Writers Den

The Business Strategy Game

COMPETING IN A GLOBAL MARKETPLACE

Your
company currently produces footwear at 2 plants—a 2 million-pair plant in
North America and a newer 4 million-pair plant in Asia. Both plants can be
operated at overtime to boost annual capacity by 20%, thus giving the company
a current annual capacity of 7,200,000 pairs. Sales volume in Year 10 equaled
5.2 million pairs, so there’s no immediate urgency to add more capacity. At
management’s direction, the company’s design staff can come up with more
footwear models, new features, and stylish new designs to keep the product
line fresh and in keeping with the latest fashion. The company markets its
brand of athletic footwear to footwear retailers worldwide and to individuals
buying online at the company’s Web site. In years past, whenever the company
had more production capacity than was needed to meet the demand for its
branded footwear, it entered into competitive bidding for contracts to
produce footwear sold under the private-label brands of large chain
retailers. In Year 10 the company sold

4.5
million pairs of branded shoes to retailers and individuals, and it bid
successfully for contracts to supply 740,000 pairs of private label shoes to
large multi-outlet retailers of athletic footwear.

Materials
to make the company’s footwear are purchased from a variety of suppliers, all
of whom have the capability to make daily deliveries to the company’s plants;
the company’s just-in-time supply chain eliminates the need for maintaining
materials inventories at its plants. Newly produced footwear is immediately
shipped in bulk containers to one of the company’s four regional distribution
centers. The distribution center for Europe-Africa is in Milan, Italy. The
distribution center for the Asia-Pacific region is in Bangkok, Thailand. The
Latin American distribution center is in Rio de Janeiro, Brazil, and the
North American distribution center is in Memphis, Tennessee. Many countries
have import duties on footwear produced at plants outside their
geographic region; import tariffs, which become payable when your
company ships footwear to foreign distribution centers, currently average $4
per pair in Europe-Africa, $6 per pair in Latin America, and $8 in
Asia-Pacific. However, the Free Trade Treaty of the Americas allows tariff-free
movement of footwear between all the countries of North America and Latin
America. The countries of North America, which strongly support free trade
policies worldwide, currently have no import tariffs on footwear made in
either Europe-Africa or Asia-Pacific. Your instructor has the option to alter
tariffs as the game progresses, so the current tariff arrangements should be
viewed as temporary.

Shipping and
Distribution Center Operations.Personnel at the company’s distribution
centers open the bulk shipments from plants, pack each incoming pair in
individual boxes, store the shoe boxes in bins numbered by model and size,
retrieve the pairs/boxes from bins as needed to fill incoming orders from
footwear retailers and online buyers, and ready orders for shipment.
Arrangements are made with

independent freight carriers to pick up outgoing
orders at the loading docks of the distribution centers and deliver them to
customers. Each distribution center maintains sufficient inventory of each
model and size to enable orders to be delivered within 1 to 4 weeks from the
time the order is placed. You and your co­managers will decide whether to
staff for 1-week, 2-week, 3-week, or 4-week delivery to retailers.

Competitive
Efforts in the Marketplace.From-time-to-time the
company enhances its footwear with new styling and performance features and
alters the number of models/styles in its product lineup. In addition, the
company strives to enhance its sales volume and standing in the marketplace
via attractive pricing, advertising, mail-in rebates, contracting with
celebrities to endorse its brand, convincing footwear retailers dealers to
carry its brand, providing merchandising and promotional support to
retailers, good delivery times on shipments to retailers, and promoting
online purchases at its Web site.

Stock
Listings and Financial Reporting.The company’s stock price
has risen from $11.00 in Year 6, when the company went public, to $30 at the
end of Year 10. There are 10 million shares of the company’s stock outstanding.
The company’s financial statements are prepared in accord with generally
accepted accounting principles and are reported in U.S. dollars. The
company’s financial accounting is in accordance with the rules and
regulations of all securities exchanges where its stock is traded.

The
number of companies in your industry will range from 4 to 12 companies,
depending on class size and the number of co-managers assigned to each
company. All companies beginThe Business Strategy
Gameexercise in exactly the same competitive market position—equal
sales volume, global and regional market share, revenues, profits, costs,
footwear styling and quality, prices, retailer networks, and so on. In
upcoming years, managers can undertake actions to alter their company’s sales
and market shares in all regions, opting to increase sales and share in some
and to decrease sales and share in others (including exiting one or more
regions or market segments entirely).

