Running head: GUILLERMO'S FURNITURE STORE RECOMMENDATION

Guillermo's Furniture Store Recommendation FIN/571

GUILLERMO'S FURNITURE STORE RECOMMENDATION

Guillermo's Furniture Store Recommendation Guillermo Navallez lives in beautiful Sonora, Mexico, where he has run a thriving furniture manufacturing business from his home for many years. He manufactures standard furniture as well as some custom, high-quality furniture sold at a premium because of the superb craftsmanship. Sonora, Mexico is known as a vacation spot and also a major furniture manufacturing areas for North America because of the supply of timber in the area. Guillermo's business was doing well with the readily available timber and the low-cost of labor. In the 1990s, his business began to decline because of two changes taking place. A competitor located in Norway utilizing a high-tech manufacturing process with the ability to build furniture to the exact specifications entered the furniture market. Competitive advantage was also realized because the Norway competitor could maintain higher production rates with fewer employees and overhead. This took business away from Guillermo and he had to lower his prices to remain competitive. Additional challenges for Guillermo pertained to the available labor force in Sonora. As the local area continued to develop and new businesses opened their doors, Guillermo noticed that the labor rates were rising, material costs were increasing, and the cost of living in Sonora was experiencing an upturn. With these two changes profit margins started to diminish and Guillermo recognized the need to change business strategies to remain competitive. Following some market research, Guillermo considered two ideas with the potential to keep his business competitive within the market:

GUILLERMO'S FURNITURE STORE RECOMMENDATION

1. Upgrade Guillermos Furniture manufacturing to utilize automated processes similar to those used by the firm in Norway, or 2. Become a local distributor (broker) for foreign manufacturers who have yet to break into the North American furniture market. Guillermo needed some help in deciding which direction to take. Which option would result in a more profitable and sustainable business? What financial plans should he make? How would he finance new equipment in the event that the high-tech manufacturing business is the best course of action? Team D has been consulted to help him decide in his new business direction and to recommend financing guidelines that will help him launch successfully. High-tech manufacturing option The high-tech manufacturing option involves expensive equipment acquisition. The main equipment is a computer controlled laser lathe that cuts wood to the exact specifications that the user inputs. Subsequent equipment would consist of robots that assemble the furniture. The use of robots will not only minimize the cost of labor but also increase productivity time as they can work around the clock. The only downtime necessary would be for routine maintenance and quality control. Adopting this option would mean a large capital expenditure that requires financial planning. However, this option would also mean reduced labor and operations costs. If this option is chosen, team D will have to be prepared to give Guillermo some financial guidance in how to obtain the capital required for such equipment to be purchased. Long-term financing will have to be discussed and a cash budget will need to be determined.

GUILLERMO'S FURNITURE STORE RECOMMENDATION

How to Address Competition and Labor Costs Guillermos strategy to determine their competition and labor costs for each option is to establish a SWOT (Strengths-Weakness-Opportunities-Threats) analysis. That is, determining its strengths, weaknesses, opportunities, and threats. This analysis will provide an advantage for Guillermo to attain survival in its industry. A competitive advantage that Guillermo already possesses is brand recognition, patented process for coating the furniture, access to key resources such as timber and inexpensive labor. However, some of the competitive advantages have shifted because of new technology and global competition. Guillermo has to address competition and labor cost through SWOT for both options. Guillermos strength will always be the proximity to the resources of timber compared to his global competitors and a robust distribution network. The companys current weaknesses are in technology, labor costs, and in the manufacturing automation. Guillermos marketing position also lacks competitiveness because of its desire to stay independent. Staying independent means there is no room for negotiation for a partnership or merger, which potentially could bring many benefits. Guillermo can take advantage of numerous opportunities to gain competitive advantage. The high-tech manufacturing option will allow Guillermos to expand its furniture selection, which is ideal in attracting new customers who have a distinctive opinion on furniture style. Furthermore, the patented furniture coating can be taken to a higher level by using it as a competitive advantage on its furniture. Currently Guillermos threats include a large global competitor that uses high technology in manufacturing its furniture. Furthermore, the continued

GUILLERMO'S FURNITURE STORE RECOMMENDATION

business partnerships and acquisitions are brining more competition to small individually owned businesses like Guillermo Furniture Company. An important force that Guillermo cannot ignore is the increase in labor costs. The following plan is suggested for both the high-tech manufacturing option and the distributor vendor option. Guillermo continues to be in a predicament because of its continuing shrinking profit margins. The combination of prices falling and labor costs rising is a threat to any business. Guillermo has learned that many of its competitors have cut costs by outsourcing labor. Outsourcing has taken the burden away from many organizations by removing time consuming jobs such as accounting, distribution, and payroll. Efficiency is key for Guillermo, which means that outsourcing will bring higher variable costs and less fixed costs. This adjustment to Guillermos accounting will alleviate capital for needed investments that will increase its marketability. Additionally, outsourcing will give Guillermo the ability to focus on its furniture manufacturing or distribution specialty.

Addressing Advantages of High-Tech Option As mentioned previously, Guillermo Furniture Store started to observe significant changes because labor rates increased and the entrance of international firms to the market in the early 1990s. Guillermo is currently losing ground to international manufacturers employing hightech methods to manufacture furniture. Guillermo observes that in the furniture manufacturing, companies should continously upgrade and improve the manufacturing techniques to maintain efficiency and scale. Over the years, technical improvements in the furniture industry have

GUILLERMO'S FURNITURE STORE RECOMMENDATION

evolved so much that furniture making has become a precision science to avoid waste and thereby reducing expense by applying lean manufacturing techniques. So industrial modifications require Guillermo upgrade its production line with high-tech machines to stay competitive. Using the hi-tech option, Guillermo will notice a substantial boost in net assets despite a capital investment of $30 Million dollars. Automation provides a substantial edge over the other options that the company can choose from. A financial analysis of Guillermos Furniture Store indicates a transformation to a high-tech method will lead to increases in overhead, direct labor costs, utilities, insurance, depreciation, property taxes, and income tax expenditures. Additionally, a transformation to a high-tech method will lead to reduced labor time, direct costs, average cost per product, and many other advantages.

