Case Study 1 - Suman Corporation

In mid-April, Mike Bradie, vice president of supply change management at Suman corporation, had become increasingly concerned about the potential shortage of supply Barac. a new high-tech raw material for air filtration. During the last two weeks, Suman's 3 suppliers add advice Mike to define long-term contracts and he was trying to assess the advisability of such commitments.

Suman

SumanCorporation of Pittsburgh PA, produced high-quality consumer and industrial air conditioning and heating units. An extensive network of independent and company-owned installation and sales centres serviced customers throughout the North American market. Company sales last year totalled $1 billion.

Air Filtration And Barac

for decades, Suman had sold air humidification and air filtration units along with its prime units in air heating and cooling. Until three years ago, air filtration had accounted for about 7% of total corporate sales and had been sold primarily as add-ons to new air cooling and heating systems. However, with the advent of Barac, air filtration has started to increase significantly as a percentage of sales. Barac, A new high-tech product developed as part of the US space effort had a range of unique properties of high interest to a variety of industries. In the case of air filtration, Suman developed and patented a process where Barac could be transformed into a thin, very light, and extremely fine, mesh-like sponge material capable I filtering extremely small particles. The manufacturing cost of a Barac filter amounted to about 28% of its selling price.

Given the population's sensitivity to air quality and the increasing number of people with asthma and allergies, the new Suman filters became popular, not only with new Suman air system installations but also as retrofits in older air conditioning and heating systems. Moreover, compared to electronic air cleaners, which costs about three times as much to install and required monthly cleaning, Barac Filters had to be replaced every six months, guaranteeing a continued sales volume of filters for years to come. When combined with an ultraviolet light unit, which killed airborne bacteria, a Barac air cleaning system was considered a huge leap forward in air treatment.

Air Filtration Sales

Along with the Barac filtration system introduction three years ago, Suman's marketing department had initiated a significant promotional campaign directed at both the industrial and consumer sectors. Marketing ability to forecast sales accurately had not been impressive, according to Mike. For the first year, marketing had forecasted Barac filter sales at $2 million when in reality they sold $13 million. In the second year, the forecast was for $18 million and actual sales was $35 million. In the third year, a forecast of $48 million turned into actual sales of $87 million. The marketing department expected sales growth to level off over the next three years to a rate of 20% per year.

Barac Supply

Suman's first BaracSupplier was Levy Chemical. a long-time supplier of paints and adhesives to Suman and a large diversified innovative chemical producer that held the pattern on Barac. Mike did not like the idea of a single sourcing, and therefore when Barac requirements rose significantly in the second year, he bought in a second supplier, Vasey Inc. which not only produced the Barac raw materials ( under license from Levy Chemicals ) but also manufactured a variety of Barac products in the textile and automobile fields. In the third year, Mike had secured a third supplier, T.R. Specialties, a much smaller company than Levy Chemical and Vasey Inc. which also produced Barac for its own applications in aerospace and the military, but had some excess capacity that it sold on the open market.

All three suppliers sold Barac at identical prices, which had increased over the past three years. Actual volumes purchased by Suman from each of the three suppliers were as shown in Exhibit 1. The current price of Barac from all three suppliers was $60.

Supplier Proposals For Long Term Contracts

During the first two weeks of April, Mike was visited by each of his current 3 Barac suppliers with Levy Chemicals first. Each one that a shortage of bark supply was looming in that unless Mike was willing to sign long-term contract, they would not be in a position to guarantee supply. However each proposal was different.

Levy Chemicalsproposed a 5 year contract that will take or pay commitments of 25,000 pounds for the current year at 20% annual increases in volume for each of the following years. Prices were subject to escalation for energy, raw materials, and labour every quarter based on the current $60 price per pound.

Vasey Inc.Proposed A2 year contract for 10,000 pounds each year with similar price provisions to those of Levy Chemicals.

T.R. Specialties suggested an agreement for 12.5% of Suman's annual requirements, which could be dropped at any time by either party and proposed a price of $68 for the current year, to be adjusted semi-annually thereafter, based on inflation, energy, labour and material.

Although Mike did not know much about the actual manufacturing process for Barac, he had heard that increases in capacity were expensive. He also understood that two of the three component raw materials for Barac were by-products from industrial processes that were reasonably stable.

Since Mike had been able to buy almost all of Suman's needs on quarterly, semi-annual or annual contracts he was not particularly keen on departing from his current supply practice. He had heard some rumours that a much lower-cost substitute for Barac might be developed in a few years. He suspected that his current suppliers were therefore anxious to tie Suman to a long-term commitment.

April 15^th

On April 15^th, Jessie Woods, the Levy Chemical sales representative, sentence an email to Mike requesting a meeting on April 22^nd. The e-mail concluded, "I would like to bring my sales manager, Rob Hares, so that we may discuss our proposal for the Barac with you. We will not be able to guarantee your supply after August 1^st, if you are unable to commit."

