Size up Germany’s foundry Industry? Is WH well positioned in it now and in the future?
The beginning of the new millennium has presented Walter Hundhausen (WH) with a big hurdle to jump. The German economy is experiencing economic stagnation, an aging population and a German labour market that is filled with many intrusive government regulations. The German economy has been growing at an average rate of 0.6 percent per year for the last 4 years; making it one of the slowest growing economies in the Euro Zone.
However, study’s suggests in 2004, the domestic economy is expected to grow above 2 percent. Moreover, one-third of Germany’s economy is comprised of exports. In performing a Pest Analysis (see Diagram 1 below), there are many macro factors affecting the German Foundry Industry.
The acronym stands for Political, Economic, Social and Technological concerns that could affect the strategic development of the casting foundry industry in Germany. By identifying PEST influences it helps gage the external environment in which the casting foundry industry operates. Political
Strict Layoff Regulations: Government regulations had strict policies in place on how organizations could layoff employees. Before employees were laid-off, management had to advise the Works Council and they had to agree to the nature and timing of the plan. In addition, the management team had to develop a social plan for each employee on how the layoff would affect them and what remedies the organization would put in place for them. If a social plan was not presented, employees could claim for compensation through the courts. This could prove to be costly in time, money and reputation.
National Bargaining on Wages: The current German industrial relations policy was based on a duel model. One part dealt with the collective bargaining, while the other dealt with codetermination. The collective bargaining agreement dealt with minimums and maximums, with respect to wages and salaries and working hours. Codetermination was an actual Act or Law that provided labourers in Germany with three levels of representation; Supervisory Board, Works Council and Labour Director. However, in the end, all collective bargaining agreements could be adjusted and then ratified through this process.
Social Market Economy: The political climate in the country is based on the social market economy, where employers and unions worked as partners to better the organization as a whole. However, in reality, the balance of power lay in the hands of the union. Unions negotiated national and regional wages and hours of operations; in addition, they also negotiated paid time-off. In 2004, the average individual worked 1,542 hours. The standard legislated work week was set at 60 hours with a minimum paid leave of 24 days. That translates to 2,832 hours per year. Despite the legislation, the average individual worked 54 percent less than was legislated in 2004.
Ordnung Principal: This is Germany’s version of the Triple Bottom Line, where economy, society and the government all participate in the mechanism for workers democracy. New Environmental Legislation: The government imposed a new ecological tax in 2000 that focused on waste reduction as opposed to waste recycling. This added costs in the form of time and money to the WH casting process. From an economic perspective, the government wanted the industry to focus on the externalities and reduce them or remove them totally.
Domestic Growth: The last three years (2001 to 2004), the German economy was growing at an average rate of 0.6 percent per year. Germany had been experiencing the slowest growth in the Euro zone. This affected many organizations in Germany, particularly mid-sized companies that were not big enough to fully utilize economies of scale. Future Growth: The economy in Germany has been slated to grow around 2 percent for the year 2004.
This represent an increase of 1.4 percent over the previous year and that may not seem big, but relatively speaking that is a 233% increases from year over year. Increase in Value of the Euro: Another concern at the macro level is the appreciation of the Euro against other currencies, most notably the American dollar. As the Euro increased, the cost of WH’s products also increased. However, the opportunity to purchase at a lower price scrap iron and steel from non-European countries has also increased. As the Euro appreciates in value, it can now purchase raw materials at a lower cost.
Aging Population: The current labour shortage in Germany is creating a nightmare in the casting industry. In order to attract and retain employees, organizations were paying a premium over scheduled tariffs. These costs were substantial, as many companies were running multiple shifts in order to keep up with demand. Reduction in Full-Time Employment: The current macro environment suggests a reduction in the number of full-time resources, because of the high labour costs. However, because of the aging population, it’s becoming increasingly difficult to find qualified workers.
