REPORT ON CLAYTON INDUSTRIES CASE

PETER ARNELL, COUNTRY MANAGER FOR ITALY

Indian institute of Management Lucknow

Written Executive Communication

SUBMITTED TO: PROFESSOR Dr .PAYAL MEHRA

A.Venkatesan
PGP26380
Section F
 To,
Daniel A Briggs,
President & CEO,
Headquarters,
Clayton Industries Inc.,
Milwaukee, Wisconsin.

From,
Peter Arnell,
XX, YYYY,
ZZZZ.

Date: 24th November 24, 2010

Subject: Growth strategy and market analysis for Clayton SpA. Strategy that can help
Clayton turn its loss in to a profit making business.
OBJECTIVE
The purpose of this report is to analyze the daunting challenges faced by Clayton SpA,
the Italian subsidiary of US based Clayton Industries Inc. Peter Arnell has just taken
charge of the Clayton SpA to turn around the current loss making status of the company
losing around $1 million a month after decades of solid returns.

BRIEF BACKGROUND:
Clayton Industries, a sixty-year-old U.S.-based firm in the HVAC industry (Heating,
ventilation, and air conditioning), with nearly $1 billion in revenue. As it expanded
abroad, it has positioned itself in the European market by acquiring four companies
namely Corliss, a UK based manufacturer of home heating, ventilation and air
conditioning(HVAC)systems, Fontaire ,a Brussels-based manufacturer of fansand
ventilating equipment, Control del clima ,a Barcelona-based manufacturer of climate
control products for industrial and commercial applications, and Aero Puro ,a Brescia,
Italy based manufacturer of compression chillers for large commercial public and
institutional installations. It has its head quarter for European operation in Brussels
(Belgium) and each of the entities country is headed by a regional company president.
As the economic crisis hit the entire Europe in 2009, Clayton company suffered huge
losses. Clayton restructured its top level management and Peter Arnell, previously
Clayton's successful country manager for the U.K., has been asked to take over the
Italian subsidiary which was incurring huge losses. The company VP Simoone Buis had
set the following targets for the company:
1. To cut the both receivables and inventories by 10% also reduce the headcount by
10%
2. Positioned the company’s products in top four in European market
About Clayton Europe & European Market conditions:
European market for air conditioners began to grow from a much lower base in 1990 .In
1998 air conditioners were present in only 7% of the total homes in Italy. Europeans
perceived air conditioners as an expensive American luxury that harmed the
environment.Clayton struggled to pierce the window unit market because of the
presence of familiar local brands that Europeans seemed to prefer.
Chart1: Industry sales of air treatment products

Determined to create a more integrated European organization, Bius first

priority was to increase the operational efficiency of Clayton.An additional
responsibility of Europe-wide profitability of products produces in their plants.
The same can be understood through the steady drop in the EBITDA of the company
performance in Italy year on year.
Chart2: Percentage change in Revenue of European operations

Major problem:

Recession in Europe has hit the company badly its sales has gone down drastically. In
Italy situation is far more challenging as compare to the other regions of the Europe.
First half of the FY 2009 has witnessed a 19.4% drop in the sales, receivables and
inventories are both above 120 day sales. Company is neither able to reduce its cost nor
it has a product which is readily acceptable by the climate friendly people. So the
company is facing a difficult situation to make profits in the time of recession when its
sales are going southward very rapidly. Company is aiming to be in top four in each
product category which is quite a difficult task ahead for Peter Arnell, the new country
manager.
 Chart2: Percentage change in Revenue of European operations

Chart3: Percentage margin in net income/loss of European operations

Reasons the company is facing problem in European market are enumerated below:

European people saw air conditioning as a luxury item which is harming environment
so they resist purchasing it. This has been a real problem for company to expand its
market share in Europe. Compression chiller produced by the company are not so
climate friendly vis-a-vis absorption chillers so company is facing a huge challenge to
make people accept their product who are climate sensitive.

Offering neither low price nor name familiarity, the Clayton and Fontaire brands
struggled in Italy’s residence climate control market. European people also have an
emotional attachment and preference towards their local national brand. Product which
had a local presence before are able to sustain well in the market even in the bad
economic conditions.

The vulnerable cost position due to the highly unionized workforce prevented Lazzaro
to lay off employees permanently or implements CIG (Cassa Ingrazione Gaurdagani), a
temporary layoff provision that exempted workers coming to work for a significant pay
cut with costs shared between the companies and the state.

