HBS Case: Jaguar PLC

HBS 9-290-005: Jaguar plc, 1984

Jaguar PLC, 1984 Harvard Business Review

Objectives

• To discuss operating exposure to real exchange rate changes
• To discuss various alternatives for managing such exposure
• This case setting is the privatization of Jaguar in 1984
• To value the shares being offered for sale as a function of expected exchange rate

Questions
1. Consider Jaguar’s exchange rate exposures. To which currencies is Jaguar exposed? What are the sources of these exposures? How would the company be affected by a 25% decline in the value of the dollar?

2. How should Jaguar’s shares be priced? Estimate the likely value of Jaguar’s equity in the following scenarios:

• no change in the real exchange rate between the dollar and the pound
• a 25% drop in the real value of the dollar against the pound
• a 10% rise in the real value of the dollar against the pound
• Create other scenarios of your own. In doing so, consider reasonable changes in price, volume, and other variables that may change as a direct or indirect result of exchange rate changes
  

3.Quantify Jaguar’s exposure in 1984 to the real dollar/sterling exchange rate. How large is it compared to Jaguar’s sales? Assets? Equity value?

4. Should Jaguar attempt to hedge its dollar exposure? Why or why not? What methods are available for hedging this exposure? What are the costs and benefits of each?

Background-dramatic turnaround from 1980 to 1983

• An increase in labor productivity
• Cost cuts
• An increase in volume to move the company past its breakeven production volume
• Sales volume increased by 13 thousand vehicles from 1980-1983.
• Nearly all of this improvement occurred in the U.S. market

What is the most important factor contributing to this increase in U.S. sales volume?
- Was it due to the appreciation of the dollar during this period (see Exh 7), rather than to the efforts of John Egan?
- Perhaps because of strong dollar
- But, both Jaguar and German competitors did not cut dollar prices in the US
- Instead, the followings contribute to sales volume increase rather than price cuts
1. Improvements in product quality
2. U.S distribution
3. Customer service


Q. Why did export volume to some countries such as West Germany and the rest of Europe actually declined from 1980 to 1983?
-It was not because of reduced European demand, but rather of Jaguar’s decision to allocate production to the more profitable U.S. market

Q. Which currencies affect Jaguar’s operating exposure?

• $/pound
• DM/$
• Daimler-Benz – Jaguar’s competitor
• Best: $/pound and DM/$ fall
• Worst: $/pound and DM/$ rise
• If we sell our products in the US but outsource from our home country, we will raise dollar prices after a weakening of the $ against home currency.
  

- A general rise in the value of sterling against all currencies is more harmful to Jaguar than a general weakening of the dollar agianst all currencies.


Valuation

• Base case
• A 25% depreciation of the $ against the pound, with no changes in $ prices or U.S. unit volume
• A 25% depreciation of the $, to which Jaguar responds with a 10% increase in $ prices  Reduce U.S. unit volume
• A 10% dollar appreciation with no price or volume changes

1. Base case
- There are three types of distinctions
1. dollars vs. pounds
2. volume changes vs. price changes
3. fixed vs. variable costs
 We divide Jaguar’s world into 2 markets, the U.S. and the rest of the world assumed to be a sterling market
 Thus, the analysis may ultimately understate $ exposure, because markets such as Australia and Canada might be more $-like than pound-like.

What is a discount rate for sterling cash flows?
- No beta is provided because there are no public shares as yet.
- Betas for other auto producers are either not available or are for very large full line producers such as G.M. and Ford,and are measured with respect to different equity markets.

Taxes
- Jaguar’s financial statements for 1980-83 show negligible taxes, but you may expect that Jaguar will soon exhaust its unutilized tax credits and carry-forwards.
- Dollar price increases in the U.S. equal to U.S. inflation, assumed to be 3% per year.
- Sterling inflation is 5% per year
- Rest-of-world sterling prices increase at this rate

Assumption
 The exchange rate starts at $1.350/pound in 1984 (given in the case)
 Declines at a rate of 2% per year (according to PPP)
 This is not what the market expect.
 Exh. 8 shows the dollar at a forward discount to the pound, despite lower U.S. inflation
 COGS –variable cost increasing at the sterling rate of inflation.
 Depreciation – fixed
 R&D, distribution, and administration - increased with sterling inflation
 Some portion of distribution costs is variable
 Some portion of COGS, other than depreciation, is fixed.
 2. 25% depreciation in $ against pound PPP holds there after. Thus there is no change in the sterling discount rate
 Assume Jaguar makes no change in its dollar prices in response to the shock Its scope for responding is affected by actions of other competitors.
 If the sterling value of the dollar drops, not its mark value, then Jaguar may have difficulty raising dollar prices because its German competitors are less likely to.
 The effect of this simple change is quite dramatic.
 The value of the CF is reduced from 515 million pound to 119 million pound a reduction of 77%

How to respond?

Other scenerios
 25% Depreciation in $ and raise $ price 10%
The value of FCF is 258 million pound compared to 119 if we don’t raise price.

 10% Appreciation in $
33% increase in FCF and 38% increase in equity value compared to the base case

Potential exposure to the Yen

 Honda, Toyota, and Nissan are expected to enter the U.S. luxury car market before the decade is out.
 None has yet entered in 1984.
 Yen/pound - the Japanese producers may enter the U.K. and European markets
 Yen/$ - The pace and progress of the Japanese entry into the U.S. market.


If yen appreciates against $, how will it affect the profit of U.S. luxury car?
 Will be less profitable for the Japanese companies
 This is even more true in less expensive segments of the U.S. market, in which the Japanese firms already compete.
 Thus, this appreciation of yen will hasten the move upscale by Honda, Toyota, and Nissan to the detriment of Jaguar and the German companies.
 It might reduce the profit of U.S. luxury car.

How to estimate exposures?
 There is a distinction between the exposure of firm value and the exposure of equity value.

 What is exposure?
It is how home currency firm value change with respect to the 1% change of home/FX exchange rate.Thus, it is foreign currency unit.

 Exchange rate change may not be permanent
 It may take only 1-2 years
 This exposure is based on unexpected change.
 If the exchange rate rises in 1985, the stock market may regard it as a deviation from PPP, but not as a surprise.
 Exchange rate +/-1%  Cash flow change +/- 50 million pound 50*$1.35/pound = $67.5 million

 Overestimated number

Why is 67.5 million an overestimate of exposure?
 It takes no account of Jaguar’s ability to blunt the exposure with operating responses:
$ appreciate -> Raise $ price -> Decrease sales volume
 It assumes that exchange rate change is permanent
 In the volatile rate environment of the 1980s, a given real exchange rate shock might have both permanent and

temporary parts
 Exposure to a temporary change occurs during a year or 2, rather than the PV of all future dollar CF


It assumes that the exchange rate change is unexpected.

 The expected scenario is not the base case, but rather one in which PPP is not expected to hold.
 If the exchange rate rises in 1985, the stock market may regard it as a deviation from PPP.