Sounds counter intuitive; a reduction of full-time staff to cut costs, but many companies in the industry are paying premiums over scheduled tariffs in order to keep their current workforce. Strong Social Employment Contracts: The Germany foundry industry has a strong employment contract system, where employers are responsible for the well being of their workers. The contract is enforced by the Works Council and the Labour Director who is part of the origination. Their main objective is to resolve disputes through intensive informal contacts.
Strong Union Presence: The dual model in the industry consists of a collective bargaining agreement and codetermination. This dual system gives the unions a strong position within the foundry industry. Their presence has lead to numerous bouts of conflict with management when negotiating collective agreements and in some cases these disagreements lead to long and bitter strikes.
Above Average R&D Investment: R&D is a major competent in the casting foundry industry. R&D creates better products and above all reduces costs through the automation of the casting process. Moreover, by being a Tier 1 supplier, customers are expecting better products and lower costs year over year. Frequent Technology Changes: In the casting process, technology changes occur frequently, in order to maintain lower sand-to-metal ratios and scrap ratios. Largest European Foundry: Being the largest casting foundry in Europe, economies of scale can have significant cost savings, as the organization can purchase large amounts of scrap iron and steel.
Close Proximity to Clients: By being close to customers, shipping costs and delivery times are reduced substantially; giving the local casting foundry a cost advantage over their long distance competitors. Efficient Sand Casting Process: The casting process is highly integrated and labour intensive. By having a disjointed process, the cost of the process will be high and the products produced would be of an inferior quality. A process that is tightly controlled and automated will reduce unnecessary waste and cut costs in the form of wages and raw material.
Below are the specific micro forces that will influence how WH reacts to the environmental issues assessed above.
The cost of raw materials was increasing 23 percent year over year (see Diagram 2 below). Raw materials have been the single most expensive cost to WH. Diagram 3 below, illustrates the cost of raw materials to revenues and the cost of wages and salaries to revenues. As for wages and salaries, they have been holding steady. Moreover, the trend seems to be downward sloping (see Diagram 3, below).
Total revenues have been increasing steadily since 2001; with a significant increase occurring in 2004 (see Diagram 4, below).
Year over Year Increase in Revenues
However, in 2004, the index price of scrap iron and steel has been averaging around 191.00, that is a 43 percent increase, year over year. The trend seems to be heading higher, potentially breaking the 250.00 barrier (see Diagram 5, below).
Competition from non-OEM organizations was growing. However, customers today are more sophisticated and understand that quality plays an important role in the decision to purchase a product versus purchasing a product on price alone. The real threat will come from organizations in the casting industry from Eastern European that will eventually become tier 1 suppliers. One of the challenges facing WH is the current workforce in Germany. WH has been experiencing a high degree of absence due to leaves and sick days.
The above graph (see Diagram 6) illustrates by department where the greatest number of absences are occurring. The stars indicate the average per department and in 2004, there was an increase in the number of absences in Core Marketing, Finishing and Heat Treatment. Finishing can be explained because of the nature of the work itself. It is one of the most difficult parts of the casting process. Some of the other notable information to mention, is when the automated casting process is operating efficiently, sick days and leaves are kept to a minimum.
For example, pouring and melting in 2003 experienced numerous mechanical problems, thus the department experienced a higher level of absences as opposed to 2004, when the process was operating with little interruptions, sick days and leaves decreased substantially. Moreover, for the first 6 months of 2004, the average cost of the total days off work amounted to 3.39 million, which represents 8.7 percent of the overall company’s revenues (see Diagram 7, below).
The biggest threat facing WH is their ability to reduce costs. Their customers are demanding lower prices and the organization has been responding, by investing heavily in R&D to improve the casting process. However, if they do not get the costs of the casting process under control, they will not be able to meet the increasing demand from the motor vehicle industry. The motor vehicle industry in 2004 purchased a total of 68% of the total industry’s output. Diagram 8, below illustrates the percentage increase or decrease year over year by industry and the tonnage sold by industry. Clearly, the industry that has been adding value to WH has been the motor vehicle industry. On average, over the last three years, the motor vehicle industry has increased 13 percent.