Market
Growth.The prospects for long-term growth in the sales of athletic
footwear are excellent. Athletic shoes have become the everyday footwear of
choice for children and teenagers. Adults buy athletic shoes for recreational
activities as well as for leisure and casual use, attracted by greater
comfort, easy-care features, and lower prices in comparison to leather shoes.
Athletic footwear has proved very attractive to people who spend a lot of
time on their feet and to older people with foot problems.

The
combined effect of these factors is reliably expected to produce 7-9% annual
growth in global demand for athletic footwear for Years 11-15, slowing to
about 5-7% annual growth during Years 16-20. But the projected growth rates
are not the same for all four regions, as indicated in the table below:

Projected
Growth Rates

10% Years 11-15 10% Years 11-15 10% Years 11-15

Private-Label
Footwear Markets

8.5% Years
16-20 8.5% Years 16-20 8.5% Years 16-20

Note:Branded
footwear sales to individuals at the company’s Web site (which were 5%of
total branded sales in each geographic region in Year 10) are projected to
rise by 1 percentage point annually to 15% of total branded sales in each
region in Year 20.

Just where the
actual growth will fall within the indicated 2 percentage-point intervals
varies both by year and by region—thus sales might grow 5.3% in Year 11 in
North America and 6.6% in Year 11 in Europe-Africa, then grow 6.2% in Year 12
in North America and 5.8% in Year 12 in Europe-Africa. Moreover, there’s a
possibility that (1) intense competition among rival footwear companies (in
the form of declining prices, higher footwear quality, and so on) can spur
market growth above the projected levels or (2) weak competition (in the form
of rising prices, subpar footwear quality, and so on) can produce weaker than
projected rates of market growth. Hence, there’s a modest element of
uncertainty regarding just what actual sales volumes will be in each of the
upcoming years.

In Year 10,
unit sales of branded footwear in North America and Europe-Africa were about
50% larger than the unit volumes in the Latin America and Asia-Pacific
regions, but the higher annual growth rates in the two lower-volume regions
will result in almost equal market sizes in all four regions by Year 20.
Assuming that market growth falls close to the midpoint of the indicated
ranges in growth rates, unit sales per company should be in the vicinity of
5,650,000 pairs in Year 11 and 6,100,000 pairs in Year 12. Unit volume
forecasts for Years 11-14 for the four geographic regions (based on growth
rates at the midpoint of the forecasted ranges) are shown below:

Projected Unit
Sales Volumes per Company

Note:All forecasts
are averages per companyand assume that market growth averages 6% in
North America and Europe-Africa (the midpoint of the 5-7% projected range)
and 10% in Asia-Pacific and Latin America (the midpoint of the 9-11%
projected range). The forecasts also assume that competition among rival
companies will be “normal”, such that intense competition among rival
companies won’t produce higher-than-projected growth in buyer demand for
athletic footwear or that weak efforts to capture additional sales (perhaps
accompanied by sharply rising prices) won’t result in lower-than-expected
growth in buyer demand.

Ratings of
Athletic Footwear Styling and Quality.The International Footwear
Federation, a well-respected consumer group, rates the styling and quality of
the footwear of all competitors and assigns a styling-quality or S/Q rating
of 0 to 10 stars to each company’s branded footwear offerings. Currently, the
athletic footwear lines of all competitors have a 5-star S/Q rating. The
Federation’s ratings of each company’s shoe styling and quality in each
market segment are often the subject of newspaper and magazine articles.
Market research confirms that many consumers are well informed about the S/Q
ratings and consider them in deciding which brand to buy. For example, if two
competing brands were equally priced, most consumers would be inclined to buy
the brand with the highest S/Q rating. It is unclear whether spirited
competition will lead to higher/lower S/Q ratings or to large/small
differences in S/Q ratings from company to company.

Athletic
footwear manufacturers have three distribution channels for accessing the
ultimate consumers of athletic footwear, the people who wear the shoes:

•
Wholesale sales to independent footwear
retailers who carry athletic footwear—department stores, retail shoe and
apparel stores, discount chains, sporting goods stores, and pro shops at golf
and tennis clubs. Worldwide, there are some 60,000 retail outlets for
athletic footwear scattered across the world. North America and Europe-Africa
each have 20,000 retail outlets selling athletic footwear, while Latin
America and the Asia-Pacific each have 10,000 retail outlets for athletic
footwear.