Why do we tend to overestimate exposure?
 It is not a surprise.
 The MV of Jaguar assets (and equity) has already been discounted for some expected drop in the value of the $
 That’s why Jaguar’s equity value drops to 200 from 450 million
 Info about expected future exchange rates is available from the term structure in the forward market
 The case does not provide the term structure of FW market except in Exh 8.
 If available, it would be another way to construct the projected exchange rates

Should we hedge?
 Although Jaguar’s exposure is much less than $24 billion, it is still large
 Quite possibly larger than equity value or asset value

Pros of hedging
 Reduced volatility increases firm value
 By reducing contracting costs
 Firms can hedge more cheaply than investors
 Because of lower transaction costs and better information
 Investor can hedge for themselves if they want to
 A hedging program may be expensive
 Difficult to control
 Set up potentially perverse incentives
 Ultimately ineffective



Cons-Derivatives
1. The are nominal contracts that only work well when nominal exchange rate changes are highly correlated with real

changes.
 This has been the case for most major exchange rates for most of the 1980s.
2. They can significantly distort reported financial results
3. Except for LT debt, they are not easily obtained for terms much beyond 24 months.
4. Jaguar’s exposure is so large that any effective hedge would be large compared to the rest of the firm


 Jaguar’s CFO remarked that, for LT US$ debt functioned as an effective hedge,…
 Jaguar would have to issue a huge amount (over US$1 billion), convert the proceeds to pound, and sit on the cash.
 He felt this would intolerably distort Jaguar’s financial reports.
 Use real hedges:
 Sourcing policies
 Manufacturing locations
 Selling locations
 John Eagan stated the importance of quality
 Use of real hedges made the company successful so far in the 1980s.

What happened
 At the end of July 1984, 177.88 million Jaguar shares (of a total 180 million shares) were offered.
 At a price of 165 pence per share
 Implied a market cap of 297 million pound.
 The offer was oversubscribed
 The shares traded up about 7% upon being first listed on Aug 10.
 Selling $ forward 50-75% of the next 12 months
 It would not nearly hedge all of Jaguar’s exposure, but would give the manager some time to respond to dramatic

currency swings.
 $ rose for a short time after the share offering in July 1984, reaching $1.159/pound at the end of 1984; it did not peak

until the first Q of 1985.
 $ began to fall in Feb 1985
 In the spring of 1985, Jaguar executives felt that forward rates were attractive and pushed their rolling hedge out 24

months instead of 12 effectively locking in sterling rates through the spring of 1997
 This proved quite prescient, as the dollar’s slide accelerated, until by the end of 1987.
 Jaguar’s management was roundly praised
 DM/pound was fairly stable
 In 1988-89, some of the forward contracts lost money as the dollar recovered
 Many employees were dissatisfied  Labor negotiations were more difficult
 Unable to hedge its exposure effectively
 Jaguar remained competitive through improvements in its dealer network and production efficiencies
 Capital expenditures were tripled from 1983-1987 to modernize manufacturing capacity and lower costs.
 Ford acquired Jaguar at the end of October 1989 in buying the entire company for 1.6 billion pound (about $2.5 billion)

Estimated Exchange Rate Risk	90.0
	Value	Risk as a % value
Q1 1984 Sales	143.3	15.7%
1984 Sales Annualized	573.2	15.7%
1983 Sales	472.6	19.0%
Fixed Assets	119.0	75.6%
Current Assets	130.5	69.0%
Total Assets	249.5	36.1%
Equity	125.0	72.0%

HBS Case: Threshold Sports

Harvard Business School Case : Threshold Sports
Cycling Market
Europe

* Popular as amateur and professional sports
* Well supported

1. Prestigious Tour de France
2. 1 billion viewers

United States

* Growing in popularity as a professional sport
* Lack of community support and organization
* Growing interest due to cycling icon

1. Greg LeMond
2. Lance Armstrong

S.W.O.T Analysis
Strengths
Management experience

* Cycling
* Event planning
* Contacts
* Over 100 professional cycling events

Current sponsorship agreements

• First Union Series, BMC Software Grand Prix, U.S. PRO Cycling Tour

• Event-staging equipment Acquired for less than 1/3 of the value

Weaknesses

* New Company: 3 months old
* Management has limited experience in finance
* Financing needed for first growth phase
* Identification for potential investors/banks
* No tangible assets

Opportunities

* First movers to emerge in the United States
* To become a household name – “branding”
* Growth potential

Interest by spectators – the next “NASCAR”
Expansion across the U.S.

* Selling more sponsorships
* Expansion of TV coverage
* Developing new revenue streams
* Potential profit growth

31.17% in 2001
15.47% in 2002
Threats

* Risk of competitors gaining the advantage
* Loss of market share
* Being taken over by an umbrella organization
* Cycling does not gain popularity

Lack of investors
Lack of marketing

Growth Plans
* Create financing need for Threshold Sports
– Estimated need of $500,000 for upcoming expenses
– Growth plan consists of emerging European style cycling events into the US market

Issues Facing Valuation

* New firm
* No tangible assets
* Limited comparable companies

Possible Valuation Methods
EBITDA

* EBITDA multiplier for private companies = 6.0
* EBITDA multiplier average for comparable companies based on the industry for fiscal yr 1999 = 17.35
* Comparable company with a positive EBITDA

– Cordiant Communications Group
– 15.09
Valuation based on EBITDA
$14,743,000
P/E Multiples of Comparable Companies
Valuation based on P/E multiple
$32,004,000
Discounted Cash Flow
Key assumptions:
Rf = 6.04%
Βeta = 1.2
Rm = 15.04%
Re = 16.84%
Valuation of Threshold based on DCF method
$4,337,000

Financing
FRICTO Analysis of Debt Financing
Flexibility
– Not flexible, but customizable
Risk
– Risk off-set by a higher interest rate by the bank
– It is a risky loan for the bank
Income
– Structured into the loan, coupon payments, lump sum payment, etc.