If the motor vehicle industry continues on their current growth path, by the end of 2005, WH will have reached plant capacity of 95,000 tonnes per year (see Diagram 9, below). The forecast includes a 13 percent increase in motor vehicle tonnage per year and holds the other two industries with no growth or decline in tonnes required.
The rising cost of scrap iron and steel, a stagnate Germany economy, the German labour market and its regulations are proving extremely difficult for WH to deal with. In addition, WH is reaching plant capacity and they have not been able to control rising costs to date. For the last three years,
wages and raw material purchases have been well over budget. SWOT ANALYSIS
A SWOT analysis was completed for WH to evaluate their Strengths, Weaknesses, Opportunities, and Threats (see Diagram 10, below). The analysis identifies the key internal and external factors that will hinder or help WH achieve their stated goals and objectives.
One of the key factors to WH success was their ability to understand their customer’s business needs and create new products for them. This was one area in the casting foundry industry that separated WH from their competitors; WH was and still is “Best in Class”, when it comes to product innovation. One area of improvement would be to eliminate or reduce the number of products that have low margins.
By producing these low margin products, WH is tying up valuable resources both in time, money and material. One of the greatest threats WH will encounter is the surging casting foundries from Eastern European countries, such as Spain, Turkey and Poland. Currently, many of the Eastern European organizations either small or big are not OEM rated. However, with time and additional investment dollars, these organizations will be able to compete against WH on price.
PORTERS FIVE FORCES
One final assessment was completed to determine the profitability or attractiveness of the casting foundry industry in Germany. By utilizing Porters Five Force model, a more realistic assessment of the competitive rivalry that exists in the market can be determined. This will give WH insight as to the attractiveness of the industry and determine what course of action (if any) is required.
The analysis clearly demonstrated that the industry is highly profitable (see Diagram 11, above). The Barriers to Entry are high, making it difficult for organizations to enter. Entry requires a high initial capital investment and ongoing R&D dollars. Moreover, the bargaining power of the Buyer is Low, because switching costs are high. Substitutes products are available, but in the motor vehicle industry highly unlikely to be used.
The bargaining power of Suppliers is strong, because there is strong union presence and the raw material is based on world supply and demand prices. In short, the competitive rivalry within the Casting Foundry Industry is high, suggesting that the industry is profitable. Furthermore, with high exist barriers, because of the high fixed costs, it makes it extremely difficult to exit the industry, and thus remaining organizations will continue to suffer and lose more market share.
Question 1A: Is WH well positioned in it now and in the future?
Not with their current casting process. Clearly, WH’s core competency lies in their ability to produce exactly what the customer needs and then takes that knowledge one step further by producing new products that customers ends up wanting; WH creates demand for their new more profitable products. Moreover, WH links their internal logistical and informational systems with their customers. Basically, WH becomes an extension of their customers. The future for WH would be to outsource some non core activities of their value chain to 3rd parties in the casting foundry industry; perhaps in Eastern Europe, such as Poland, where wages are less and employment is more bountiful.
In conclusion, with the current trends in the casting foundry industry, where growth is expected to increase 2% per year in tonnage and 3% per year in value, WH does not have the current structure to capitalize on this growth opportunity. Pricing has also become an issue and they are trying to go head to head with their customers and asking them to pick up the additional surcharges on the price of scrap steel and iron. Moreover, with the additional investment in R&D, costs have not decreased. Revenues have been steadily rising, but so have costs and costs have outpaced revenues. This is evident, as WH is expected to lose 6 million in 2004, making it the worst loss in the company’s 4 year history.
Question 2: Is the alternative that WH’s management called “strategic change” really strategic? Justify you answer.