•
Online sales to consumers at the
company’s Web site.

•
Private-label sales to large
multi-outlet retailers of athletic footwear.

All
manufacturers have traditionally utilized independent footwear retailers as
their primary distribution channel for selling branded footwear.
Manufacturers have built a network of retailers to handle their brand in all
geographic areas where they market. Retailers are recruited by small teams of
company-employed sales representatives working out of regional sales offices
in each geographic region; the role of the sales reps is to call on
retailers, convince them of the merits of carrying the company’s brand,
solicit orders, and provide assistance with merchandising and in-store
displays. Retailers typically carry anywhere from 1-3 brands of athletic
footwear (depending on store size and location) and usually stock only
certain models/styles of the brands they do carry (since manufacturers have
anywhere from 50 to 500 models/styles in their product lines). Retail markups
over the wholesale prices of footwear manufacturers can run anywhere from 40%
at discount chains to as high as 100% at premium retailers. Thus, a pair of
shoes wholesaling for $50 usually retails for between $70 and $100.

However,
mounting use of the Internet by shoppers has prompted all footwear
manufacturers to launch a Web site displaying their models and styles and
giving consumers the option to purchase footwear online. Sales have been
growing steadily at the company’s Web site, partly because selling online
gives the company access to consumers located in areas where there are no
retailers carrying the company’s brand and partly because some consumers like
the convenience of online buying. As indicated earlier, online sales to
individuals are projected to grow from 5% to 15% of total branded sales in
each geographic region by Year 20. Whether companies will gradually
de-emphasize selling through retailers and shift their marketing emphasis to
promoting online sales remains to be seen.

The third
channel—private-label sales to large chain store accounts—is attractive for
two reasons:

•
The private-label segment is
projected to grow a healthy 10% annually during Years 11-15 and a brisk 8.5%
during Years 16-20. The growth in private label sales is being driven largely
by the practice of multi-outlet chains to use lower-priced private-label
goods to attract price-conscious consumers. Chain retailers that sell
athletic footwear under their own label outsource the pairs they need from
manufacturers on a competitive-bid basis.

•
Making private-label shoes for
chain retailers allows a manufacturer to use plant capacity more efficiently.
For example, a manufacturer selling only 5.5 million pairs of branded shoes
with plant capacity of 6 million pairs (7.2 million pairs with maximum use of
overtime) can reduce overall costs per pair by utilizing some or all of its
unused capacity to produce private-label shoes. The added production volume
from being a successful low-bidder to supply private-label shoes to chain
retailers helps spread fixed costs over more pairs and can improve overall
financial performance (provided the price received for producing the
private-label shoes is above the direct costs per pair).

The Demand Side
of the Market for Athletic Footwear.Consumer demand for athletic footwear
is diverse in terms of price, styling, and purpose for which athletic
footwear is worn. Many buyers are satisfied with no-frills, budget-priced
shoes while some are quite willing to pay premium prices for top-of­the-line
quality, multiple features, or trendy styling. The biggest market segment
consists of customers who buy athletic shoes for general wear, but there are
sizable buyer segments for specialty shoes designed expressly for walking,
jogging, aerobics, basketball, tennis, golf, soccer, bowling, and so on. The
diversity of buyer demand gives manufacturers room to pursue a variety of
strategies—from competing across-the-board with many models and below-average
prices to making a limited number of styles for buyers willing to pay premium
prices for top-of-the-line quality. Price, styling/features/quality (as
reflected in the S/Q ratings), and a wide choice of appropriate styles and
models typically have the most influence on a buyer’s choice of which brand
to purchase.

All of the
materials used in producing athletic footwear are readily available on the
open market. There are some 250 different suppliers worldwide who have the
capability to furnish interior lining fabrics, waterproof materials for
external use, rubber and plastic materials for soles, shoelaces, and
high-strength thread. It is substantially cheaper for footwear manufacturers
to purchase these materials from outside suppliers than it is to manufacture
them internally in the relatively small volumes needed. Delivery times on all
materials are usually less than 48 hours. Suppliers have ample capacity to
furnish whatever volume of materials that manufacturers need; no shortages
have occurred in the past. Just recently, suppliers confirmed they would have
no difficulty in accommodating increased materials demand in the event
footwear-makers build additional plant capacity to meet growing worldwide
demand.

