SOFT DRINK COMPANY OF NIGERIA THE SITUATION Mr. A. Williams, Managing Director of Soft Drink Company of Nigeria, Ltd. (SDCN) smiled as he opened the letter from the bankruptcy receiver. Williams had offered 15 million naira for the French bottle factory, and fully expected the receiver’s letter to confirm that his offer had been accepted. Scanning the letter, however, Williams was stunned to discover that SDCN was not the only bidder. A second bidder had offered 50 million naira for the factory, and had included with their bid a four million naira check, to validate desire and financial capacity. Knowing the intensity of SDCN’s own interests, the receiver was offering Williams one last opportunity to counter-offer. However, unless SDCN made a more attractive offer within the next four working days, the receiver indicated that he would be obliged to accept the second bidder’s offer. THE COMPANY SDCN’s primary business is the bottling and distribution of soft drinks in Nigeria. The company acquired its first nationwide franchise for an internationally-known soft drink in the 1960’s. During the 1970’s, SDCN experienced substantial growth, growing from a single plant outside of Lagos to three geographically dispersed plants able to serve most areas of the country. Around each plant, SDCN developed networks of warehouses, tractor-trailers, and delivery trucks. By the mid-1980s, SDCN was selling more than 10 million cases (24 bottles each) of soft drinks per year in the 100 million case per year Nigerian market. Williams became Managing Director of SDCN in the mid-1980s. In preparation, he had spent three weeks each of the preceding three years attending the Harvard Business School (HBS) in Cambridge, Massachusetts. During his course, Williams had developed an aggressive growth plan, in which SDCN’s objective would be to double its market share within two years. Longer run, Williams hoped and expected that SDCN would challenge the soft drink market share leader in Nigeria. Unfortunately, changes in Nigeria’s economic environment postponed William’s ambitious growth plans. Due to substantial oil price decreases in 1981-1984, the Federal Government of Nigeria was unable to meet its foreign currency obligations (contracts, debt repayments, and so on). To allocate the meager amount of foreign exchange available, the Nigerian government created an import licensing scheme. Under this scheme, small low-share companies like SDCN received few import licenses, and thus were unable to acquire the basic inputs (in SDCN’s case, sugar, concentrate, trucks, and bottling equipment) needed to maintain their operations. Clearly, planning for growth was impossible. This case was written by Professor Dr. David K. Smith, Jr., Department of Marketing at Southeast Missouri State University, as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. In light of the changed economic environment, Williams revised his plans. Maintaining and retaining business developed over the preceding fifteen years became his primary objectives. While each one of his three plants had more than twice the capacity needed to process all available inputs, he continued to allocate sugar and soft drink concentrate to all three plants, so as to maintain SDCN’s market presence. In addition, Williams worked intensively to retain SDCN’s human resources, believing that in the long run battle for market share, the benefits of capable and experienced staff far outweighed the costs of short-run decreases in profits. In September of 1986, in response to many complaints by legitimate businesses, the Nigerian government discontinued the import licensing scheme. Instead, the Central Bank of Nigeria began holding foreign exchange auctions every two weeks. At these auctions, businesses desiring foreign exchange could bid for it through the banks. While the amounts of foreign exchange available were limited, it appeared that businesses willing to bid aggressively would be able to satisfy some of their requirements. Given the improved outlook for foreign exchange availability, Williams moved aggressively to increase SDCN’s business and market share. Over the next several years, SDCN developed and maintained an intense schedule of “under the cap” (UTC) consumer promotions (consumers remove the cap and inspect the underside to see if they have received a prize) and trade promotion programs (distributors buy ten cases, get one free), to increase the awareness and desire of consumers and dealers. Also, SDCN built additional plants, to bolster its presence in markets distant from existing facilities. To augment his market presence and penetration, Williams acquired additional internationally-recognized soft drink franchises, and moved aggressively to introduce them to markets all across Nigeria. Finally, because the above initiatives required substantial financial resources, and the arrival of cash did not always match the timing of accounts payable, Williams increased SDCN’s uncommitted bank lines of credit to more than 100 million naira. Distributors and final customers responded very positively to SDCN’s initiatives. While it took Williams somewhat more than two years to double his market share, a Nigerian consulting firm specializing in business information estimated that by 1992, SDCN’s market share was nearly 30%. The consulting firm also reported that SDCN, not the soft drink share leader, played the role of market innovator and developer in Nigeria. SOFT DRINK INDUSTRY CHARACTERISTICS The soft drink business is intensely competitive. Because a substitute product (water) is free