In order to justify the answer, one must first define what strategic change is. According to Joseph N. Fry, one of the authors of Strategic Analysis and Action he suggests that it is a tool for building, communicating and maintain the direction of the business. As for Lawrence G. Hrebiniak, he suggests that strategic change is all about execution. In his book, Making Strategy Work, he suggested that without a careful, planned approach to execution, strategic goals cannot be attained.
Albeit, in both examples above, little reference is made to the actual strategy, but in reality both authors agree that the strategy is important, but the execution of the strategy is key to success. An analogy that can be used to illustrate their point of view would be a golfer that needs to fade a shot around a tree. The strategy has been set, the trajectory of ball flight has been visualized; wind and all other factors have been taken into consideration. What’s left is the actual striking of the ball. However, if the golfers’ core competency is to hit a draw, rather than a fade, the strategy has little to do with the result of the execution.
One of WH alternative is to shut down Line 2, reduce employment by 114 workers and increase sales through a radical marketing campaign that started in 2003. However, the radical marketing campaign emphasizes a differentiation strategy as opposed to a price strategy as indicated by Klaas. The key to their current success is WH’s ability to understand their customer’s business needs and create specific casting moulds for them. In addition, WH has been able to develop new products with higher margins for their customers and then sell those products back to their customers; push marketing.
By adopting a low cost strategy, rivals in the industry will eventually out price WH and take market share away from them. One of the reasons why WH can be out priced in the market is that their main competitors from Eastern Europe, such as Poland, have a much lower wage structures. To conclude, WH’s alternative does not fit the traditional definition of a strategic change. After reviewing the data and the definition, the answer remains a resolute no. The reason for the decision is that strategic change must take into consideration other aspects of the organization.
The changes suggested by Klaas will not delivery the strategy in a controlled manner that is efficient and effective to implement. Strategic management is not about delivering one single project or addressing one particular issue, but a process that governs the entire organization and how the entire organization is affected by the strategic change (see Diagram 12, above). The so called alternative “strategic change” in the end will not deliver any real value to the organization, thus further suggesting that this is not a strategic change. Strategic change at the end of the day must deliver real value, not perceived value.
In Germany that value takes on the form of a stakeholder, rather than a shareholder. Thus, by simply focusing on profits and ignoring the human costs of the layoffs, WH will not execute this strategy with any conviction or success. Both Fry and Hrebiniak realize that the process is complicated and contains many moving parts. In short, there is no magic bullet. Simply cutting workers and installing automated processes does not guarantee costs reductions and increased revenues.
Question 3: How much “flexibility” did the company have in dealing with its problem?
The reality of the situation is that WH only had perceived flexibility. With economic stagnation, an aging population, tight employment regulations and a shortage of workers, WH has limited flexibility in being able to deal with the problem. Moreover, with the increase in tariffs, raw materials and energy, WH has even less flexibility in addressing their current problem. WH was able to negotiate concessions with the Works Council; however, the concessions came with a hefty price. The Works Council’s goal was to save jobs in the short term for the promise of better pay in the long term. Thus, WH was able to negotiate special agreements to break the current collective agreement.
WH negotiated for more free hours, less pay and forgone holidays and vacation pay, but had no control over dismissal’s and working exemptions; the Works Council held the balance of power in these two categories. For example, if employment dropped below 570 permanent employees, the regional tariff rates would come into effect and they did. The Works Council’s position for long term better pay may present a problem with a few of the alternatives being suggested by WH.
The Works Council may not approve any of the alternatives that involve significant layoffs and pay reductions. These alternatives are in direct conflict with their own goals and objectives. In conclusion, perceived flexibility is much different than actual flexibility. WH may think they can suggest an alternative that makes sense for them, but the reality is that without buy in from the Works Council, the strategy will surely fail to execute.
Question 4: What could management do to address the problem?