Distribution Vendor Option Guillermo Furniture distributions vendor option offers a variety of opportunities for Guillermo Furniture Store. Some distributors have only a fraction of the space to distribute a small percentage of the furniture on hand. Guillermos Furniture also has to look at the advantages and disadvantages of distributing their furniture through different companies while keeping in mind to keep their extended customers happy while attracting new customers. They have to make and keep their reputation that the company stands for, which is producing excellent quality furniture as well as high-end custom furniture. Guillermos Furniture has also been talking with some of their distributors about what they expect to achieve with

GUILLERMO'S FURNITURE STORE RECOMMENDATION

distributing their furniture through another company with a list of ideas on hand that appeal to them and the distributor in mind. 1. Would they be able to keep their trade name? 2. Would their current employees be able to keep their jobs, even if they choose to become a distribution broker? 3. With only a fraction of space available when distributing through another vendor would their furniture be limited to what customers can see on hand? 4. What is the foreseeable strategy for the company? Guillermo furniture is also looking at a second competitor, which is currently operating their business out of Norway, and looking at other channels to distribute in North America. The store operating their business did not take into consideration that they did not operate furniture outlets, favoring instead to rely on chain distributors. Guillermos Furniture can coordinate their existing distributors network, and become a broker for the company in Norway.

Option Selection Reasoning In the spreadsheet provided for Guillermos financial position there are some necessary adjustments to demonstrate annual performance metrics for the firm. On the Income Information sheet, production numbers were changed to reflect an estimated 5,882 high-end units and 30,146 mid-range units. The new values for Net Margins were then discounted by the annual estimated overhead costs to yield net income values for before and after taxes as depicted in Table 1.

GUILLERMO'S FURNITURE STORE RECOMMENDATION

Table 1 (Annual values) Continue Hi-Tech Broker Net Margins $3,132,952 $10,533,738 $3,268,609 Overhead 1,293,045 1,487,739 388,665 Net Income before taxes 1,839,907 9,045,999 2,879,944 Net Income after taxes 1,067,146 5,246,680 1,670,368

It is important to understand that these are projected values and not based on actual sales data. As the budget sheet clearly indicates, actual sales figures have fallen below expectations for the high-end products and exceeded expectations for the mid-range products. The cost of labor for the high-end units can be attributed toward the monthly deficit for the firm. For our analysis, however, the projected sales figures will be used. If Guillermo were to finance $30 million for the option to upgrade to the high-tech production equipment, at a discount rate of 15% the payoff period would be six years, nine months and eight days. At the end of 10 years, the high-tech option less investment amount and cost of funds would yield almost $17 million in profits for Guillermo. Comparatively, the Net Present Value (NPV) for the current and broker options for a 10 year production effort at an estimated 8% investment value would yield $7.6M and $12M respectively for the two options. Clearly the high-tech option has the advantage. Even if we add in time for plant construction, assembly, and staff training, say perhaps two years, the high-tech option will still be favorable for the 10- year objective. If the discount rate were to stray from the assumed 15% on the $30 million payback, Guillermo would only need to be concerned if the rates were either less than 11.5% or greater than 29% (see Chart 1). At less than 11.5%, the broker option will yield a higher return on the

GUILLERMO'S FURNITURE STORE RECOMMENDATION

ten year objective and at greater than 29% the current option may be more viable after some inefficiencies were corrected.

Long-Term growth Based on our reasoning and financial calculations, the high-tech option offers a long-tem solution to Guillermo and offers the ability to maintaining its core assets: branding and manufacturing. Without a long term outlook on the future, an organization will be like a ship without sail. With the current situation, Guillermo would become obsolete within a few years as its equipment becomes outdated. As a broker, Guillermo would have to lose its brand and not make use of its patented technology. More importantly, the company could be vulnerable to

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other distributors waging price war. So high-tech manufacturing option makes financial sense and is the long term growth model of choice. Guillermo still gets to innovate by leveraging the latest furniture making equipment while increasing productivity and efficiency. He will also dedicate a R&D lab that can develop more innovative products to build into the line up. The R&D lab also can be commissioned to create highly customized furniture that gives a feel that they are handcrafted. The combination of high-tech manufacturing, custom made furniture, and unique finishing materials offer Guillermos Furniture a long term plan that will set them apart from any competitors.

Conclusion After analyzing Guillermos business options the ideal proposition is for Guillermo to choose the high-tech manufacturing option. If Guillermo is proactive in utilizing the SWOT analysis and the financial evaluation provided in this report, Guillermo will be on the right path to staying competitive. Guillermo will continue to have industry and economic challenges; however, it is critical for Guillermo to keep enough capital ready to be invested in new technology. Guillermos success will continue for many years to come if it stays aware of new ways to cut costs, new technology, and continues its brand image.

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References Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate financial management (3rd ed.). Morristown, NJ: Wohl Publishing Inc. University of Phoenix. (2012). Week Six supplement: Guillermo's Furniture Store Scenario. Retrieved from University of Phoenix, FIN/571-Corporate Finance course website.