Suppliers offer
two basic grades of materials: standard and superior. The qualities of
superior and standard materials are the same from supplier to supplier. All
suppliers charge the going market price because of the commodity nature of
both standard and superior materials. The use of superior fabrics and shoe
sole materials improves shoe quality and performance, but shoes can be
manufactured with any percentage combination of standard and superior
materials.All footwear-making equipment in present and future
plants accommodates whatever percentage mix of standard and superior
components that management opts to use.

The “base
prices” for materials, which are subject to change by your instructor as the
game progresses, are currently $6 per pair for footwear made of 100% standard
materials and $12 for footwear made of 100% superior materials. However, the
prevailing base prices are adjusted up or down according to the percentage
mix of standard-superior materials usage and the strength of demand for
footwear materials:

•
The going market
prices of standard and superior materials in any one year deviate from their
respective base prices whenever the percentage mix is anything other than 50%
for standard and 50% for superior materials.The
going market price of superior (or standard) materials will rise 2% above the
base for each 1% that worldwide use of superior (or standard) materials
exceeds 50%. Simultaneously, the global market price of standard (or
superior) materials will fall 0.5% for each 1% that the global usage of
standard (or superior) materials falls below 50%. Thus, worldwide materials
usage of 60% superior materials and 40% standard materials will result in a
global market price for superior materials that is 20% above the prevailing
$12 base price for superior materials and a global market price for standard
materials that is 5% below the prevailing $6 base price for standard
materials. Similarly, worldwide usage of 55% standard materials and 45%
superior materials will result in a global market price for standard
materials that is 10% above the $6 base price and a global market price for
superior materials that is 2.5% below the prevailing $12 base. In other
words, greater than 50% usage of superior materials widens the price gap
between superior and standard materials, and greater than 50% usage of
standard materials narrows the price gap.

•
Materials prices fall
whenever global production levels drop below 90% of global production
capacity and materials prices rise when global production levels rise above
110% of global plant capacity.Should global shoe
production fall below 90% of the footwear industry’s global plant capacity (not
counting overtime production capability), the market prices for bothstandard
and superior materials will drop 1% for each 1% that global shoe production
is below the 90% capacity utilization level. Such price reductions reflect
increased competition among materials suppliers for the available orders. On
the other hand, when global production levels exceed 110% of the industry’s
global plant capacity (reflecting use of overtime production), the prices of both
standard and superior materials will go up 1% for each 1% that global
production levels exceed 110% of global production capacity. Thus once
overtime production exceeds a global average of 10% of installed plant
capacity worldwide, then material suppliers are able to exert pricing power
and can command higher prices. In the event global production reaches the 20%
overtime maximum, the prices of standard and superior materials will be 10%
higher than they would otherwise be.

Footwear
manufacturing has evolved into a rather uncomplicated process, and the
technology is well understood. At present, no company has proprietary
know-how that translates into manufacturing advantage. The production process
consists of cutting fabrics and materials to conform to size and design
patterns, stitching the various pieces of the shoe top together and adding
the eyelets, molding and gluing the shoe soles, binding the shoe top to the
sole, and inserting the innersoles and laces. Tasks are divided among
production workers in such a manner that it is easy to measure individual
worker output and thus create incentive compensation tied to piecework. Labor
productivity is determined more by worker dexterity and effort than by
machine speed; this is why piecework incentives can induce greater
output per worker. On the other hand, there is ample room for worker
error; unless workers pay careful attention to detail, the quality of
workmanship suffers. Training production workers in the use of best
practice procedures at each step of the manufacturing process has recently
become important to minimizing the reject rates on pairs produced.

Footwear
producers carry no inventories of standard and superior materials because
suppliers have the capability to make daily deliveries. Plant managers
customarily provide suppliers with production schedules one week in advance
to enable them to deliver the materials needed for each day’s work shift.

Footwear
industry observers expect companies to take a hard look at the economics of
producing a bigger fraction of athletic shoes in Asian-Pacific and Latin
American countries where trainable supplies of low-wage labor are readily
available. Compensation levels for Asian-Pacific and Latin American workers
currently run about 20% of annual compensation levels in Europe-Africa and
North America. However, worker productivity levels at different plants can
vary substantially because of the overall experience of the work force, the
use of different incentive compensation plans, the degree of emphasis placed
on best practices training, and the use of up-graded footwear-making
equipment. All workers worldwide are paid

1.5 times their
regular base wage for working overtime (more than 40 hours per week).