Exhibit 1 - Suman Barac Purchases and Prices

	Purchases ( in Pounds )
Company	Capacity ( in Pounds )	Year 1	Year 2	Year 3
Levy Chemical	80,000	5,000	10,000	20,000
Vasey Inc.	40,000	0	3,000	8,000
T.R. Specialties	20,000	0	0	4,000
Prices		$47.00	$50.00	$53.00

Table TN-1

Barac History and Projections

(In Millions of Dollars and Percentages)

Year	1	2	3	4	5	6	7	8
Marketing's Projections ($)	2	18	48	104	125	150	180	216
Marketing Growth Forecast (%)		28%	37%	20%	20%	20%	20%	20%
Actual Sales ($)	13	35	87
Growth Actual (%)	1,300%	170%	150%
Optimistic (%)				120%	100%	80%	60%	40%
Optimistic $				191	382	688	1,100	1,540
Pessimistic $				96	96	77	54	32
Pessimistic %				+10%	0	-20	-30	-40

Table TN-2

Historical Performance

	Year 1	Year 2	Year 3
Filter Sales	$13 million	$35 million	$87 million
Barac Purchases lbs.	5,000	13,000	32,000
Barac Purchases $	$235,000	$650,000	$1,686,000
Barac $ as % of sales	1.81%	1.86%	1.94%
Manufacturing Cost 28% of sales (given)	$3.64 million	$9.80 million	$24.36 million
$ Sales/lb. Barac	$2,600	$2,690	$2,720
Selling and Administrative (est. 25% of sales)	$3.25 million	$8.75 million	$21.75 million
Profit Before Tax	$6.11 million	$16.45 million	$40.89 million
Variable overhead (est.: 30% of SG&A)	$975,000	$2.625 million	$6.525 million
Contribution [sales - (mfg. + variable overhead)]	$8.4 million	$22.6 million	$56.1 million

Table TN-3

Marketing Forecast

	Year 4 (F)	Year 5 (F)	Year 6 (F)	Year 7 (F)	Year 8 (F)
Marketing forecast ($)	$104 mm	$125 mm	$150 mm	$180 mm	$216 mm
$ Sales/lb. Barac (est.)	$2,700	$2,700	$2,700	$2,700	$2,700
Barac Purchases lbs.	38,000	46,000	55,000	65,000	80,000
Barac Purchases $*	$2.5 mm	$3.3 mm	$4.3 mm	$5.5 mm	$7.2 mm
Manufacturing Cost (28%)	$29 mm	$35 mm	$42 mm	$50 mm	$60 mm
Selling and Administrative	$26.0 mm	$31.3 mm	$37.5 mm	$45.0 mm	$54.0 mm
Profit Before Tax	$49 mm	$59 mm	$71 mm	$85 mm	$102 mm
Variable overhead	$7.8 mm	$9.4 mm	$11.3 mm	$13.5 mm	$16.2 mm
Contribution	$67 mm	$81 mm	$97 mm	$116 mm	$139 mm

* $65 year 4; $72 year 5; $78 year 6; $84 year 7; $90 year 8

Table TN-4

Optimistic Forecast

	Year 4 (F)	Year 5 (F)	Year 6 (F)	Year 7 (F)	Year 8 (F)
Market forecast ($)	$191 mm	$382 mm	$688 mm	$1,100 mm	$1,540 mm
$ Sales/lb. Barac (est.)	$2,700	$2,700	$2,700	$2,700	$2,700
Barac Purchases lbs.	70,000	140,000	255,000	410,000	570,000
Barac Purchases $*	$4.6 mm	$10.2 mm	$20.0 mm	$34.2 mm	$51.3 mm
Manufacturing Cost (28%)	$54 mm	$107 mm	$193 mm	$308 mm	$431 mm
Selling and Administrative	$48 mm	$96 mm	$172 mm	$275 mm	$385 mm
Profit Before Tax	$90 mm	$180 mm	$323 mm	$517 mm	$724 mm
Variable overhead	$14.3 mm	$28.7 mm	$51.6 mm	$82.5 mm	$115.5 mm
Contribution	$123 mm	$246 mm	$ 444 mm	$710 mm	$993 mm

* $65 year 4; $72 year 5; $78 year 6; $84 year 7; $90 year 8

Questions - Case 1 - Suman Corporation 40 Marks

Answer Any 4 of the 5 of the following Questions. ( 10 Marks Each )

1. What is the price that a purchaser has to pay for procurement flexibility?

2. How can supply be guaranteed in a period of market shortages?

3. What should the criteria be for establishing long-term contracts?

4. What are the real risks of being without Barac for Suman?

5. Why are the suppliers interested in obtaining long-term contracts?