It was early June 2010, and two months had passed since Heather Larson had been granted exclusive Canadian distribution rights to the Nutrifusion product. She had been very busy trying to develop the best strategy for this exciting new product. Nutrifusion had been sold successfully in the United States, and Larson believed it had the potential to earn strong profits and to provide her with a new career; however, as with any new venture, inherent risks were involved. Larson, in partnership with her father, Jeff Larson, was contemplating the launching of Healthy Life Group (HLG) to market Nutrifusion throughout Canada. The partners wanted to evaluate the product's financial feasibility before deciding whether to proceed with the opportunity. If they did decide to proceed, HLG would incorporate and begin operations on January 1, 2011.

NUTRIFUSION

Nutrifusion was an intriguing new product in the health-food industry. A patented production process used select parts of the fruits and vegetables, namely the stem and core, and protected micronutrients1 and phytochemicals2 to retain 99.7 per cent of their nutritional value. The end result was a tasteless powder that could be added to baked goods or to liquids to provide additional servings3 of fruits and vegetables, thereby significantly increasing the food's nutritional value. Nutrifusion also had the benefits of high levels of antioxidants, was an excellent source of plant-derived vitamins A and C, was 100 per cent natural, and had a shelf life of 36 months. See Exhibit 1 for a comparison of the nutritional value of normal tortilla chips and tortilla chips made with Nutrifusion.

HEALTHY LIFE GROUP

The Partners

Heather Larson was a fourth-year student at The University of Western Ontario. She was working towards a bachelor's degree in management and organizational studies, with a double major in sociology. Larson had spent the previous summer working as an assistant product manager at Loblaws in the dairy, snack and beverage department. She had been exposed to entrepreneurial activities most of her life since her father had founded and owned several companies. Upon graduation, Larson hoped to have a full-time job in a venture that would allow her to start up her own company.

Larson's father, Jeff Larson, was eager to support his daughter with her business venture. He offered an array of experience in the retail food industry, including a valuable network of contacts. In 1994, Jeff Larson co-founded Concepts Food and also worked for Cott Corporation. While at Cott, he worked closely with Dave Nichol, the long-time president of Loblaws who launched the "President's Choice" label. The pair was involved in the management buy-out of Destination Products, a division of Cott Corporation. Currently, Jeff Larson (no longer working for Cott Corporation) owned Innovative Food Group, a company that specialized in private-label sales and marketing.

Objectives

Larson and her father hoped HLG could earn a profit of $50,000 in its first year of operations, with plans to grow profits by 20 per cent each subsequent year. This growth could be achieved by broadening the product line and expanding into additional stores. Another of HLG's goals was to help society move towards a healthier lifestyle: the Nutrifusion product would allow Canadians to improve their diets and overall health by supplying servings of fruits and vegetables in products like bagels, chips and cookies, which may otherwise be considered junk food.

Investment

In order to start the business Larson and her father planned to invest $25,000 each, and, in return, each would receive 1,000 common shares. The largest portion of this capital investment would be used to obtain the Canadian patent on the Nutrifusion production process. The company's law firm, Stikeman Elliot LLP, estimated the drafting of this patent would cost $10,000, and the cost to prosecute the patent into issuance would be $12,000.4 HLG would also incur fees, estimated to total $8,000, to incorporate the business, obtain a master business licence and complete name registration. These start-up costs would be expensed in HLG's first fiscal year.

THE FOOD INDUSTRY

Food sales of Canadian supermarkets and convenience stores surpassed $75,727 million in 2007. The Province of Ontario represented 33.5 per cent of the total sales. The grocery industry typically averaged a net profit margin of six per cent. Canadians had readily supported the movement towards healthier lifestyles, as reflected in an increased demand for organic and healthy foods, as well as vitamins and supplements, over the past five years; however, these nutritional products were often more expensive than

alternative food choices. Industry studies reported that high-income households most often met the recommended minimum fruit and vegetable intake; however, lower-income families and "on-the-go" individuals were less likely to consistently eat organic produce. Larson completed a survey of grocery shoppers, and her results showed a desire for higher nutritional value in bread products and snack foods. A recent study revealed that 75 per cent of U.S. residents failed to consume the minimum recommended intake of five servings of fruits and vegetables each day.5

In 2009, Canada was in the midst of an economic recession. In particular, Southwestern Ontario, a major automotive manufacturing centre, was hard hit, a circumstance that forced Canadian consumers to reduce their spending and to become more price-conscious. As a result, many Canadians eliminated non-staple items from their grocery lists, such as vitamins, supplements, and organic fruits and vegetables. Although the economy showed signs of improvement in 2010, economists predicted that Canadian consumers would remain price-conscious for some time.

All products sold in the food industry were subject to approval from the Canadian Food Inspection Agency (CFIA). Before distribution occurred, companies had to submit nutritional and production information to CFIA for evaluation, a process that could take up to two years to be completed

THE COMPETITION

Nutrifusion had no direct competition in Canada. It was the only product of its kind that offered full servings of fruits and vegetables in the form of a tasteless powder that retained micronutrients and phytochemicals. Furthermore, HLG had been granted exclusive distribution rights to the Nutrifusion product for Canada. To ensure that other companies could not duplicate this product in Canada, HLG planned to obtain a patent for the ingredients, the technology and the process used to break down fruits and vegetables into the powder.

