Production and Operations Management. Lenzing AG - Case Study Example

?BUSI3308: Production and Operations Management Assignment 4: Case Analysis Introduction Lenzing AG was considered to be amongst the biggest producers of the rayon fiber worldwide in the year 1990. The company was situated in a small town that was around 70 kilometers away from Salzburg and is a company of Austrian origin. The company had its base in the town near Salzburg since long and never felt the need to spread out far from there. The company was content with its operations and business till the year 1978 when the zeal to spread out internationally was initiated in Lenzing. The initiation or the possibility was triggered by a phone call which was made by an entrepreneur of Indian origin named Ashok Birla. The Indian entrepreneur came up with an idea of structuring a manufacturing unit in Indonesia. Initially, this proposal was turned down by the management of Lenzing owing to their lack of experience in foreign joint ventures as well as investments. However, with time Lenzing was able to identify the immense potential of the enormous and unexploited market of textile in Indonesia which made the Chairman ultimately initiate a joint venture with Birla. The outcome of the venture was a new firm named South Pacific Viscose (SPV) which was also the first foreign associate of Lenzing (Spar & Et. Al., 2008). Problem Statement or Issues The joint venture resulted to be quite successful and in a short period of time the firm SPV started earning huge profits by being a contributor of rayon fiber to the flourishing textile trade of Indonesia. It was found that there was a huge demand of the rayon fiber in the country and the firm efficiently exploited this opportunity which resulted in the augmentation of their profits by around 15 percent every year. In the year 1988, another production plant was set up by Lenzing due to the impressive profits. The second plant was established so as to enhance its production ability from 32,000 to 73000 tons each year. With the taste of success in Indonesia, Lenzing started spreading even out of Europe by way of initiating quite some fresh projects. The experience achieved with the help of its joint venture, SPV assisted Lenzing to expand. In the year 1992, a third plant for the purpose of rayon production was acquired by the company at Tennessee. It also started its manufacturing operations in China in 1994 by way of entering into a contract with the government of China to build a manufacturing plant of rayon around Beijing. These various investments and expansions helped Lenzing acquire the reputation of the sole rayon company across the world which boasted of a factual global presence (Spar & Et. Al., 2008). The company’s joint venture with Birla in Indonesia was functioning quite productively and profitably by the year 1994. This made the company Lenzing think yet once again of expanding more with the help of starting a third manufacturing plant of SPV which would facilitate to enhance up the production to 109,000 tons. It was also planned by the company that the third plant would focus on manufacturing rayon fibers of the most exceptional quality. The company was aware of the fact that with the addition of the third manufacturing plant, the firm SPV would be placed amongst the biggest facilities in rayon manufacturing and would be ranked in the second position after the Austrian plant owned by Lenzing (Spar & Et. Al., 2008). Along with the profitability factor, there were other important factors too which were considered to be significant as they would majorly contribute towards the expansion. The other aspects that were measured to facilitate the expansion were the strong recognized associations with the firm’s downstream customers and also the admirable working association with the Indonesian local partner. The location of the firm in Indonesia was considered to be the major inducement behind the expansion owing to the country’s potential of turning into a motivating force for the international textile industry. Apart from the advantages that triggered the expansion, there were other factors too which could turn out into hindrances as well. The most important factor was that as the manufacturing of rayon was closely related to the manufacturing of garments as well as apparels, a further expansion would involve a condition that the downstream customers of Lenzing would stay back too and shift their focus to Indonesia. The company could have rested assurance on this factor in 1994 when there were fewer competitors. There were high chances of the downstream customers shifting their focus to India or China which were considered to be budding textile centers then (Spar & Et. Al., 2008). Secondly, the firm needed to reconsider the factor of accessing wood pulp which serves as the key raw material that is used in the production of the rayon fiber. Although the firm was situated in Indonesia which had the biggest tropical forests worldwide, it still lacked the availability of wood pulp. Owing to this problem, the firm SPV had to bring in that input from other countries like South Africa and Brazil which significantly added to its expenses and also acted as a disadvantage. This particular problem was capable