FRICTO Analysis of Debt Financing
Control
– Founders can keep control
Timing
– Timing can affect the interest rate, not as important as other 2 options
Other
– Can default on loan, bankruptcy, debt restructuring
Valuation of Debt Financing
Tax shield value = $135,511
Value of Threshold Sports = $4,473,000

FRICTO Analysis of Issuing Common Stock
Flexibility
– Liquid – easy to change ownership

Risk
– Higher Risk for investor
– If company goes bankrupt, common stock holders are behind bond holders in line for assets

Income
– Capital appreciation
– Dividend

Control
– Owner of company with voting rights
– Founders will lose some control
– If they wanted to keep control, they can sell 49% of the company as long as they all vote the same

Timing
– Best to offer stock when company has strong financials and positive outlook, this way they can raise the max. capital

Other
– Financial statement implications, looks better than debt


The added value to the company is the equity received from the stock issue
$4,837,300

FRICTO Analysis of Issuing Convertible Preferred Stock
Flexibility
– Pre-established terms state that it could be converted into common stock
– Preferred stock = 1.5 units of common stock executable at the strike price

Risk
– If company fails preferred stock holders may lose some initial investment
– Increase in interest rate
– Company risk

Income
– 10% dividend on par value that will accrue and be payable on a cumulative and noncumulative basis

Control
– Holders of convertible preferred stock do not have voting rights
– Control remains in the hands of the founders
– If the preferred stock holder wants to sell, first must offer to the company for a buy back and then to existing preferred stockholders

Timing
– Interest rate sensitive; not ideal to offer during increasing interest rates
Other
– Tax disadvantage/No tax shield offered
– Taxed as personal income, not as a business expense

Value of the Preferred stock
– $4,176,000
– Deducted discounted dividend payments from the discounted cash flows

Convertible Preferred Stock
Convertible preferred stock has an embedded option that allows the holder to exchange each preferred share for a specified number of common shares. Convertible preferred is usually callable. This allows the issuers to call the stock and force preferred shareholders to choose between accepting either par value or common shares. This is called a conversion-forcing call.

Option #1

* Find a corporate partner to provide capital in the form of a loan
* For collateral on the loan issue the lending company common stock
* This will provide a tax shield to Threshold Sports and allow them to retain majority control of the company

Option #2

* Issue convertible preferred stock

Recommendation
Convertible preferred stock

attachment : http://www.filefactory.com/file/a0ee91e/n/Threshold_Sports_Exhibits_xls

HBS CASE : Home Depot

Home Depot - Strategic Internal Organization & Financial Analysis
Summary:

Home Depot has many distinctive competencies that it uses to capture the majority of the Do It Yourself market, which represents a $100 billion dollar market. The key Issue is that while Home Depot is satisfying the DIY market they have not yet gained a significant share of a much larger $265 billion dollar, professional market. It has already built a foundation of key competencies that can be used to attract the professional buyers. These competencies include the incorporation of up to date technologies, which aid in its internal and external environment and allows it to gain a competitive edge over its competition. Home Depot’s ability to supply extensive product lines, and provide services and support for those products, also enables it to differentiate itself from many of its competitors.

Internal Organization Analysis

Strategy and Direction

The company started off with plans to cater to the Do-It-Yourself market, and over the years has been successful with it. This is a $100 billion market. Over the years, since Home Depot has expanded over most of the states and areas in United States and neighboring countries, its time they find another target market that they can address. Hence now Home Depot is thinking of concentrating on the Professional business customer market with is a $265 billion dollar market. Even though the profit margin is low in this business, Home Depot can expand and supply this market and still make good amount of Profit instead of having around $150 million per year in cash savings.

Key Managers
The Key Managers for Home Depot are widely experienced in other retail markets. Many of the key managers have been promoted from within. Because of internal promotions employees have an attachment to the company and are motivated to work hard at their jobs. The company has further improved productivity by cross training its employees. It has invested a considerably large amount of money towards training therefore employee turnover is a concern. Currently Home depot has a 30% turnover rate an this issue needs to be addressed.

Bernard Marcus, Arthur Blank and Ronald Brill are a part of the key management team. Marcus and Blank are co-founders and serve on the board of directors. They have also served on many other boards which bring them more experience in management. Marcus’s background before Home Depot was in the retail industry. Brill has been with Home Depot since its inception in 1978 and was the Treasurer and more currently an Executive Vice President and CFO.

Board of directors
The Board of Directors consists of ten really experienced people. Most of the board members are from outside the company. Like the management team, the board of directors needs to have members with more outside experience in similar retail markets. This will allow them to guide the company in with regard to where competitors are moving, and would help Home Depot take a few critical steps forward. Home Depot Values its employees, and pays them decent wages.

Value chain
As mentioned earlier Home Depot’s wide array of products which is coupled with its supporting services, and extremely helpful and knowledgeable staff proves to be a strong source of added value to its products. This makes the Do-It-Yourself task much simpler. Home Depot has also applied its cutting edge technology to reduce the huge customer lines associated with its large customer base. They have incorporated a self-checkout system which makes it a lot faster, and convenient for customers to complete the purchase process; this is another aspect that adds value to purchasing products at home depot.

Financial analysis
Home Depot has been successful financially, and has showed impressive growth since its beginning. The Do-It-Yourself market has proved to be successful with 24.1 billion in sales, which is more than twice their nearest competitor. The growth numbers have been impressive for this company. If one had invested $1,000 in this company on June 30, 1982, their investment would have been worth $152,479 on June 28, 1997. Home depot’s Inventory turnover increased significantly following the application of a new inventory management system. The change was from 4.1 in 1985 to 5.7 in 1994. This rate helped Home Depot carry 40 million less in inventory tying up less working capital to finance it. This allowed for a cost structure that was significantly lower than its competition.Home Depot had a quick ratio of 54% in 1997, and 35% in 1998; even then they have increased their current assets and inventories. The current ratio for Home Depot in 1997 was 2.01 and in 1998 it was 1.81. This is pretty strong, since they have 1.81 assets for each liability. They have taken no risk at all; they actually have an equivalent of almost half their debts on hand. This means that they have a lot of cash that hasn’t been used for anything yet. These available funds can be used towards the implementation of strategies that support expansion in to the professional market.


Resources , capabilities and performance evaluation
Home Depot is expanding pretty rapidly and making more and more profits every year. Their Balance sheet for 1997 and 1998 shows that Home Depot has an equivalent of $146 million and $172 million in cash and in cash equivalents. The company has always been able to translate its resources into capabilities, by trying to expand in new markets by opening more and more new stores every year and continuously incorporating new technology in its processes. The company’s past performance has been really good. They have used their finances efficiently to expand their business. The Company has been successful up till now with their Do-It-Yourself strategy, and hasn’t yet failed in any strategies that they have tried to implement. Home Depot was mainly focusing on the DIY strategy up until now, when they decided to enter in to the professional market. New strategies that utilize their healthy finances will have to be implemented in order to increase market share of this large target market.

Strategy
While Home Depot has been doing very well over the past few years there is still much room for improvement in a couple areas. The more minor area that Home Depot could look at improving is there employee turnover. While the 30% turnover rate is extremely good in the retail business it is costing Home Depot a lot of money. The reason that there is such a high cost involved is that employees go through an extensive training process. Home Depot needs to find a way to cut the cost involved when they lose an employee.

Unlike the first new strategy suggestion, the second more major strategy involves generating more revenue rather then cutting costs. Our suggestion is for Home Depot to enter the large Professional builder market. Currently Home Depot has the largest market share of the DIY market and is making tons of money. If they are able to do the same with the professional market then their profit potential would skyrocket. Also, the DYI market tends to do better during times of recession while the professional market tends to do better during times of economic growth. By capturing both markets not only would Home Depot make more money, but also their cash flows would be more even throughout the years (not as affected by economic trends).