and available, successful development of a soft drink franchise requires high perceived value for soft drinks on the part of consumers. Achieving that value requires intense monitoring and control of costs plus a hard sell using all available marketing mix ideas and tools. Cost control is important because the soft drink business is extremely capital intensive. Opening a market involves heavy investments not only in advertising and promotion but also in packaging and distribution. For example, each new market SDCN enters is likely to require six new in-city delivery vans at 1.5 million naira each, and three new over-the-road tractors at 4.0MM naira each. In addition, a new market may contain as many as 5000 new distributors, each of whom will require ten plastic cases holding 24 bottles each. Each plastic case costs SDCN 60 naira. However, because SDCN requires a 30 naira deposit on each case, SDCN’s net investment on each case is 30 naira. The other key and costly aspect of packaging is bottles. In developing countries, glass is the preferred packaging for soft drinks. Because glass bottles are re-usable, consumers buying a soft drink need not be charged the full cost of the packaging. In the case of the single-use packaging used in much of the developed world (for example, PET plastic two liter bottles or 330 cl. metal cans), prices to the consumer must cover not only the soft drink but also the packaging, which is used once and discarded. Other disadvantages of PET two liter bottles in developing countries like Nigeria include the following: The large size makes the product too expensive for many consumers; and The large size does not match existing patterns of consumption (frequently, individual consumers purchase a soft drink at a restaurant, canteen, bar, or kiosk and consume it on the spot); and The large size and the fact that the bottle can be re-sealed leads some consumers to fear that products in two liter PET bottles may have been diluted by wholesale and/or retail sellers; and Because PET packaging is one-way, channel members (that is wholesalers, retailers, etc.) have no investment in it and are less likely to remain part of the bottler’s loyal distribution team when competitors come round offering special incentives for dealers willing to switch their support. Investment in bottles can help build distributor loyalty and consumer brand loyalty as well. While glass is cheap for consumers, has a relatively long shelf life, and avoids most of the above problems as well, the investment in glass bottles for bottlers like SDCN is very substantial. As indicated earlier, opening of a single new market can involve 100,000 cases of bottles, at 24 bottles per case. While SDCN does collect a 120 naira deposit from distributors and dealers for the case and the 24 bottles, that deposit covers only 63% of SDCN’s cost. SDCN’s unrecovered investment in each set of 24 bottles is approximately 72 naira. Thus, opening a single new market can require a 7.2MM naira investment by SDCN in glass bottles. SDCN’s growth from 10% to approximately 30% of a 100 million case market (assuming a static total market since 1986 and assuming each case turns 10 times per year) implies an increase from 1 million total cases in 1986 to 3 million total cases in 1993. This 2 million case increase over the last eight years implies the purchase by SDCN of 48 million glass bottles (no allowance for breakage or wear-out included) costing approximately 144,000,000 naira. The average purchase is six million glass bottles per year, at a cost to SDCN of at least 18,000,000 naira. However, glass breakages in SDCN’s plants and/or warehouses represent approximately one percent of annual sales. Consequently, an additional five million bottles are required annually, at a cost of 40,000,000 naira. Generating sufficient funds to make these glass investments and replacements is a key issue for bottlers like SDCN. It is not, however, the only challenge. Finding suppliers who can and will provide bottles when and where they are needed is absolutely critical. Because the soft drink business is capital-intensive, the break-even plant utilization rate is approximately 60%. Plants can not operate without packaging. If bottles are not available when and where they are needed, both plant utilization and profits are at risk. Suppliers of glass bottles can impact on the success of bottlers in several additional ways as well. Both price and promotional aspects of the packaging are important. For example, while soft drinks don’t change much, package characteristics (size, shape, color, design, and graphics) can change considerably. These changes can provide competitive advantage in the marketplace. During its period of rapid growth, SDCN’s adoption of a larger container selling at the same price as the market leader’s smaller package provided a unique selling proposition (USP) and tangible benefits to both distributors and final customers. THE GLASS PACKAGING INDUSTRY IN NIGERIA: PRE-1986 Bottling Company of Nigeria (BOTCON) is the only local producer of soft drink bottles in Nigeria. BOTCON is a joint venture formed in the mid-1970s by two multinational companies to produce glass packaging for the beverages, pharmaceutical, and cosmetic industries in Nigeria. Prior to the formation of BOTCON the primary source of glass packaging for these firms were countries such as Czechoslovakia. The disadvantage of such sources include the fact that economies of scale for purchase and transportation required very large orders and that importation of these goods required the use