There was plenty of indirect competition facing both HLG and Nutrifusion. Consumers could readily purchase servings of fruits and vegetables and consume them on their own or use them as ingredients in various dishes; however, for the nutritional value offered by Nutrifusion, consumers would need to purchase organic fruits and vegetables for consumption. Alternatively, consumers could choose to forgo the fresh fruit and vegetable servings, instead opting to improve their diets through vitamins and supplements, which were widely marketed to provide similar benefits. Varieties of these products existed and were easily available throughout grocery stores, drug stores and nutritional supplement specialty stores, which were growing in popularity.

Another form of indirect competition existed. If HLG chose to infuse products such as potato chips, cookies and bagels with Nutrifusion powder, it also had to convince consumers to purchase the company's new line of these three items: potato chips, cookies and bagels. Consequently, all other brands of potato chips, cookies and bagels would become HLG's competition. Because of their high fibre content, items such as multigrain and whole-wheat bagels had historically represented healthy-choice items to consumers, but they did not provide any fruit or vegetable servings. For potato chips, the closest competition likely came from kettle chips that were marketed as containing 65 per cent less fat than regular potato chips. Whichever product HLG chose, many competitive products existed, some made by large international companies. Corporations such as Lays and Nabisco had the resources and ability to market their snack foods as "healthy" based on a variety of parameters, and they often had eye-catching advertisements to attract buyers.

DISTRIBUTION PLANS

After evaluating several distribution alternatives, Larson believed a strategic alliance with Loblaws Companies (Loblaws) would be most lucrative. Loblaws showed strong interest in the Nutrifusion product and was willing to work closely with HLG since it had exclusive distribution rights to the product. The agreement would use Nutrifusion in the production of several President's Choice products. President's Choice was Loblaws' own private label brand and was distributed in over 1,700 stores throughout the provinces of Ontario and Quebec. President's Choice offered a variety of grocery products, which were marketed as equal quality to brand name merchandise but at a lower price.

In its first year, HLG planned on infusing President's Choice cookies, bagels and potato chips with Nutrifusion powder to improve the products' nutritional values. Both Loblaws and HLG were excited to see the sales results of these test products and would consider adding Nutrifusion powder to more products if the test's sales results were successful.

PROJECTED SALES AND COSTS

Sales

In its first year of operations, all HLG sales would be made to Loblaws on credit. HLG agreed to offer Loblaws credit terms of net 60. Loblaws would purchase quantities of Nutrifusion powder for use in its production of cookies, bagels and potato chips. Although there was no guarantee of sales volumes, Loblaws and HLG estimated first-year sales based on a combination of U.S. data and Loblaws' experience in launching new products. Together, the companies estimated that first-year sales would be 36,500 packages of the Nutrifusion cookies, 50,000 bagels and 28,000 bags of potato chips. Loblaws production requirements called for 10 grams of Nutrifusion for each package of cookies and potato chips and five grams of Nutrifusion for each bagel. HLG would sell the Nutrifusion powder in bulk to Loblaws at $19.99 per 100-gram package.

Costs

HLG purchased the Nutrifusion powder from its American distributor on account, and the American supplier extended credit terms of net 30. The powder cost amounted to 30 per cent of HLG's sales to Loblaws. HLG also planned to maintain a 15-day inventory of Nutrifusion powder at all times.

HLG planned to rent office space in close proximity to the Loblaws headquarters, in Toronto, Ontario, in order to facilitate distribution. Office rent would be $990 a month for a three-year term and required immediate payment of both first and last months' rent. The office space needed some furnishings and fixtures, such as desks, chairs, tables and additional lighting, so Larson budgeted $5,000 for these items. The furniture and fixtures would be depreciated using the straight-line method and had an estimated useful life of five years with no residual value. Another $4,500 would be spent on computer equipment, which would be depreciated using the double declining balance method over an estimated useful life of four years, assuming a residual value of $500.

Other anticipated annual costs are listed in Exhibit 2. All costs in Exhibit 2 would be paid in full by fiscal year-end. Any income taxes owing would have to be paid two months after the fiscal year ended, i.e., December 31.6

Larson would work full-time for HLG as its only employee, while her father pursued another business opportunity. Larson projected a $40,000 salary for herself in HLG's first year of operations. Larson and her father were also interested in receiving dividends from HLG, but they thought it would be wise to wait until after the first year of operations to see whether the business had sufficient cash and retained earnings to pay any dividends.

CONCLUSION

The partners were excited about securing the exclusive Canadian distribution rights for Nutrifusion. Before making a decision to pursue the venture, they had to assess the attractiveness of Nutrifusion to the industry, the idea's overall feasibility and the financial viability of their arrangement with Loblaws. Heather Larson wanted to project an income statement and a balance sheet for the year ending December 31, 2011, to see whether HLG could generate the profit targeted by the Larsons and, if so, whether it could pay dividends. She also wondered whether Loblaws was too optimistic in its sales projections, so she wanted to determine what effect a 20 per cent decrease in Loblaws' original sales estimate would have on HLG's projected statements. Projections and profitability aside, would the Larsons' decision to distribute solely through Loblaws foster or inhibit future growth? Taking these questions into consideration, Larson hoped to make a decision quickly on whether to launch HLG so she could either begin the process of incorporating the business or move on to another new business idea.

Assignment:

What are the advantages and disadvantages to the proposed distribution strategy?

Read: 1. A NOTE ON FINANCING ALTERNATIVES (First Term Casebook)

2. FINANCIAL PLANNING—PROJECTED FINANCIAL STATEMENTS (Casebook)

Topic Slides: FINANCING ALTERNATIVES, PROJECTED FINANCIAL STATEMENTS (OWL)

Answer rating: 100% (QA)

The advantages to the proposed distribution strategy are that HLG will have exclusive Canadian dis... View the full answer