Dairy Pak The value chain concept has been discussed in the strategy

13-1

DairyPak

Teaching Commentary

OVERVIEW

This case is a fairly simple, straightforward exercise in creating a value chain (for the paper milk carton industry) and in

using it to facilitate managerial decision making (product emphasis, customer emphasis, capital expenditure analysis,

make/buy analysis).

The value chain concept has been discussed in the strategy literature since at least 1980. As a generic concept

ANSWERS TO ASSIGNMENT QUESTIONS

Question 1

Calculational Difficulties

I do not wish to imply that constructing a value chain for a firm is easy. There are several thorny

problems to confront: calculating a value for intermediate products, isolating key cost drivers, identifying linkages

across activities, and computing supplier and customer margins.

The analysis starts by segmenting the chain into those components for which some firm somewhere does make

Part of the “art” of strategic analysis is deciding which stages in the value chain can meaningfully be decoupled,

conceptually, and which cannot. Unless some firm somewhere has decoupled a stage by making a market at that stage,

one cannot independently assess the economic profit earned at that stage. But the opportunities for meaningful analysis

across a set of firms that have defined differently what they make versus what they buy and sell are often very

13-2

A PROCESS FLOW VALUE CHAIN

REGIONAL DAIRY BRANDED OJ

Milk OJ MM/CH Tropicana

Consumer Pays $1.16 $1.50 $1.89 $2.26

Per Ton Per Ton

Price to Processor $1,152 $864

Converter Margin 318 30

Freight to Processor 10 10

Converter Cost 231 231

*Estimated Market Value Transfer Prices. The

converting operations have a “true” market price for sales

to the processors. But how can we approximate “value”

for intermediate products? Uncoated board is transferred

internally from the mill to the extruder and coated board

ESTIMATING A MARKET PRICE FOR COATED BOARD

(Extruder to Converter)

We exported 32,000 tons of Coated Board in 1987

Per Ton

Selling Price (Exhibit 5) $577

Approximated market price between Extruder and Converter for

Coated Board

Per Ton

Mill cost $424

Freight to Extruder 3

Extruder Cost 94

In 1987, we sold 10,000 tons of uncoated board domestically

and exported 12,000 tons.

Per Ton

Selling Price (Exhibit 5) $530

Margin (as above) 59

Approximated Market Price $486

Question 2

Total $3,379 $7,555 $10,435

CHAMPION % 11% 5% 0.6%

New Insights? Does the information based on

value chain analysis lead to new insights? We believe it

13-3

DairyPak realized $355 (11% of the total value). In sharp

contrast, in the differentiated processor segment,

DairyPak’s share of the total profit in the chain is only

.6%! The buyer power in the differentiated segment is

There is no particular reason, ex ante, to believe

that 11% of the overall profit in the commodity segment

is a “reasonable” or “unreasonable” share for the carton

manufacturer versus the processor or the retailer. But

whatever the share is for the carton manufacturer in the

commodity segment, the share should be higher in the

Question 3

Estimated Asset Investment. Assets per ton of

board at each value activity are estimated using current

replacement costs and assuming full utilization of

capacity. Current replacement costs were estimated from

discussions with plant engineers and equipment vendors.

Tons of production at full capacity were estimated from

differentiated segment.

From a conventional BCG-grid (Exhibit A,

here), the differentiated processor segment would look

extremely attractive. But based on the value chain

analysis, this market looks much less attractive. The

differentiated processors have enormous leverage (buyer

processors are willing to share some of their profit in

order to entice an investment by a new competing

supplier).

EXHIBIT A

RETURN ON ASSETS PER TON OF BOARD

REGIONAL DAIRY BRANDED OJ

MILK OJ

Margin Assets ROA Margin Assets ROA Margin Assets ROA

Store* $1,728 $1,800 96% $4,320 $1,800 240% $6,768 $1,800 376%

Boston Consulting Group Grid

High

Question Mark

Star

• Regional Dairy Segment?

• Branded OJ Segment?

• Export Market?

Question 4

On the choice of market segments, DairyPak

considered three specific alternatives (see Exhibit B here).

First, the company could continue to emphasize the

DairyPak recognized its weaknesses vis-à-vis the

differentiated segment:

• Technologically obsolescent manufacturing. Most of

Their low market share in the differentiated

segment reflected their status as largely a “backup”

supplier. Major capital investments (a total of $61.5

million) had to be made if DairyPak was serious about

rebuilding market share in this fast-growing segment.