of foreign exchange. Because sourcing bottles from BOTCON avoided the two problems identified above, SDCN became one of BOTCON’s first clients. While SDCN continued to import bottles from time to time so as to maintain alternative sources and also monitor BOTCON’s price/quality relationship, buying FOB BOTCON’s factory also saved SDCN the cost of transportation, insurance, and duties on imported bottles. Even so, pricing of the bottles procured from BOTCON was a source of continuous arguments and negotiations. With the advent of Nigeria’s import license program in 1983, BOTCON aggressively increased their glass packaging prices. Unfortunately for SDCN and most of BOTCON’s other customers, there was initially no viable alternative to sourcing bottles locally at whatever price BOTCON demanded. Subsequently, however, a major BOTCON customer and SDCN competitor entered into a joint venture with another multinational company to produce soft drink bottles in Nigeria. In addition, a French firm set up a glass factory in Northern Nigeria. While the French group was undercapitalized and experienced problems acquiring their primary raw material (sand), their existence plus BOTCON’s loss of business led BOTCON to ease up slightly on their aggressive price policy. At this time, SDCN emerged as BOTCON’s largest single customer. POST-1986 PACKAGING INDUSTRY DEVELOPMENTS: BOTCON Following the termination of the import licensing scheme in 1986, BOTCON re-implemented their very aggressive price policy. Unfortunately for SDCN and other BOTCON customers, their ability to negotiate successfully and/or apply pressure to BOTCON on prices was reduced by three factors: 1. The introduction in Nigeria of many new food and beverage products requiring glass packaging; and 2. A move toward glass by the pharmaceutical industry in Nigeria; and 3. The inability of the French glass factory to deliver quality products in a dependable fashion. SDCN”s initial response to BOTCON’s return to a very aggressive stance on pricing and margins (approximately 50%) was to call for meetings where SDCN’s bitter complaints could be expressed to local management and overseas directors. These complaints included the following issues: Glass bottles sourced from Turkish and Egyptian firms were cheaper than buying from BOTCON, ever after adding in transportation, insurance, and duties (unfortunately, foreign exchange shortages precluded SDCN from overseas sourcing); and BOTCON’s price hikes were putting severe pressure on SDCN’s margins, given the fact that competitive pressures from the market leader prevented SDCN from raising prices; and Falling margins were calling into question SDCN’s growth plans and the assumptions Williams had made regarding SDCN”s ability to generate funds for growth; and Williams found BOTCON’s approach to communicating price increases particularly galling, especially a letter he received indicating that because the value of the naira had not changed, BOTCON would again be increasing prices. Williams warned BOTCON repeatedly that they were forcing SDCN to consider alternatives including self-product of its own glass. In addition, he communicated to BOTCON both orally and in writing that its current pricing strategy and the implementation of that strategy were totally unacceptable to him. Nonetheless, BOTCON ignored this feedback from its largest customer and continued to aggressively increase bottle prices. POST-1986 PACKAGING INDUSTRY DEVELOPMENTS: THE FRENCH FACTORY In 1990, the French glass factory filed for bankruptcy. Shortly afterwards, the receiver for the banks contacted Williams, to see whether SDCN would bid for the company. The receiver indicated that none of the offers he had received were attractive to the banks. While the French firm owed the banks approximately 30MM Naira, the receiver indicated that an offer of 15 million naira would probably be acceptable. Williams’ reaction to the receiver’s initial contact was mixed. On the one hand, he had little desire to move into the complex, technical, and capital intensive business of making glass. On the other, Williams was galled by the arrogance of BOTCON management and their lack of response to his complaints. In addition, he wanted to protect himself against a scenario where the market leader would be able to utilize its own lower packaging costs to squeeze margins and place the profitability of SDCN’s growing franchise at risk. Ultimately, Williams decided that it was necessary to examine the opportunity to buy the French glass bottle factory more closely. To help him do so, he hired a number of consultants with specialized expertise in glass production. One step taken by the consultant early on was to go to the French glass factory to examine the quality of the equipment there and its current condition. The consultants’ unanimous conclusion was that the original equipment had been of a very good quality, and that the equipment was in refurbishable and/re-constructable condition. A second step taken early on by the consultants was to examine the records of the French glass factory and talk to the former managers, to find out why it had failed. The investigation uncovered three key problems with the operation: 1. irregular supply of sand; and 2. irregular supplies of electrical power; and 3. insufficient working capital. About this time, Williams learned of a very excellent source of sand approximately 50 kilometers from the site of the glass factory. Against the chance that he might at some point try to reactivate the factory, Williams acquired for a rather nominal sum an