Statement of the Problem
1. Mueller-Lehmkuhl GmbH (MLG) is a major producer of apparel fasteners. It has corned the European market with its 17% average market share and is operating in nine European countries among others. It also has stretched its markets as far as Africa, as a result of joint-venturing with the German subsidiary of a large American company called Atlas.
2. The European market for apparel fasteners is sizeable. In 1986, the estimated sales value of the apparel fastener industry exceeds half a billion US$. Given that the market operates in a seemingly oligopolistic manner, with non-financial barriers to entry, and a growth rate of only 1% projected over the next years, entry into the market seems to be precarious.
3. To protect its market share, MLG sees its business as an integrated fastener-attaching machine model. It produces the apparel fastners and the attaching machines needed to use the fasteners. It either sells or leases out these machines and provides close customer service, free of cost.
4. The entry of Hiroto Industries (HI) threatens the business of MGL. HI is a large Japanese competitor, having significant size advantage in its home base and wants to pursue a 25% share of its business in Europe. It gained entry into the European market by offering the same high quality fasteners but at a price that’s lower by 20%. Both price and quality issues have become pending concerns for MGL. How could MGL, retain its profitability, market share and level of quality and service in the face of competition that has changed the way business is done?
1. Mueller-Lehmkuhl GmbH (MLG) produces apparel fasteners and sits comfortably in a mature European market. The barriers to entry to the industry are subjective; customers and suppliers have long-standing business relationships, so much so that the company MLG has included the production, sales or rental of attaching machines as part of its business model and has provided free maintenance services for clients.
2. A Japanese market has successfully entered the market, gaining a 7.2% hold in the US$ 551 million industry. It has done so by under-pricing competitors by 20% and has successfully maneuvered the restrictions imposed by MGL and other suppliers through the exclusive use of its attaching machines.
3. For MGL to compete, it must change its business strategy. It now must disenfranchise the segment of the business that produces and maintains attaching machines to become competitive with HI. Doing so decreases unit costs and increases both net income and gross margins.
4. Selling the fasteners, unburdened with the additional costs incurred from the production and servicing of the attaching machines makes MGL competitive even at HI’s prices (20% less than the original MGL price).
5. MGL will maximize profit and retain if not expand market share if it implements this business strategy and continue cultivating the bonds it has made with its clients.
Mueller-Lehmkuhl GmbH (MLG) is a major producer of apparel fasteners. The company president, Richard Welkers believes that the recent joint venture with Atlas has given MLG competitive advantage. This statement, originally presented as the case header, must be taken into perspective.
MLG originally enjoyed a highly secured position in the US$551 million fashion apparel fastener industry. It had 17% of the market cornered, the biggest player but closely followed by several others who are similar in size and reach. As a matter of fact, the market has been inhabited by these businesses for so long, that the biggest barrier to entry is the long-standing relationship of customers and suppliers.
MLG believes that an integrated approach is the best business model. Of its 4-storey building, it devotes one floor for producing the attaching machines and three floors for the production of fasteners. The cost accounting system is now based on batch costing, consistent with modern cost allocating procedures. The current cost structure of the company is shown in Table 1 below.
The entry of HI into the market, selling products at a 20% discount has disrupted MLG. What could HI hope to achieve by taking a losing position in terms of price and believe to survive? However, HI seems to have found a solution, gaining a 7.2% market share in 1986, or approximately $40 million in sales.
HI has captured ground by treating the business of producing fasteners separately from the business of producing attaching machines required to attach the fasteners. This new and innovative approach is something that MGL has not done before. MGL prides itself on the integration of the fasteners and the machines required to use them, turning this into a way of protecting its market share. In light of HI’s entry however, a re-examination of the cost structure of MGL using the same approach yields the following results.
The effect of modifying how business is done yields better financial performance as shown in the table below. Note that the if MGL were to continue selling all these products without the burden of selling attaching machines, it would generate an average 62% gross margin versus the original computed gross margin of 18%! Shown below are the net income and gross margin comparison between the two scenarios.
If MGL wishes to compete and retain its market share, as it would in reaction to the entry of HI into the market, it would change could reduce its selling prices by 20%, thereby matching HI and yield the following results.
Reducing prices does not affect the profitability of MGL. Intuitively, it also will not affect market share nor position. MGL will continue to lead if it adheres to the separation of its fastener business and production of attaching machines business. If it does so, net income will increase from 9.5 million to 35.6 million while gross margins will increase to 21% from 18%.