Ritedoors plc (RD) manufacture garage doors for domestic properties. It sells entirely to retailers on a business-to-business basis.

Company history

RD was established in 1994 and obtained a stock exchange listing in 2010. The directors own 20% of the ordinary share capital, with the other 80% being held by institutional investors.

From incorporation, RD produced reasonable quality, basic garage doors at relatively low cost. It did not aim to be the cheapest, but it did aim to offer best value to customers, selling garage doors at prices towards the lower end of the market. RD established a good reputation with end-consumers, who demand a reliable product at reasonable prices. This helped RD to stand-out from its rivals in an otherwise undifferentiated and crowded market place.

RD sells to retailers located throughout the UK. Around 12% of turnover comes from small shops which buy from RD only when they receive an order from a customer. The remaining turnover comes from two very large national retail chains. They carry high inventories of RD doors to allow immediate delivery to consumers. The two retailers are very cost conscious and demand the best possible prices from their suppliers, as they only achieve a small margin on their sales. The retailers often use the size of their orders as a bargaining tool in negotiations.

A cost reduction policy

In December 2019 a new chief executive, Gayle Rodrigo, was appointed by RD to increase profitability. After briefly reviewing the operations of the business, she decided on a cost reduction exercise, commencing in January 2020. This involved: reducing the quality of the materials used to make the garage doors; reducing staffing levels; replacing some staff at a lower skill level; freezing any unnecessary capital investment in machinery; and reducing maintenance. Strict performance management procedures were introduced to ensure that output volume was maintained, despite the changes.

The changes had a favourable effect on reported profit in the year ended 31 December 2020 (see Exhibit) but by May 2021 some problems were being reported. A board meeting was arranged to discuss these issues.

Board meeting

Gayle, the chief executive, explained the reasoning for her cost reduction plan. 'We have not yet developed a long-term strategy, but the cost reductions were immediately necessary just to make a profit.

We've had some quality problems lately, but the cost of correcting these faults is small in comparison with the cost savings we have made. I realise that the durability of the current products is questionable. Problems will increase after about 18 months of usage of the garage doors, and there may be serious problems after three years of usage. I have made sure, however, that this is not going to be too costly to RD, by reducing the guarantee period to customers from five years to two years. This means that by the time most doors start to develop serious faults after usage, they are out of guarantee and we have no obligation to repair them.

As a result, I have prepared a schedule (see Exhibit) which shows that we expect to make a profit in the year to 31 December 2021, whereas we made a loss in 2019, and the share price is higher now than then. This demonstrates that the strategy is working. This is a competitive market and we need to compete on low prices, so we must keep our costs low.'

The marketing director disagreed: 'This business model is not sustainable. The number of complaints from our customers is growing and our reputation is declining. One of the large retailers has given us a final warning about quality standards and is threatening to stop buying our products when its long-term agreement period with RD is completed. This cost reduction policy is just to improve short-term profits and share price. We should try to keep our customers happy in the longer term, so we must return to our previous policy of best value.'

The chairman joined the discussion: 'We need to balance the cost of rectifying faults with operating cost savings, but it's an increasingly competitive market. Personally, I doubt we can sustain our position as a manufacturer. One possibility is to close down our manufacturing facility and import garage doors from Malaysia at a cost (including transport) that is just below our expected operating cost per door for 2021. In effect, we would become an importer and wholesaler of garage doors. To do this cost effectively, we would need to order in large batches so we can fill a whole shipping container with each order, as there is a high fixed cost for transporting each container. I would like your views on whether we should consider this possibility further.'

An ethical issue

Ritedoors recently received an email from Nailfix Inc (Nailfix), a company located in nearby Eurasia, which is a developing nation. The following is an extract from that email:
'We would like to become your first export customer by placing a major order with RD However, in order to keep the price low, we would require a modification to your garage doors, which is the removal of the safety cut-off sensor system. Unlike the UK, it is not a legal requirement in Eurasia, so it is not necessary for us to have this feature.'

The safety cut-off sensor is a pressure sensing system that stops the closing mechanism of a garage door when an object is detected. This feature was made a legal requirement in the UK following a number of incidents involving both young children and pets in which serious injuries were suffered.

Exhibit

Years to 31 December	2019	2020	2021 (expected)
Revenue	£32m	£32m	£30m
Selling price to retailer per door	£400	£400	£400
Fixed operating costs	£15m	£14m	£14m
Operating profit/(loss)	£(1m)	£3m	£2m
Number of doors repaired under guarantee	8	24	96
Price per share	£2.10 at 31 Dec 2019	£4.50 at 31 Dec 2020	£3.20 at 31 May 2021

Question requirements on following page

Requirements

(a) On the basis of the information in the Exhibit, determine:

1. The expected variable cost per garage door for 2021; and

2. The break-even level of sales by volume for RD in the years ended 31 December 2019 and 31 December 2020.

Comment on the usefulness and implications of these calculations for the business.

(11 marks)

(b) In the context of Porter’s Five Forces discuss the Power of Customers for Ritedoors.

(7 marks)

(c) Evaluate the benefits and problems of each of the three strategies for RD that were discussed at the board meeting:

• Return to the original strategy of producing in the UK at low cost and selling at best value, as suggested by the marketing director;

• Continue with the cost reduction programme introduced by the chief executive; or

• Cease manufacturing and import garage doors from Malaysia, as suggested by the chairman.

(15 marks)

(d) Discuss the ethical issues that arise for Ritedoors from Nailfix’s request to modify its garage doors, and outline how Ritedoors should respond.

Answer rating: 100% (QA)

a The expected variable cost per garage door for 2021 The expected variable cost per garage door in 2021 can be calculated by taking the total expected fixed costs of 14m and dividing it by the projec... View the full answer