Implementation Plan

Since Home Depot has done so well in the past they should be able to use some of their past experiences to better help them with our new suggestions. For our first suggestion of cutting cost involved with employees leaving the company Home Depot needs to develop some controls that would allow them, when hiring, to determine which individuals are high risks for turnover. When someone is determined to be high risk Home Depot could decide to not give the employee all of the four to six weeks of training at once. For example; only train an employee on the cash register to begin with, once they have stayed employed for a few months give them training in another section. Hopefully this will be able to save Home Depot some costs that are involved with training then loosing help.

The second suggestion has the ability to make Home Depot a lot of money. The suggestion is that Home Depot try to expand into the professional builder market. What is important about this strategy is that they not let it affect their current efforts with the DYI market. In order for Home Deport to tap into the professional market they will need to expand their current stores; making a section of the store that caters to the professional. As well as expanding their stores Home Depot will also need to come up with a very good delivery system so that building materials can be delivered directly to the job site of the professional. The third step in the process would be that Home Depot would need to do a lot of marketing and advertising to people in the professional market. Basically Home Depot would need to change their image in the eyes of the professional while at the same time maintain their image to the DIY market.
Home Depot is in the fortunate position that they have enough resources to pay for such an expansion. Even though Home Depot has a lot of cash and cash flows it is a good idea to try to leverage some of there equity. Basically try to let the banks pay for as much of their expansion as possible.

External Task Environment (Porters five forces plus two)

Supplier bargaining power:
Home depot has approximately 5700 vendors. The large number of vendors enables it to have high bargaining power where as each supplier has very little to no bargaining power. It is able to demand lower prices due to its large volumes of purchases which in effect give it an advantage over its competitors.

Customer bargaining power:
Customer bargaining power is very low because Home Depot is like a one stop shop with almost everything a person would need; in addition it also provides many workshops and demonstrations which add value to any purchase. By having such a wide array of products and services Home Depot is able to minimize customer bargaining power.

Substitutes:
Professionals such as tradesman builders and general contractors serve as Potential substitutes to Home Depot’s current DIY target market. A benefit of capturing the professional market is that it will allow Home Depot to eliminate threat of these substitutes. Once they sell products to these professionals; whether they provide the service on their own, or are given opportunities through Home Depot’s contracting; either way supplies will be primarily purchased from their store.

Complimentors:
Home Depot’s owns TLC Inc, a very popular channel with remodeling and home maintenance repair shows. These shows serve as a complimentor to Home Depot’s products. These shows increase the viewer’s desire to do their own home improvements, which draws them into the store. Professionals, such as interior designers and other home improvement specialist, compliment Home Depot by giving people new ideas and the means to carryout those same ideas.

Rivalry:
Home Depot’s main competition includes Loews, PayLess, and Builder’s Square. Rivalry has been mainly fuelled by low prices, location and product offerings. Home Depot has managed to excel in these areas due to their bargaining power against suppliers,and the up to date technology that allows it to have lower prices, and enough inventory on hand to satisfy demand, which makes Rivalry considerably low for Home Depot.

Barriers to entry:
Home depot continues to cannibalize sales of existing stores by opening two other stores in a single area. While this may lower same store sales it is also able to drive existing stores out of business and keep competition from entering. Home Depot has managed to raise entry barriers themselves. Also, there is a large amount of capital cost involved in starting up a new store which reduces the threat of new entry.

Stake Holders:
Home Depot managed to build strong relationships with all its stakeholders. Its internal “network” structure coupled with higher wages and employee stock ownership plans helped motivate and gain employee loyalty. Home Depot’s customers are satisfied because they have been given support with installation of purchases through work shops, and by their licensed contractors. Environmental awareness and strong social activeness gives back to the community, through programs such as “Habitat for Humanity” which has built thousands of homes and increased brand exposure. Such activities have helped free the company from any stakeholder threats

Product life cycle/Economies of scale:
Even though Home Depot sells DIY products to fix up houses and these are mature products, in effect they are commodities because individuals will always update and fix their houses. These products can also be commodities because homes are always being built regardless if there is a recession or not. So Home Depot ultimately benefits from selling most items that will always be in demand no matter how bad the economic conditions may be. Even in the last recession Home Depot performed well as the DIY customers would upgrade and maintain their households. However, access to the professional building market is also beneficial because in good economic conditions Home Depot will prosper with the abundance of new homes being built. If rough times are expected Home Depot can always rely on its bread and butter; the do it yourselfers to drive the business.

As the number one home improvement retailer in the market Home Depot sets the standard for its competitors. This allows them to have an economy of scale on how they obtain their supplies. Like Wal-Mart, Home Depot provides a huge outlet for all its vendors. With the vast size of their stores, Home Depot can get bulk discounts that come with ordering large amounts of inventory. They have the DIY and BIY market cornered. However, they may have a large learning curve to overcome to their low percentage in the professional builders market.

Technology:
Technology is highly integrated into Home Depots operational structure. Using EDI (Electronic Data Interchange) with its thousands of vendors Home Depot is able to keep a good window of communication open so they know when a store is low on inventory. Usage of UPC codes and tracking each item sold allows Home Depot to keep an accurate inventory of items and see which items are selling better than others. The integration of technology gives Home Depot a distinct advantage in inventory management. Thus they are able to increase their inventory turnover through the use of these inventory management systems. By turning over inventory quicker, their capital isn’t tied up in a warehouse but able to be used for other projects.

HBS Case Study : Interco 9-291-033

HBS Case Study : Interco 9-291-033

• Started out as shoe company – been around a long time
• •Business has spread to other consumer products / services through acquisitions
• •Fairly conservative financially, debt level is relatively low
• Interco has moved away from apparel and general retail (went from 59% to 40% of total sales) •
• Placed more emphasis on the footwear division. (acquired Converse in 1986) •
• Placed much more emphasis on the furniture division (sales rose from 20-33% of Interco’s total sales)

Current Scenario

• •Cheap imports hurting profitability of U.S. apparel manufacturers
• •Retailing industry profits reduced due to drop-off in consumer spending and deep discounting programs being offered by retailers in 1987
• •Furniture and home furnishings prospects appear bright given favorable demographic trends in family formations (success of firms like Home Depot proved this ex post!)
• •October 1987 stock market crash still in rear-view mirror

Operations

Currently has four major divisions

1. Apparel (e.g., London Fog)
2. General retail merchandising (Central Hardware)
3. Footware (Converse, Florsheim)
4. Furniture and home furnishings (Ethan Allen)

Interco's Goal

• •Improve long-term sales and earnings growth •
• •Earn increased return on assets and equity

Concern
Interco concerned stock price may be undervalued

• Management felt that bad performance in apparel group is unduly dragging down Interco’s stock price.
• Because of this “undervaluation,” Interco’s management afraid may be a takeover target.