of becoming a string hindrance, as the local competitors enjoyed the advantage of backward integration which implied they could get involved into producing pulp (Spar & Et. Al., 2008). The final factor that needed serious thinking was the unstable political as well as economic condition of the country. It was important to think over the predictions of the expansion by assessing that whether the country was a suitable foundation for the increasing global business. Therefore, it became to be a critical issue to decide on the possibility of expansion by way of establishing another manufacturing plant in Indonesia (Spar & Et. Al., 2008). The present problem faced by the company is to decide on the fact that whether it should proceed with its plan of setting up a third rayon manufacturing plant in Indonesia. Environmental Analysis An environmental analysis would help to gain an understanding of the country’s various factors which would assist in the process of decision making. The political condition of the country was considered to be quite unstable as it had an authoritarian control. The economy of the country was principally under the command of President Suharto who controlled the country in 1978. The president did give rise to a string of trade monopolies but the control of those industries along with the major portion of the revenues generated rested on the president’s relatives as well as friends. Therefore, establishment of a fresh business would imply to take into confidence the president’s circle with the help of bribery. Moreover, the president was planning to introduce fresh players in the country’s economy as well as political system. The president made declarations of giving up the control of the country to an independent political system. This shift in power was equally capable of facilitating development as well as of creating a violent situation which would weaken the economic as well as the political conditions of the country. Therefore, the political situation of the country was quite uncertain which might prove to be disastrous for the business environment. A difference between the residents of the country was also observed and as a result there were high chances of a probable fiery division between the Chinese who majorly formed a part of the country’s business leaders and the extensive Muslim community who were much poorer. Although the demand of rayon fiber was quite high in the country, the unstable political situation posed a great threat to the industries (Spar & Et. Al., 2008). The economic condition was partly dependent on the political situation of the country as it had an authoritarian control. The tariffs were set quite high and foreign exchange was limited by the authoritarian. All these factors made the economy of the country centered on a torrent of regulations which made it unattractive for the foreign companies to make investments. Most of the industries and the major portion of the revenues generated by them were under the control of the president and his family and friends. This made the concentration of finance or funds in just few hands and implied that the funds were not properly divided in the country. This hampered the economic development along with the condition of the country. This made the business of the foreign companies’ tough in the country. The social condition of the country was also not considered to be stable as there was conflict between the two classes of residents in the country. This conflict was said to be capable of taking a violent shape which would obviously hamper the industries in that country. The conflict was between the elite business class and the poorer class both of which formed an integral part of the business industries. However, the cost of labor was quite low in the country which made it quite attractive for the foreign manufacturing industries (Spar & Et. Al., 2008). The technological environment of the country was not sound enough as, there were few domestic industries which concentrated on the production of wood pulp. Therefore, it can be inferred that technology was not considered to be an important factor in the country, Moreover, the severe regulations of the country did not encourage foreign trade and thus, there was hardly any introduction of fresh technology in the country. The technological equipments used in the manufacturing industries were imported from other countries (Spar & Et. Al., 2008). SWOT Analysis SWOT analysis helps to recognize the internal strong and weak points of a company along with the external prospects and threats. The strengths of the company include its large downstream customer support. This support would help them to reap benefits from them even at difficult times and keep the demand of rayon fiber constant. The company had a firm hold on the European fashion market. The company Lenzing also had the advantage of backward integration. The company had an easy access to wood pulp as it had the availability of an obtainable pulp mill which acts as the key raw material for the production of rayon fiber. The company also enjoyed a technological advantage as it utilized its resources in enhancing the technology as well as the efficiency related to the production process of rayon. The company maintains an