option allowing him to mine sand from this source. Having assured a source of sand for the factory if he needed it, and as a next step toward examining the viability of the factory, Williams put several additional initiatives in play. First, he invited two firms, one German and one Indian, to submit bids for the reconstruction and/or refurbishment of the glass factory. Second, he requested notified his contacts in Europe to see whether they could find at a reasonable price any of the huge, low-RPM generators which would be needed to assure the steady and continuous electrical power which would be needed to run the glass furnace. He also instructed them to search for several very large tippers which would be needed to move sand from the mine to the factory in an economic and efficient way. Over the next several weeks, Williams received back some encouraging news. His contacts in Europe uncovered several large high-quality used gen sets which could be rebuilt at a reasonable price. In addition, they found four huge Euclid (that is, General Motors) trucks in the United States which could be acquired for a reasonable price, refurbished, and then guaranteed by firms believed by William’s contacts to be highly reputable re-builders. As regards the refurbishment of the factory, the news Williams received was less cheering. Both the German and Indian firms came up with numbers far higher than what he had expected. Consequently, Williams decided to try contacting the manufacturers of the equipment and invite them to bid on an in-place reconstruction of the factory. This approach yielded very satisfactory results. The manufacturer responsible for the majority of the equipment in the plant assembled a team which offered to do the entire reconstruction project at a price approximately 25% lower than the bids received from the German and Indian teams. At this point, Williams had been working on the glass factory project for approximately one year, with almost full-time assistance from one consultant in the U.K. and the occasional involvement of additional consultants as well. His discussions with the receiver indicated that no alternative offer for the glass factory had been received or was expected. The receiver also indicated that the banks had agreed to write off as much as 15 million naira of the 30 million naira total owed them. Based on his sense that it was time to decide whether to extend an offer of 15 million naira, and knowing that he needed the support from his Board of Directors for an initiative of this scale and scope, William’s wrote his directors a memo over-viewing his reasons for being interested in the glass factory and a simplified version of his analysis of the financial aspects of the proposed transaction. A simplified version of the memo is shown in Exhibit 1. At the ensuing meeting, the Board of Directors deliberated the glass factory issue at great length. While few questioned the strategic rationale, several voiced substantial reservations as to whether SDCN had sufficient human and financial resources to tackle this particular project. Ultimately, however, the Board unanimously endorsed a motion authorizing Williams to offer the receiver 15 million naira for the glass factory. Williams had written the offer, hand-carried it to the receiver’s office, and announced to his project team that he would be meeting with them to begin planning as soon as he received the acceptance letter. YOUR ASSIGNEMENT Assume you are A. Williams, and that you must decide whether to make a counter-offer for the bottle plant. Make sure to use the 7-step case solution process discussed in class! EXHIBIT 1 TO: SDCN BOARD OF DIRECTORS FROM: A. WILLIAMS, M.D., SDCN RE: GLASS FACTORY ACQUISITION PROJECT As you know, our company has been investigating the possibility of acquiring and refurbishing the French glass factory. The strategic rational for this project is the fact that packaging is key to SDCN’s success and that our company has been squeezed mercilessly for many years by BOTCON. Having our own glass factory would remove this constraint, and would as well protect us from a situation where our key competitor’s lower packaging costs (because they own their own bottle factory) might allow them to squeeze our margins and impact very negatively on our continued ability to build and maintain profitable soft drink franchises in Nigeria. Please see attached a simple financial analysis of acquiring and refurbishing the glass factory. Based on this analysis plus the strategic considerations set forth above, I believe that the company should offer the bank receiver a sum of 15 million naira for the glass company and its equipment. So as to ensure that this very significant item receives the consideration and discussion it deserves, I propose that we place this item at the top of our agenda for next week’s meeting of the Board of Directors. cc: attachments FINANCIAL CONSIDERATIONS COST OF THE FACTORY AS AN ONGOING BUSINESS: Purchase price from the receiver: 15,000,000 Refurbishment of the factory: 123,652,000 Cost of supporting equipment: 15,867,000 (includes gen sets, trucks, etc.) TOTAL INVESTMENT: 154,519,000 BREAK-EVEN ANALYSIS: Total fixed costs (including financing costs): 41,106,000 Selling price per bottle (same as cost from BOTCON): 8 naira Average variable costs per bottle: 3 naira BREAK-EVEN VOLUME (number of bottles): 8,221,000 RETURN/PAYBACK ANALYSIS: Annual glass bottle production volume: 64,255,000 ANNUAL RETURN ON INVESTMENT: 47% PAYBACK PERIOD: Less than one year.
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