Action taken by Interco

Following 1987 crash, Interco’s board authorized repurchase of 5 million shares (by end of fiscal 1988 over 4 million shares had been repurchased – over 10% of the equity)

7/15/88 Interco announces reorganization plan

–sell the apparel division that is dragging down rest of company
–take the money raised from this sale and return it to shareholders (via special dividend or repurchase)

Raise of new problem
Rales Brothers: they buy undervalued companies with strong brand-names

• City Capital (formed by Rales) has Interco in it sights
• Thinks currently that the sum of Interco’s parts exceeds Interco’s current stock price
• Plans to sell apparel division and also sell part of footwear division, focus on home furnishing

Offer for takeover

• City Capital has accumulated 8.7% of Interco’s stock
• Ups the ante on 7/27/88: City Capital proposes a merger/takeover of Interco and offers to buy Interco’s stock for $64 per share (price was $44.75 on 6/30/88)
• Morning of 8/8/88:Offer raised to $70 per share
• Offer is timed well – Interco happens to have a Board meeting scheduled for 8/8/88.
• Board wants their financial advisor, Wasserstein, Perella, & Co. to evaluate City Capital’s offer.

Solution:

WACC calculation:

discount rate for Interco’s free cash flows:

10-year Treasury bond returns 9%
10-year AAA bond returns 9.5%

Long-term Growth Rate Given multiple applied and discount rate assumed, can back out the implied long-term growth rate of free-cash flow. Way to check if value obtained using market data of competitors can be justified by DCF analysis.

Value of firm10 = FCF11 / (r - g) = FCF10 * (1+g) / (r - g)

Value of firm10 = 14*FCF10 (by assumption)

=> 14 = (1+g) / (r - g)

r = .10 => g = .027

r = .11 => g = .036

r = .12 => g = .045

r = .13 => g = .055

r = .14 => g = .064

Stock price at various discount rates

Discount rate	14 times	15 times	16 times
10.00%	$80	$84	$87
11.00%	74	77	81
12.00%	69	72	74
13.00%	64	66	69
14.00%	59	61	64

End of Interco

• •8/22/88 Wasserstein, Perella adjust valuation range to $74-87 •
• 9/10/88 City Capital raises offer to $72 per share •
• 9/19/88 Board adopts restructuring plan and rejects $72 offer •
• 10/17/88 City Capital raises offer to $74 •
• 10/19/88 Board declares large dividend financed by debt (and anticipation of proceeds from selling off divisions), rejects $74 offer •
• 11/16/88 City Capital $74 offer expires, Interco stock price falls closing at $63.375 •
• 11/16/88 group of shareholders file lawsuit against Interco and its Board in connection with Interco’s avoidance of the hostile tender offer by City Capital (breach of fiduciary responsibility) •Under 11/88 restructuring, Interco to pay $1.42 billion cash dividend
• Earnings were less than forecast during 1989-1990
• Proceeds from asset sales less than anticipated
• Spring of 1990, Interco pays $18.5 million to settle the shareholder lawsuit
• Spring of 1990, Interco begins to work with creditors to restructure its debt
• 6/15/90 Interco defaulted on bond payments
• 1/24/91 Interco filed for bankruptcy and sued Wasserstein, Perella, & Co. for negligence

Interesting side note (footnote 2 of the case): Wasserstein, Perella, & Co. get $1.8 million from Interco for its advice/services, however get a $3.7 million bonus if City Capital rescinded their offer to buy Interco and Interco then put in place its own restructuring plan.

Short notes on Option contract

Option contract

Options Contract is a type of Derivatives Contract which gives the buyer/holder of the contract the right (but not the obligation) to buy/sell the underlying asset at a predetermined price within or at end of a specified period. The buyer / holder of the option purchases the right from the seller/writer for a consideration which is called the premium. The seller/writer of an option is obligated to settle the option as per the terms of the contract when the buyer/holder exercises his right. The underlying asset could include securities, an index of prices of securities etc.

Under Securities Contracts (Regulations) Act,1956 options on securities has been defined as "option in securities" means a contract for the purchase or sale of a right to buy or sell, or a right to buy and sell, securities in future, and includes a teji, a mandi, a teji mandi, a galli, a put, a call or a put and call in securities;An Option to buy is called Call option and option to sell is called Put option. Further, if an option that is exercisable on or before the expiry date is called American option and one that is exercisable only on expiry date, is called European option. The price at which the option is to be exercised is called Strike price or Exercise price.

Therefore, in the case of American options the buyer has the right to exercise the option at anytime on or before the expiry date. This request for exercise is submitted to the Exchange, which randomly assigns the exercise request to the sellers of the options, who are obligated to settle the terms of the contract within a specified time frame.

As in the case of futures contracts, option contracts can be also be settled by delivery of the underlying asset or cash. However, unlike futures cash settlement in option contract entails paying/receiving the difference between the strike price/exercise price and the price of the underlying asset either at the time of expiry of the contract or at the time of exercise / assignment of the option contract.

OPTIONS NOMENCLATURE


OPTION HOLDER; OPTION WRITER


The option holder is the person who buys the right conveyed by the option.

EXAMPLE: The holder of a physical delivery XYZ call option has the right to purchase shares of XYZ Corporation stock at the specified exercise price upon exercise prior to the expiration of the option. The holder of a physical delivery XYZ put option has the right to sell shares of XYZ Corporation at the specified exercise price upon exercise prior to the expiration of the option. The holder of a cash-settled option has the right to receive an amount of cash equal to the cash settlement amount (described below) upon exercise prior to the expiration of the option.

The option writer is obligated, if and when assigned an exercise to perform according to the terms of the option. The option writer is sometimes referred to as the option seller. An option writer who has been assigned an exercise is known as an assigned writer.

EXAMPLE: If a physical delivery XYZ call option is exercised by the holder of the option, the assigned writer must deliver the required number of shares of XYZ common stock. He will be paid for the shares at the specified exercise price regardless of their current market price. If a physical delivery put option is exercised, the assigned writer must purchase the required number of shares at the specified exercise price regardless of their current market price. If a cash-settled option is exercised, the assigned writer must pay the cash settlement amount.

No certificates are issued to evidence options. Investors look to the confirmations and statements that they receive from their brokerage firms to confirm their positions as option holders or writers.

CASH SETTLEMENT AMOUNT, SETTLEMENT CURRENCY and EXERCISE
SETTLEMENT VALUE

The cash settlement amount is the amount of cash that the holder of a cash-settled option is entitled to receive upon exercise. It is the amount by which the exercise settlement value of the underlying interest of a cash-settled call exceeds the exercise price, or the amount by which the exercise price of a cash-settled put exceeds the exercise settlement value of the underlying interest, multiplied by the multiplier for the option.

EXAMPLE: Assume that a holder of a cash-settled call on the XYZ index that has an exercise rice of 80 exercises it when the exercise settlement value of the index is 85. If the multiplier for XYZ index options is 100, the assigned writer would be obligated to pay, and the exercising holder would be entitled to receive, a cash settlement amount of $500 ($85 minus $80 multiplied by 100=$500).