But locating
most of the company’s production in Asia-Pacific and/or Latin America has two
potentially significant disadvantages. Tariffs have to be paid on footwear
exported from Asia-Pacific plants to markets in Latin America ($6 per pair)
and Europe-Africa ($4 per pair); likewise, tariffs have to be paid on
footwear exports from Latin American plants to markets in Europe-Africa ($4
per pair) and the Asia-Pacific ($8 per pair)—it’s uncertain whether tariffs
in future years will rise or fall and by how much. Also, all companies are
subject to unfavorable year-to-year exchange rate fluctuations in shipping
footwear from one region to another (as discussed below). One way to guard
against adverse changes in tariffs and exchange rates is to maintain a
production base in each of the four geographic regions and rely upon those
plants to satisfy demand for the company’s branded footwear in their
respective region. It remains to be seen how companies will weigh the pros
and cons of locating plant capacity in one region versus another.

All footwear
companies are subject to exchange rate adjustments at two different points in
their business. The first occurs when footwear is shipped from a plant in one
region to distribution warehouses in a different region (where local
currencies are different from that in which the footwear was produced). The
production costs of footwear made at Asia-Pacific plants are tied to the
Singapore dollar (Sing$); the production costs of footwear made at Europe-Africa
plants are tied to the euro (€); the production costs of footwear made at
Latin American plants are tied to the Brazilian real; and the costs of
footwear made in North American plants are tied to the U.S. dollar (US$).
Thus, the production cost of footwear made at an Asia Pacific plant and
shipped to Latin America is adjusted up or down for any exchange rate change
between the Sing$ and the Brazilian real that occurs between the time the
goods leave the plant and the time they are sold from the distribution center
in Latin America (a period of 3-6 weeks). Similarly, the manufacturing cost
of footwear shipped between North America and Latin America is adjusted up or
down for recent exchange rate changes between the US$ and the Brazilian real;
the manufacturing cost of pairs shipped between North America and
Europe-Africa is adjusted up or down based on recent exchange rate
fluctuations between the US$ and the €; the manufacturing cost of pairs
shipped between Asia-Pacific and Europe-Africa is adjusted for recent
fluctuations between the Sing$ and the €; and so on.

The second
exchange rate adjustment occurs when the local currency the company receives
in payment from local retailers and online buyers over the course of a year
in Europe-Africa (where all sales transactions are tied to the €), Latin
America (where all sales are tied to the Brazilian real), and Asia-Pacific
(where all sales are tied to the Sing$) must be converted to US$ for
financial reporting purposes— the company’s financial statements are always
reported in US$. The essence of this second exchange rate adjustment calls
for the net revenues the company actually receives on footwear shipped to
retailers and online buyers in various parts of the world to reflect
year-to-year exchange rate differences as follows:

•
The revenues (in €) the company
receives from sales to buyers in Europe-Africa are adjusted up or down for
average annual exchange rate changes between the € and the US$.

•
The revenues (in Sing$) received
from sales to Asia-Pacific buyers are adjusted up or down for average annual
exchange rate changes between the Sing$ and the US$.

•
The revenues (in Brazilian real)
received from sales to Latin American buyers are adjusted up or down for
average annual exchange rate changes between the Brazilian real and the US$.

No adjustments
are needed for the revenues received from sales to North American buyers
because the company reports its financial results in US$.

BSG
is programmed to access all the relevant real-worldexchanges
rates between decision periods, handle the calculation of both types of
exchange rate adjustments, and report the size of each year’s

percentage
adjustments on the Corporate Lobby page, on pertinent decision screens, and
in the company reports. While you do not have to master the details of how
the two types of exchange rate adjustments are calculated, you
definitely will need to keep a watchful eye on the sizes of the exchange rate
adjustments each year and understand what you can do to mitigate the adverse
impacts and take advantage of the positive impacts of shifting exchange rates
on your company’s financial performance.

The
sizes of the exchange rate adjustment each year are always equal to 5 times
the actual period-to­period percentage change in the real-world exchange
rates for US$, €, Brazilian real, and Sing$ (multiplying the actual % change
by 5 is done so as to translate exchange rate changes over the few days
between decision periods into changes that are more representative of a
potential full-year change). However, because actual exchange rate
fluctuations are occasionally quite volatile over a several day period, the
maximum exchange rate adjustment during any one period is capped at ±20%
(even though bigger changes over a 12-month period are fairly common in the
real world).

There
will be no exchange rate adjustments in Year 11.The
real-world exchan