amicable relation with its customers which helps to generate revenues. The company is only involved with the manufacturing of rayon fiber but also sells machinery that is required for the manufacture of rayon to various companies across the world (Spar & Et. Al., 2008). Weaknesses of the company can be stated to be their lack of expansion ideas. The company has its strong presence in and around Europe and is yet to make its presence felt in several other countries. The company’s joint venture in Indonesia lacks the access to wood pulp which can be stated as one of the major weakness of the company (Spar & Et. Al., 2008). Opportunities for the company can be said to be the increasing possibilities of venturing into the markets of the other countries and exploiting those markets. The production capacity in their company in Indonesia was enhanced which provided a chance to them to export a part of their production to other countries. The company bought a certain percentage of shares in a Brazilian firm that manufactured pulp which bestowed them with the opportunity of sufficient supply of wood pulp. This would also prove helpful in their functions in Indonesia owing to the problem of availability of wood pulp in that country. The manufacturing plants of the company were situated in a way which made them easily accessible to their suppliers (Spar & Et. Al., 2008). The threat of the company came in the form of growing number of companies that were connected to the production of rayon fiber. Previously, the company did not face much competition but many new manufacturers were entering the market and tried capturing the various flourishing markets as well as the unexploited markets. Although, the company bought stakes in a Brazilian wood pulp manufacturing company but the problem of availability of raw material still persisted in Indonesia. The company had to get the wood pulp shipped from Brazil to Indonesia which increased the expenses of the company. This acted as an advantage for the local manufacturers as they had the benefit of backward integration. This acted as a significant threat for the company (Spar & Et. Al., 2008). Porter’s Five Force Analysis Bargaining Power of Suppliers The main raw material utilized in the production of rayon fiber is wood pulp. There are quite a number of suppliers of wood pulp but it is to be noted in this context that the prices of wood pulp does not depend on the consumption of the rayon manufacturing industries. Wood pulp is mainly used in making paper and so, the price of wood pulp is controlled by the paper industry. Thus, the rayon manufacturing industry depends on the paper industry for the availability and prices of wood pulp. Therefore, the manufacturing industry is not capable of manipulating the wood pulp prices (Spar & Et. Al., 2008). Bargaining Power of Customers There is a significant demand for this fiber as it is chiefly used in the garments and apparel industry. The customers are also incapable of influencing the prices of rayon fiber as, there is a high demand for the fiber nationally as well as internationally and there is no substitute of this fiber. Therefore, the price of the fiber does not get influenced by the customers (Spar & Et. Al., 2008). Threat of New Entrants The threat of new entrants is quite high. The demand of the fiber has been rising and so, many firms are planning to come into the market of rayon manufacturing. Even, if the total production was not consumed within the country, the rest of the production could be exported owing to the escalating demand. Many new entrants were already planning to enter the Indonesian market. This would increase the competition but at the similar time the existing firms would be at an advantage because of their access to wood pulp. The new entrants are likely to face difficulty in this matter. The Indonesian president was also encouraging new investments in the country (Spar & Et. Al., 2008). Threat of Substitutes The rayon fiber is said to be the substitute for other synthetic as well as natural fibers like wool, polyester, cotton and nylon. Therefore, the fiber is itself and substitute and there is no substitute available for this particular segment (Spar & Et. Al., 2008). Competitive Rivalry between Existing Players There are not many existing competitors in this industry. In Indonesia there were few manufacturing industries but they were not large players. Lenzing’s venture in Indonesia, SPV had the highest producing capacity of fiber. The company was also technologically quite sound and so, did not get affected much by the existing competitors. Price competition is high as there is not much demarcation in the fiber. Barriers to leave the industry are high as, the production of this fiber calls for the requirement of setting up a plant for which the costs are quite high and the equipments used are technologically advanced which also entails a significant amount of investment (Spar & Et. Al., 2008). Financial Analysis The financial ratios of SPV have been calculated in order to assess the financial soundness of the company. This would help to decide that whether it would be financially feasible to construct a third Indonesian plant. The current ratio of the company in the year 1992 was $3.88 and in 1993 $2.49. There was a decrease in the current ratio. It means that the company had $3.88 & $ 2.49 of current assets in the years 1992 & 1993 to meet $1.00 of the incurred current liabilities. The quick asset ratio for the company in 1992 and 1993 was $2.60 & $1.61.There was also a decrease observed in this ratio. This meant that the company had the mentioned amounts in order to meet $1.00 of its current liabilities. The debt equity ratio in 1992 & 1993 for the company was $1.12 & $1.00 and this has a positive impact as, the debt has been observed to decrease. It means that the company had $1.12 of debt and $1.00 in equity to meet this obligation (refer to table 1 in the appendix). The debt decreased in the next year which meant that the company had less debt to meet (Spar & Et. Al., 2008). From the above analysis of the liquidity ratios it can be stated that in-spite of a decrease in the current and quick ratio but the company was still profitable. The current ratio and quick ratio were still ideal for the firm. In the year 1992 the debt equity ratio was not ideal for the firm but in the next year it was close to the ideal criteria. An improvement in the profitability ratios were observed as well. The return on sales for the company for both the years was 12.21% & 12.72% respectively. It implies that the company makes $12.21 & $ 12.72 on every $1 of sale. The return on assets for both the years was 8.36% and 9.38% respectively. This implied that the company makes a return of $8.36 & $9.38 on its assets that is employed towards the operations (refer to table 2 from appendix). The return was observed to increase in the next year (Spar & Et. Al., 2008). The return on equity for the company was 17.76% and 18.78% which meant that these were the returns that were made from the invested capital of the company. The return was seen to increase in the year 1993 which implied that the profits of the company were increasing. The above evaluation of the profitability ratios and the liquidity ratios proves that the company was financially sound to further expand and it would prove profitable as well (Spar & Et. Al., 2008) (refer to table 2 from appendix). From an overall point of view, the financial analysis can be observed to prove that the company made profits from its manufacturing plants. The profits of the company and the sales increased each year. Therefore, it implies that setting up a third plant was likely to prove profitable for the company from the financial aspect keeping aside the other issues. Alternatives The company, instead of setting up a new plant in Indonesia could expand in other countries like Brazil by setting up production plants for manufacturing rayon where it bought stakes of a wood pulp manufacturing firm. This would save the transportation costs to bring in the raw material and would also provide a competitive advantage, as it would always have a steady supply of wood pulp. The company could also try and buy some shares in a wood pulp manufacturing firm in Indonesia or should try and set up its own wood pulp manufacturing unit which would solve the trouble of availability of wood pulp in Indonesia (Spar & Et. Al., 2008). Therefore, investing in a wood pulp manufacturing unit in Indonesia would prove to be more beneficial owing to the existing popularity and client base of the company in that country. Recommendations The company should plan a wide expansion owing to the increasing popularity of rayon and its demand. The company should utilize its experience, technology and resources to enhance the quality of the product which would assist it to cater to the international market. The company should also plan backward integration in the countries where there is a problem in accessing wood pulp. This implies that the company should plan backward integration in Indonesia by setting up a wood pulp manufacturing unit. The company is already popular in the country and is facing problem owing to the dearth of availability of wood pulp. Backward integration would help the company to gain more popularity and earn more revenues (Spar & Et. Al., 2008). Conclusion The firm had been quite successful in the textiles market of Europe since decades and basically had its sales centered on the significant number of weaving as well as spinning firms, which accounted to be the major customer support for Lenzing AG. Expanding in Indonesia was the initial step that was taken by the company towards expansion. After tasting huge success in the Indonesian market, the company expanded in China as well. The financial analysis of the company’s venture in Indonesia was learned to be quite sound. The company should take advantage of this factor and move forward to set up the third plant in the country. The company has a strong technological edge as it employs it resources in enhancing the technological process of rayon production. It should take benefit of its technical skills and is customer base for the purpose of expansion (Spar & Et. Al., 2008). References Spar, D. & Et. Al., (2008). Lenzing AG: Expanding in Indonesia. Harvard Business School. Chary. (2009). Production and operations management. Tata McGraw-Hill. Appendices Table 1: Calculation of Liquidity Ratios Table 2: Calculation of Profitability Ratios Read More