The currency in which the cash settlement amount is payable is called the settlement currency. The settlement currency for all cash-settled options with standardized terms that are trading at the date of this booklet is U.S. dollars. It is possible that another currency will be the settlement currency for some options introduced in the future.

The manner of determining the exercise settlement value for a particular option series is fixed by the options market on which the series is traded. The exercise settlement values for options on a particular underlying interest traded in one options market will not necessarily be determined in the same manner as the exercise settlement values for options or futures on the same underlying interest that may be traded in other markets.

Options markets may change the method of determining exercise settlement values for particular options series on specified days or on all days. These changes may be made applicable to series outstanding at the time the changes become effective. Alternatively, an options market might phase in a change in the method of determining exercise settlement values by opening new series of options identical to outstanding series in all respects other than the method for calculating exercise settlement values. Such new series would trade alongside the old series until both series expire, but the two series would not be interchangeable. In the future, options markets may, subject to regulatory approval, introduce options whose exercise settlement values may not exceed a specified maximum amount.

ADJUSTMENT and ADJUSTMENT PANEL

Adjustments may be made to some of the standardized terms of outstanding options upon the occurrence of certain events. Adjustments that may be made to a particular type of options are discussed in the chapter relating to that type. The determination of whether to adjust outstanding options in response to a particular event, and, if so, what the adjustment should be, is made by a majority vote of an adjustment panel. Every determination by an adjustment panel is within its sole discretion and is binding on all investors.

PREMIUM

The premium is the price that the holder of an option pays and the writer of an option receives for the rights conveyed by the option. It is the price set by the holder and writer, or their brokers, in a transaction in an options market where the option is traded. It is not a standardized term of the option. The premium does not constitute a "down-payment." It is simply and entirely a non-refundable payment in full-from the option holder to the option writer-for the rights conveyed by the option. The premium is not fixed by the options markets. Premiums are subject to continuous change in response to market and economic forces, including changes in the trading conditions on the markets where the particular options are traded. The factors which may generally affect the pricing of an option include such variables as the current value of the underlying interest and the relationship between that value and the exercise price, the current values of related interests (e.g., futures on the underlying interest or other interests related to the underlying interest), the style of the option, the individual estimates of market participants of the future volatility of the underlying interest, the historical volatility of the underlying interest, the amount of time remaining until expiration, cash dividends payable on the underlying stock (in the case of stock and stock index options), current interest rates, current currency exchange rates (in the cases of foreign currency options and options whose premiums or cash settlement amounts are payable in a foreign currency), the depth of the market for the option, the effect of supply and demand in the options market as well as in the markets for the underlying interest and for related interests, the information then available about current prices and operations in the markets for the underlying interest and related interests, the individual estimates of market participants of future developments that might affect any of the foregoing, and other factors generally affecting the prices or volatility of options, underlying interests, related interests or securities generally. Also see the discussion below of "Intrinsic Value and Time Value." Readers should not assume that options premiums will necessarily conform or correlate with any theoretical options pricing formula, chart, last sale, or the prices of the underlying interest, related interests or other options at any particular time.

The currency in which the premium is payable is called the premium currency. The premium currency for most options is U.S. dollars. However, the premium currency for cross-rate foreign currency options is a foreign currency, and other options with premiums payable in a foreign

currency may be introduced after the date of this booklet.

OPENING TRANSACTION

This is a purchase or sale transaction by which a person establishes or increases a position as either the holder or the writer of an option.

CLOSING TRANSACTION

This is a transaction in which, at some point prior to expiration, the option holder makes an offsetting sale of an identical option, or the option writer makes an offsetting purchase of an identical option. A closing transaction in an option reduces or cancels out an investor's previous position as the holder or the writer of that option.

EXAMPLE: In June an investor buys a December XYZ 50 call at an aggregate premium of $500. By September the market price of the option has increased to $700. To seek to realize his $200 profit, the investor can direct his broker to sell an offsetting December XYZ 50 call in a closing transaction. On the other hand, if by September the market price of the option has decreased to $300, the investor might still decide to sell the option in a closing transaction, thereby limiting his loss to $200.

POSITION LIMITS

The rules of the options markets generally limit the maximum number of options on the same side of the market (i.e., calls held plus puts written, or puts held plus calls written) with respect to a single underlying interest that may be carried in the accounts of a single investor or group of investors acting in concert. These limits which are called position limits-differ for options on different underlying interests. Information concerning the position limits for particular options is available from the options market on which those options are traded or from brokerage firms.

COMBINATIONS; SPREADS and STRADDLES

Combination positions are positions in more than one option at the same time. Spreads and straddles are two types of combination positions. A spread involves being both the buyer and writer of the same type of option (puts or calls) on the same underlying interest, with the options having different exercise prices and/or expiration dates. A straddle consists of purchasing or writing both a put and a call on the same underlying interest, with the options having the same exercise price and expiration date.

LONG and SHORT

The word long refers to a person's position as the holder of an option, and the word short refers to a person's position as the writer of an option.

COVERED CALL WRITER

If the writer of a physical delivery call option owns or acquires the amount of the underlying interest that is deliverable upon exercise of the call, he is said to be a covered call writer

EXAMPLE: An individual owns 100 shares of XYZ common stock. If he writes one physical delivery XYZ call option-giving the call holder the right to purchase 100 shares of the stock at a specified exercise price-this would be a covered call. If he writes two such XYZ calls, one would be covered and one would be uncovered.

The distinction between covered and uncovered call writing positions is important since uncovered call writing can involve substantially greater exposure to risk than covered call writing. A call option writer who is not a covered writer may hold another option in a spread position and thereby offset some or all of the risk of the option he has written. However, the spread may not offset all of the risk of the uncovered writing position. For example, if the long portion of the spread has a higher exercise price than the exercise price of the short, or if the long has an earlier expiration date than the expiration date of the short, then the writer may still be exposed to significant risks from his uncovered writing position.

AT THE MONEY

This term means that the current market value of the underlying interest is the same as the exercise price of the option.

IN THE MONEY

A call option is said to be in the money if the current market value of the underlying interest is above the exercise price of the option. A put option is said to be in the money if the current market value of the underlying interest is below the exercise price of the option.

EXAMPLE: If the current market price of XYZ stock is $43, an XYZ 40 call would be in the money by $3.

OUT OF THE MONEY

If the exercise price of a call is above the current market value of the underlying interest, or if the exercise price of a put is below the current market value of the underlying interest, the option is said to be out of the money by that amount.

EXAMPLE: With the current market price of XYZ stock at $40, a call with an exercise price of $45 would be out of the money by $5 as would a put with an exercise price of $35.

INTRINSIC VALUE and TIME VALUE

It is sometimes useful to consider the premium of an option as consisting of two components: intrinsic value and time value. Intrinsic value reflects the amount, if any, by which an option is in the money. Time value is whatever the premium of the option is in addition to its intrinsic value. An American-style option may ordinarily be expected to trade for no less than its intrinsic value prior to its expiration, although occasionally an American-style option will trade at less than

its intrinsic value. Because European-style and capped options are not exercisable at all times, they are more likely than American-style options to trade at less than their intrinsic value when they are not exercisable.