In past most of the company policies were centred towards getting large projects from
government in Italy so it is not only losing potential commercial customer but also
losing the chance to reach in other parts of Europe. Brescia’s staffing levels were 20%
to 30% high. Clayton produced compression chillers which had 85% of the market
share; But Environmentalists emphasized on the absorption chillers which were less
carbon sensitive and used water instead of ozone depleting refrigerants.
 The 27% increase in the prices of steel in the past years was also one of the prime
reasons since cost could not be recoupled due to foreign competitor’s aggressive
pricing. Because of its inefficient operations the compression chillers produced by the
company are too expensive which are facing tough competition from the cheap Asian
products.

Its air conditioners are not suitably designed according to the Italian buildings which
lacked the duct work. As the company is neither offering low price products nor able to
cope up with the perception of climate friendly product. Company is struggling in the
European market where it is not a familiar local brand.

CHOICES AVAILABLE TO THE PARNELL:

One of the options that are available to Parnell is to focus on Italian market and increase
plant’s efficiency and at the same time prepare a plan to expand its market in other parts
of Europe.
PROS
1. Implements existing European strategy

2. Compression chillers are key components in a $20 Billion European industry

3. Gives Italy a chance to step up under new leadership

4. Italian management team’s strategy

5. Fits Brigg’s belief of “opportunity in crisis”

6. Buis is likely to be supportive

CONS

1. $5 million investment is too much to invest as the company is already making losses
(Clayton lost $24.2 million in the last six months)

2. Recognize the failure and move on

3. Little hope for cost improvement

4. Rebuilding market share will take time

5. Becoming the #3 or #4 competitor almost impossible

The next option is to establish a new plant for absorption chillers in Spain. Absorption
chillers are climate friendly while at the same time producing in Spain will cost company a
reduction of 20% labour costs. It will be increasingly popular in future since they are more
eco-friendly. It will require investment: $15 million over five years with most costs starting
in the phase-out and restructuring process two to three years down the line. However,
restructuring might call for layoffs which will be a tough nut to crack in Italy's highly
unionized business space.
PROS
1. Absorption chillers a fast-growth segment.

2. Spanish company has good product, technology, and market to build on.

3. Can achieve #3 or #4 position in this niche market. (Perhaps #1 or #2)

4. Staged strategy allows phase out of existing line

5. Investment timing is more reasonable

CONS

1. Contrary to existing European strategy

2. Abandons mainstream commercial air-conditioning prematurely.

3. Short-changes the Italian plan

4. FILM will oppose production phase out

5. Requires very large investment

Third alternative which Arnell is considering is to wait for some time, as the economy
is unstable so taking any strategic decision at this time can boomerang. In the meantime
company he can focus on improvement in operational efficiency to reduce cost of the
product.

PROS
1. Lower risk option.

2. Affordable, appropriate for the time.

3. Offers more time to study options.

4. Arnell and team need the chance to prove them.

5. Keeps future options open.

CONS

1. Delaying for six months is not cost-free

2. Arnell set his team in motion.

3. Briggs and Buis want turnaround proposal.

4. Lazzaro was fired for his “batten down the hatches” approach.

RECOMMENDATIONS:
On considering all these suggestions I would suggest the third option in the short term.
As the economy is still struggling this is clear from the draft budget projection of 4.8%
contraction in the economy so any strategic commitments to suppliers for expanding its
production and thereby sales can have repercussions. Company is already struggling
with its inventory which kept on and is increasing. It would be good for the company to
make necessary adjustments in the operations so that its inventory level can go down.
In the long term company can invest in a new plant for absorption chillers. European
peoples avoid purchasing compression chillers so it would be good for the company in
near future to focus on absorption chillers which is more climate-friendly. A marketing
strategy associated with a better Corporate Social Responsibility of Clayton in reducing
the ozone depletion will give a better entry for Clayton and market penetration. As
forecasted by the government that economy will take some time to come back on
growth path so it would be a good decision for the company to focus on improvement in
its operations and rethinking on its product line.
Chart4: Long term Debt analysis
 Chart5: Current Ratio Analysis

The long term debt analysis and the current ratio analysis clearly gives an indication
that the company should not invest immediately in manufacturing absorption type
chillers.
Investing in a new absorption chillers plant will require significant cost in layoffs and
restructuring with a gradual phased changeover process. But the absorption chillers is
not only eco-friendly but also it has growing market in Europe. This will increase
company’s chances to increase its market share across the region. Also due to
economic crisis it is not a wise decision to concentrically diversify now in the European
market. Hence it would be a good strategy to focus on investments only in the long run.

CONCLUSION:
The company should focus on sustaining the market losses in the short term and wait
for the economic recession to change to better conditions. The company should
formulate the growth strategies for the long term to capture the phenomenal amount of
market share in the long run in absorption type chillers and conditioners that connect
with the people of Italy.