25 in 2016 and $11.40 in 2017.
Pros:

May result to a high contribution margin considering that the cost of labor (standard five
hours per unit, thus resulting to a labor cost of $56.25 in 2016 and $57.00 in 2017 per
unit) plus a specific amount for materials costs, would be expectedly lower compared to
the cost of local producers and probably even that of the overseas manufacturers.

More controlled inventory levels can be attained, as production can be done using a justin-time approach.

The Proprietor can more carefully monitor the quality of the handbags.

The uniqueness and intricacy of the design of the handbags will be preserved since there
will be no need to reduce the design seams which outsourcing would require.

Cons:

The company will be responsible for the training and other more requirements for
employment by the direct laborers.

Additional employee accommodations, like desk, chair and other working materials.

A labor-intensive production process can compromise quality due to differences in skills

and human factors.

Susceptibility of piracy of design due to direct involvement with the designer.

May lead to exhaustion to both the Proprietor and the hired laborers and production
bottlenecks as demand further increases.

Laborers may demand higher pay, and if such is not provided, it can lead to work
dissatisfaction which would affect efficiency and quality of production

The opportunity of widening the market scope of the brand through outsourcing
production is foregone.

V. RECOMMENDATION

ACOA #1 Outsource production of bags from local manufacturers only. Increase market
share through intensifying marketing campaigns of the products online via social media
advertisements and other internet platforms.

Rationale
Local manufacturers

Overseas manufacturers

56,640

78,240

(1,560)

(13,840)

55,080

64,400

Contribution margins for 2016

and 2017
Loss on sale at below cost for
2016 and 2017
Contribution margins for 2016
and 2017, net of loss on sale
of excess orders

Quantitatively speaking, outsourcing to overseas manufacturers result to higher contribution

margins in spite of the assumption that excess orders are sold at a loss (i.e. at 95% of cost). But
considering other qualitative factors, it is best to initially outsource the products to local
manufacturers before stepping up to manufacturing overseas. Outsourcing to local manufacturers
coupled with increasing online marketing is a good balance of risk and efficiency. The ease of
monitoring quality, access to production sites, and control over minimum orders will most likely
compensate for the higher production costs in the short run (fiscal year 2016 and 2017). Once the
market for the bags stabilizes, that would be the perfect time to slowly outsource the
manufacturing of the products overseas.

VII. POTENTIAL PROBLEM ANALYSIS

The case assumes that demand is stable, raw materials are widely available and production costs
are constant over the years regardless of the alternatives chosen. However, in real life, this is not
the case. Demand may fluctuate due to uncontrollable market factors, and production costs
naturally increase over time due to inflation. The computations above excluded such factors. In
the case that the market does not respond as expected or resources for the production become
costly or scarce, the benefits expected from the recommendation may not be fully realized.

Another factor that must be considered is the number of local manufacturers available and the
terms of the contract between the manufacturers and the Proprietor. There must be a sufficient
number of local manufacturers to cater to the demand on a continuous basis. Also, the terms of
the contract should make it clear to the parties the nature and timeframe of the supplier
agreement.