EXAMPLE OF A CALL WITH INTRINSIC VALUE: At a time when the current market price of XYZ stock is $46 a share, an XYZ 40 call would have an intrinsic value of $6 a share. If the market price of the stock were to decline to $44, the intrinsic value of the call would be only $4. Should the price of the stock drop to $40 or below, the call would no longer have any intrinsic value.

EXAMPLE OF A PUT WITH INTRINSIC VALUE: At a time when the current market price of XYZ stock is $46 a share, an XYZ 50 put would have an intrinsic value of $4 a share. Were the market price of XYZ stock to increase to $50 or above, the put would no longer have any intrinsic value.

EXAMPLE OF TIME VALUE: At a time when the market price of XYZ stock is $40 a share, an XYZ 40 call may have a current market price of, say, $2 a share. This is entirely time value.

An option with intrinsic value may often have some time value as well-that is, the market price of the option may be greater than its intrinsic value. This could occur with an option of any style.

EXAMPLE: With the market price of XYZ stock at $45 a share, an XYZ 40 call may have a current market price of $6 a share, reflecting an intrinsic value of $5 a share and a time value of $1 a share.

An option's time value is influenced by several factors (as discussed above under "Premium"), including the length of time remaining until expiration. An option is a "wasting" asset; if it is not sold or exercised prior to its expiration, it will become worthless. As a consequence, all else remaining the same, the time value of an option usually decreases as the option approaches expiration, and this decrease accelerates as the time to expiration shortens. However, there may be occasions when the market price of an option may be lower than the market price of another

option that has less time remaining to expiration but that is similar in all other respects.

An American-style option's time value is also influenced by the amount the option is in the money or out of the money. An option normally has very little time value if it is substantially in the money. Although an option that is substantially out of the money has only time value, the amount of that time value is normally less than the time value of an option having the same underlying interest and expiration that is at the money.

Another factor influencing the time value of an option is the volatility of the underlying interest. All else being the same, options on more volatile interests command higher premiums than options on less volatile interests.

Time value is also influenced by the current cost of money. Increases in prevailing interest rates tend to cause higher premiums for calls and lower premiums for puts, and decreases in prevailing interest rates tend to cause lower premiums for calls and higher premiums for puts.

The following is a description of the terminology applicable to capped options:

CAP INTERVAL

The cap interval is a constant established by the options market on which a series of capped options is traded. The exercise price for a capped-style option plus the cap interval (in the case of a call) or minus the cap interval (in the case of a put), equals the cap price for the option. For example, if a capped call option with an exercise price of 360 has a cap interval of 30, then the cap price at which the option will be automatically exercised would be 390.

CAP PRICE

The cap price is the level that the automatic exercise value of a capped option must reach in order for the option to be automatically exercised. The cap price of a call option is above, and of a put option below, the exercise price of the option.

EXAMPLE: A 360 ABC capped call index option has an exercise price of 360 and a cap interval of 30. The call option has a cap price of 390.

EXAMPLE: A 310 XYZ capped put index option has an exercise price of 310 and a cap interval of 20. The put option has a cap price of 290.

AUTOMATIC EXERCISE VALUE

The automatic exercise value of a capped option is the price or level of the underlying interest determined in a manner fixed by the options market on which the option is traded for each trading day as of a specified time of that day.

EXAMPLE: A 310 XYZ capped put index option has a cap interval of 20, and therefore has a cap price of 290. Assume that the options market on which the option is traded has specified the close of trading on each trading day as the time for determining the automatic exercise value on the XYZ index, and that the index level reaches a low of 289 during a particular trading day, but is at 291 at the close. The automatic exercise value has not reached the cap price, and the automatic exercise feature of the option is not triggered, because the index level was not at or below the cap price at the time of day specified by the options market for determining the automatic exercise value.

CASH SETTLEMENT AMOUNT

This is the cash amount that the holder of a cash-settled capped option is entitled to receive upon the exercise of the option. In the case of a capped option that has been automatically exercised, the cash settlement amount is equal to the cap interval times the multiplier for the option, even if the automatic exercise value on the day that the automatic exercise feature is triggered exceeds (in the case of a call) or is less than (in the case of a put) the cap price. If the capped option is voluntarily exercised at expiration, the cash settlement amount is determined in the same manner as for other styles of cash settled options.

EXAMPLE: A 360 ABC capped call index option has a cap interval of 30 and a multiplier of 100. The automatic exercise value of the ABC index is 396 on a particular trading day. The call option is automatically exercised, and the cash settlement amount is $3000 (equal to the cap interval of 30 times the multiplier of 100).

EXAMPLE: A 360 ABC capped call index option has a cap interval of 30 and a multiplier of 100. The automatic exercise value of the ABC index never equals or exceeds the cap price of 390 during the life of the option, and the exercise settlement value of the option is 367 on the final trading day. Upon exercise of the option, the holder is entitled to receive a cash settlement amount of $700 (equal to the multiplier of 100 times the difference between the exercise settlement value of 367 and the exercise price of 360).

CPFR: Supply chain redefined

Introduction to CPFR

A highly recognized collaboration initiative used in the retail industry is Collaborative Planning, Forecasting, and Replenishment (CPFR). CPFR’s underlying premise is that broad integration of firms within the supply chain will lead to a better focus on customers through the development of a single shared forecast of demand and a reduction of lead times. The benefits resulting from a successful application of CPFR include reductions in stock-outs, improved inventory management, shorter cycle times, increases in sales revenues, stronger relationships between trading partners, better overall system visibility and customer service, and improved cost structures.

CPFR originated in 1995 as an initiative co-led by Wal-Mart and consulting firm Benchmarking Partners. With assistance from Benchmarking Partners and IT firms such as IBM, SAP, i2, and Manugistics, Wal-Mart and Warner-Lambert implemented the first pilot of CFAR to increase sales, reduce inventory, and improve the in-stock position of Listerine, the project’s pilot product.Since this project, CPFR has evolved and is a strategic initiative implemented by many companies throughout North America and Europe.

In 2003, it was estimated that in the United States alone, more than $15 billion in the supply chain is managed by CPFR. VICS created guidelines for CPFR in 1998. Since the development and publication of these guidelines, over 300 companies have successfully implemented CPFR. The implementation of CPFR has also extended to industry sectors beyond retail, including high-tech industries. Rosettanet, a non-profit consortium of high-tech firms, has developed a collaborative forecasting standard for applying CPFR practices to that industry. Today, the VICS CPFR Committee works “to develop business guidelines and roadmaps for various collaborative scenarios, which include upstream suppliers, suppliers of finished goods and retailers, which integrate demand and supply planning and execution.

According to the Gartner Group, “Enterprises that collaboratively integrate disparate forecasting systems…will improve revenue predictability by 10 to 25 percent and decrease inventory carrying costs by more than 30 percent over a three-year period.”