WH management must develop a Strategic Management Process. The new strategic management process is to be undertaken by the executives at WH and GMH. The executives will review and interpret the Germany foundry industry and determine the direction for WH. At this point in the process the executives will set the Corporate Strategy (strategic direction) and priorities, while understanding and taking into consideration resources and budget constraints (see diagram 13, below).
The seconds step is to create the “right” Corporate Structure with the proper incentives and controls to ensure that the Corporate Strategy can be achieved. The final step is to ensure that the Business Units understand the objectives set forth and have the necessary resources in place to achieve their goals and objectives. It is the business unit who is responsible for ensuring that they have the correct skills and capabilities in place in order to achieve the Corporate Strategy. Once the strategic management process has been developed, the next critical step in the process is to formulate a well defined plan that has clear and focused goals and objectives. These goals and objectives must be measurable, attainable and realistic.
Moreover, the plan must address how these achievements will affect the overall organization, but more importantly, if the goals and objectives are not meet, what are consequences to the organization. This process must be open and transparent that will ensure that buy in will occur quickly. In conclusion, the execution of these key activities is the heart of any successful strategic management process. In addition, WH must ensure that the Works Council understands that the long term success of WH is in everyone’s best interest. The Works Council’s long term goal is for better pay for its workers, without WH, their goals and objectives will never be realized.
Question 5: What had management done so far?
Management has accomplished a lot to date. They sold WH to GMH who had experience in purchasing distressed companies and providing them with fresh equity and motivating their work force. In addition, in 2003, WH implemented a radical marketing plan that increased revenues by approximately 13.6 % in 2004. WH invested heavily in operations, by trying to automate the sand casting process. WH believed that they could further reduce the operating costs by automating a lot of the high touch processes.
WH has also outsourced the finishing process, as this is one of the most costly processes in the sand casting process. WH hired a consultant by the name of Knight Wendling who was hired to improve productivity and reduce costs. His first mandate was to get customer to pay a scrap surcharge and eliminate unprofitable products. By the middle of 2004, 91 percent of customers were paying the surcharge and he eliminated 5,000 tonnes of products that were generating low contributions. Finally, in 2004 WH made some major changes to their current management structure and sent out a new message to their workers, that management was looking for fresh ideas that would make a difference.
Question 6: What actions were left open to WH’s management and would they make sense?
One action that was left open was continuing with the Radical Marketing Plan that WH started in 2003. The marketing plan would continue to increase sales by 8.2 million and contribution by 5.2 million in 2005. However, one of the major issues with this action was that costs were also increasing and the increase in revenues and contributions was being offset by the rising cost of scrap iron and steel and wages. The rising costs, coupled with WH’s increase in prices were opening the doors to some of their direct competitors in Eastern Europe, such as Poland, Hungary and the Czech Republic.
This plan would only make sense if they could get the Works Council to increase the number of hours that employee’s could work and reduce the minimum number of workers required, before tariffs are enforced. Moreover, this approach would make sense, if WH could convince the Works Council that their short term objective to keep as many employees as possible is actually going to hurt their long term goal of better pay for their workers. If WH and the Works Council could overlook their short term objectives and focus on their long term objectives, everyone would be better off.
Question 7: How could it pursue the remaining actions?
WH could simply divest the entire operations and payout the 15.3 million owed to the workers ( 25,000 * 612 workers). However, this may not be in the best interest of the entire organization as an environmental assessment must be completed before the land gets rezoned. Worst case scenario, if the land is contaminated the purchaser may request that the seller clean the land before title change and this could cost GMH considerable money.
The opportunity cost of closing down the plant would be the 15.3 million, thus the company could take that money and reinvest it into WH. Currently, WH is losing 6.2 million per year, if they continue losing this amount of money, that would buy them 3 additional years and then WH could simply sell the business. WH would have to create a strategic plan that takes into consideration all the options associated with investing additional capital. More so, they will need buy in from the Works Council. Without their buy in strategic plans will prove useless.
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