Three specific new investments would be:

the rubber plates cost about $150 each, with six

needed for a standard six-color process. Although

the quality was not as good as with rotogravure

printing, the commodity processors had never

required high quality printing. Rotogravure printing

uses etched metal printing rolls and gives an

extremely precise and high quality finish, but it is

expensive. After the initial capital expense, each

etched metal printing plate costs $2,500. With a six–

color process, $15,000 must be spent for only one

13-5

EXHIBIT B

1. Commodity Dairies

Overall Size of the Market 375,000Tons

Opportunities

• Uncertain supply of plastics. This is a by-product for the oil companies.

2. Branded OJ Segment

New Growth in

Size of Annual Growth OJ Consumption Total

the Market in “Base” (5% of Base Growth

1987 Business (10%) Business) in Volume

Tropicana 15,000 tons 1,500 tons 750 tons 2,250 tons

Champion’s Potential Volume:

Is it worth the $62 million investment to chase this volume?

3. Export

Overall Size of the Market 1,112,000 Tons

13-6

EXHIBIT C

Capital Investment Analysis for DairyPak Projects

(Per Internal Documents)

All Numbers Disguised

Differentiated Segment

Capital investments needed in Year 0:

Annual Cash Flows:

Profit per ton 302

Total market (differentiated segment) = 400,000 tons

Additional Volume 48,000 tons*

* (We ignore additional growth beyond Year 1, to be conservative.)

Total annual after-tax cash flows $11.16 million

Time horizon for the project = 10 years

13-7

Conventional Analysis of the Strategic Options

How should DairyPak’s senior executives

evaluate the marketing and investment options open to

them? Conventional capital expenditure requests, using

Another way to address these options would be

through the simple 22 growth/share matrix as originally

introduced by the Boston Consulting Group (Exhibit A,

here). Even though volume had been shrinking at 3% per

year over the past five years, the firm had maintained

market share at 40% in this large segment (375,000 tons

per year). This segment appears to be the classic “cash

cow” in the BCG terminology — “high market share with

low growth.” The strategic inference from the BCG grid

would be that DairyPak should “harvest” this commodity

within DairyPak at the time of the case. This point of

view was supported by formal financial analysis using

DCF techniques (Exhibit C, here), as indicated above. A

13% “real” return certainly argues for investing $61.5

Strategic Analysis – A Value Chain Perspective

Organizing the information in the value chain

framework provides a fundamentally different view of the

As noted:

• There are very few buyers in the differentiated

segment—fewer than ten versus more than 1,000 in

the commodity segment.

appeal, printability. Plastic poses a more significant

threat to coated board in the differentiated segment

since this segment values more highly the marketing

appeal of the package. This substitution threat sets a

cap on paperboard carton prices and a corresponding

cap on investment returns, once the overwhelming

buyer power is factored into the analysis.

Buyer power can be summarized as in Exhibit D here.

Overall, the value chain perspective yields a

your hand in the draw in a poker game. Do you put more

money in the pot, even if you know you have a bad hand?

Do you fold? Or do you stay in as long as possible

without adding much to the pot?

structural and executional drivers of cost behavior for

the major cost items in the mill, extruder, and

converter operations. They then need to manage

these drivers better than the competitors. Staying in

the commodity segment is the only logical choice.

13-8

selling in the differentiated segment. Also, the

profitability at the mill is well below satisfactory

levels. A cost driver analysis at the mill and extruder

stages might go a long way in identifying profit

improvement opportunities. Such analysis is beyond

the scope of this case.

The SCM-value chain perspective thus extends

of their impact on the overall chain and the firm’s position

within it. For strategic decision making, cost analysis

today cannot afford to ignore this critical dimension.

TEACHING STRATEGY

I use this case to introduce value chain analysis in the

required course on managerial accounting. I assign it

13-9

EXHIBIT D

Buyer Power Analysis

Commodity Branded OJ

Dairies Producers

Number of Buyers 1,000 3

(buyer concentration)

Buyer Switching Costs Low. Buy com- High. Buy differen–

modity board tiated board

Ability to backward Nil. Do not buy Nil. Do not buy in

integrate into paper- in volume for a volume for a scale

board scale efficient efficient plant

plant

13–10

EXHIBIT E

Traditional Management Value Chain Analysis in

Accounting the SCM Framework

Focus Internal External

Perspective Value-added Entire set of linked activities from

raw material suppliers to ultimate end use customers

• Applied too often, only at the • Each value activity has a set

overall firm level of unique cost drivers

Cost • Cost reduction approached via • Cost containment is a function

Containment responsibility centers or via of the cost driver(s) regulating

Philosophy product cost issues each value activity

Insights for None are readily apparent. This • Identify cost drivers at the

Strategic is a major reason why the individual activity level; develop

Decisions strategic consulting firms cost/differentiation advantage

typically throw away the either by controlling those drivers