Unfortunately, the dream of inter-firm collaboration leading to supply chain improvement has yet to be realized on a large-scale basis. According to the Voluntary Inter industry Commerce Solutions (VICS) Association, this lack of adoption is due to the following challenges: (1) selecting the right partners and products with which to implement CPFR, (2) establishing discipline for regular and periodic performance measurements, (3) committing to implement CPFR on a broad scale, (4) aligning corporate philosophies with CPFR philosophies and (5) managing organizational changes that may be required.

CPFR has been generally limited to collaboration between a retailer and only one major supplier, providing evidence that the broad integration of the CPFR initiative set out to achieve has been unrealized.

Predecessors to CPFR

There have been a number of widely known initiatives started with the goal of increasing collaboration and information sharing. It is also likely that countless initiatives have been undertaken within many companies with varying practices and mixed results. The following initiatives are fairly well known and are basis of CPFR.

Vendor-Managed Inventory (VMI), introduced by Kurt Solomon Associates in 1992 is perhaps the most widely known system for managing supply chains.Under VMI, the buyer authorizes the supplier (i.e., vendor) to manage the inventory of a set of stock-keeping units (SKUs) at the buyer's site(s) under agreed-upon parameters (e.g., minimum and maximum inventory targets). The buyer provides the supplier with sales and/or inventory-status information; and the supplier makes and implements decisions about replenishment quantities and timings. VMI reduces information distortion, which is one cause of the bull-whip effect. In addition, VMI provides the supplier with the opportunity to better manage its own production, inventory, and transportation costs. In exchange, the buyer typically receives price discounts or improved terms of payment from the supplier.

Efficient Consumer Response (ECR) is a consumer goods (primarily grocery) initiative aimed at improving responsiveness to consumer demand and reducing inefficient practices, costs, and waste in the supply chain. This is basically an application of JIT to retail distribution.The consumer products industry was in the midst of a fundamental shift in attitudes concerning traditional business practices among its participants, particularly as those practices relate to trade promotions and replenishment of products across the supply chain. Contributing to this shift were significant advancements in information technology, growing competition, and global business structures, and changes in consumer demand. This shift in attitude crystallized in the formation of an industry-wide working group and the issuance of a report in late 1992 that set the stage for what has come to be known as the Efficient Consumer Response (ECR).

Quick Response (QR) or Rapid Response comes primarily from the fashion and textiles industry. It was innovated by Milliken & Company in the early 1990's and subsequently codified by VICS,the same organization that oversees the codification and standardization of CPFR practices. QR in the simplest sense is a next generation, codified version of ECR. Central to the initiative is flexible and responsive production that relies on customers along the supply chain to define when, where, and how much of a given product is needed. The initiative has four levels of application and technology. Levels 1 and 2, for example, involve retailer inventory-status information-sharing and automatic order-processing between retailer and supplier. Levels 3 and 4 include VMI and cross docking warehouses.

Although VMI and QR might be the best-known management systems among both practitioners and academics, perhaps the most highly regarded systems are proprietary systems developed by large retailers, such as Wal-Mart's RetailLink, Kmart's Workbench, and Target's Partners Online. Although the detailed inner workings of these systems are closely guarded secrets, they all have two common characteristics: (1) The sharing of transactions-level data among partners and (2) The use of agreed-upon metrics (e.g., in-stock, inventory-turnover, and on-time delivery measures) and targets to assess partner performance. Both characteristics are central to CPFR.

CPFR Model

The CPFR model offers a general framework by which a buyer and seller can use collaborative planning, forecasting, and replenishing processes in order to meet customer demand. To increase performance, the buyer and seller are involved in four collaboration activities that are listed in logical order, but companies often engage in these activities simultaneously.

The first collaboration activity is Strategy and Planning. In this activity, the buyer and seller come to an understanding about their relationship and establish product and event plans. The second activity is Demand and Supply Management in which customer demand and shipping requirements are forecasted. Execution is the third collaboration activity and involves placing, receiving, and paying for orders, and also preparing, delivering, and recording sales on shipments. The fourth and final activity is Analysis.

1. Strategy and Planning

The first collaboration task under this activity is Collaboration Arrangement, which is a method for defining the relationship in terms of establishing business goals, defining the scope, and assigning checkpoints and escalation procedures, roles, and responsibilities. The retailer task related to this collaboration task is Vendor Management, and the manufacturer task is Account Planning. The second collaboration task is Joint Business Plan. This task pinpoints the major actions that affect supply and demand in the planning period. Examples of these are introducing new products, store openings and closings, changing inventory policy, and promotions. The retailer task associated with this is Category Management and the manufacturer task is Market Planning.

2. Demand and Supply Management

Sales Forecasting, which projects point-of-sale consumer demand, is one of the collaboration tasks associated with this activity. The retailer task here is POS Forecasting and the manufacturer task is Market Data Analysis. The other collaboration task is Order Planning/Forecasting which uses factors such as transit lead times, sales forecast, and inventory positions to determine future product ordering and requirements for delivery. The associated retailer task is Replenishment Planning, and Demand Planning is the associated manufacturer task.

3. Execution

The first collaboration task under the Execution activity is Order Generation. This task transitions forecasts to demand for the firm. The retailer task related to this collaboration task is Buying/Re-buying, and the manufacturer task is Production and Supply. The second collaboration task is Order Fulfillment and this is the preparation of products for customer purchase through the process of producing, shipping, delivery, and stocking. In this case, both the retailer and manufacturer task is Logistics/Distribution.

4. Analysis

Exception Management, which oversees the planning and operations for conditions that are out-of-bounds, is one of the collaboration tasks associated with this activity. The retailer task is Store Execution and the manufacturer task is Execution Monitoring. The other collaboration task is Performance Assessment which calculates important metrics in order to discover trends, develop other strategies, and assess the attainment of business goals. The retailer task here is Supplier Scorecard and the manufacturer task is Customer Scorecard.

The model described here is a two-tiered model. However, this model can be extended to include more than two layers in the supply chain. VICS calls this N-tier Collaboration, which is a relationship that develops from retailers through manufacturers/distributors to suppliers.

Drivers & Barriers of CPFR Implementation

Trust between supply chain partners

“Retailers and manufacturers believe there is a fundamental lack of trust between trading partners that stymies collaboration.” Should a partner leak price points, strategy, or tactics to a competitor, the effectiveness of promotions would surely be undermined. However, the collaborative opportunity will not likely be met with conspirators looking to take advantage of trusting partnerships.

Measuring value and financial results

Wary of making big investments and seeing little or no returns, some companies don’t see CPFR as an imperative for their enterprise right now. They feel there is no guarantee that they will see the financial results necessary to get company-wide buy-in.

Insufficient organization/ process enablement

CPFR’s process intensive nature and the need to synchronize changes between participants make internal cultures, organization, and processes important to the success of the collaboration.