Starrett companies is certainty not immune to risks. In this paper we will be looking at the risk poised to the Starrett company in the venture of opening a distribution warehouse in Toronto Canada. 1. Internal. What are the company’s most significant internal risks and opportunities related to the project? Some internal risks to Starrett in regards to moving to Canada would be; Increasing costs: Most companies, and especially Starrett is not immune to the rising costs of doing business.
In 2016 Starrett in North America saw administrative expenses increase over 1 Million or 3%. The Starrett websites also bring to light other increased costs of travel and entertainment at 2.3 Million. Besides actual hard numbers that Starrett has experienced in 2016, the future of this project could make these numbers worse. Administrative costs will go up when we create the new warehouse.
Opportunities: The internal opportunities for a company like Starrett and opening a distribution warehouse is the opportunity to get their company products out to more customers. Currently, Starrett is not meeting the needs of their fellow Canadian customers. Canadian consumers are very limited when it comes to precision tools. The only other company they have to choose from is Kamek Precision Tools. This is an internal opportunity in that, Starrett internal produces particular precision tools that no other company does.
By opening this new distribution warehouse, we are expanding the choices for Canadian consumers. Another great internal opportunity from opening a new distribution warehouse, this will increase the speed in which orders are filled. The need for filing consumer’s in a timely manner is more important than ever. Speed has advantages such as, being a head of your competition, audiences expect it, the faster your learn, the faster you evolve and it creates a culture of speed. (Snow. K)
2. External. How will you address significant qualitative risks outside the company that might affect project success? Lower Profitability: In today’s economy companies like Starrett are struggling with lowering profitability. In the company’s annual report they talk about this very issue. The annual statement stated, “Income before tax was a loss of $20.4 million, a decrease of $30.3 million compared to $9.9 million of income in fiscal 2015. Fourth quarter pension charges accounted for 85% of the annual income before tax loss”(Starrett). Throughout the report the company hits on all the trials and tribulations they are facing as a corporation in today’s economy. When building this new distribution warehouse, it is important to keep these figures in mind. The best way to plan for this, is just by building the warehouse.
The warehouse should get the company moving more product and hopefully offsetting the low profits. Harsh Winters One big external factor for building a warehouse in Tornoto, Canada is the weather. The snow in Toronto can fall up to 4 inches a day. They also have two or three major storms bringing in 20+ inches. Knowing that Canada brings cold weather and snow storms, it is best for the company to prepare early. This means more cost than previously budgeted for. You need to budget for more robust vehicles, equipment, and even employees. Anything affected by the snow that doesn’t have the capability to handle it will certainly not help with getting those profits up.
3. Microeconomic. Assess the microeconomic factors that might affect decisions about the proposed investment. Some of the microeconomic factors for opening a distribution warehouse are things like supply and demand, consumer behavior and profit maximization. Let’s take a closer look at each one: Supply and Demand: The supply and demand for precision tools in Northern United States and Canada is booming. While Starrett saw falling profits, they have been unable to fill orders. The inability to fulfill orders and ship them in a timely manner is starting to have effect on the company.
The warehouse will hope to grab a hold of the demand and begin to push out supply, hoping to create a positive 2019. Consumer Behavior: As discussed above, the demand for precision tools only made by Starrett is increasing. This increase has started picking up as the economy in the United States has picked up. Not only are consumers demanding more, their customer behavior is changing. “Stores are in trouble. Foot traffic over the holiday was down. Sales in stores were underwhelming. Online and mobile won the holidays” (UsaToday.com).
Consumers are shopping online more than ever. While yes, Starrett is available online that is only half of the new consumer behavior. Not only do consumers want to shop online, but they want it with free shipping and for it to be at their door within 2 days. The only way for Starrett to achieve this is by opening a new distribution warehouse. Profit Maximization: As we read earlier in the 2016 annual report put out by Starrett, profits are down. Having a distribution warehouse we are starting to look at factors and use the news-vendor problem to help us determine how this will maximize profits. “The newsvendor (or newsboy or single-period or perishable) model is a mathematical model in operations management and applied economics used to determine optimal inventory levels” (Snow K.).
This sort of inventory management strategy will certainly help with maximizing profit. 4. Alternate financial scenarios. a. How would your projected financial performance change if sales fall 20% short of or are 20% higher than your base assumption? Sales Fall Short 20%: If sales were to fall short after finishing the new distribution warehouse, it could cause chaos at Starrett. Starrett is on hard times, because it cannot keep up with demand to drive up profit levels. As the annual report shows net sales have been on a steady decline since 2012, and another year down 20% would not be ideal for Starrett.
The hope of building the warehouse would help with the demand and increase value. If the sales fell 20% what would this mean for the investment in the warehouse it would initally be seen as a complete failure. I would recommend the company still proceed forward because I do believe in time the company will benefit from such a close partnership with Canada. Sales Higher 20%: If the sales from the distribution warehouse increase by 20% this would be a great win for Starrett. They really need to have this boost in numbers. Looking at the increase we would then need to analyze where and how the profits were rising.
Perhaps, looking at another distribution warehouse on the West of Canada towards California, as that is the next hot spot for Starrett. b. What do the net present value, internal rate of return, and payback values from your base scenario and the sales variation scenarios above imply for the proposed investment? The net present value of this investment we have to look at the future cash flows. Let think we initially are putting in 25 Million for the warehouse. We then should estimate this as such, lump-sum present value amount 25 Million, then let’s say we can had to sell the warehouse less than 25 million, the purchasing company would do this because it would be a positive NPV.
If Starrett sold the warehouse at 20 Million, then the investment represents a 5 million net gain, during this investment period. The 5 million is the intrinsic value. If we take the IRR of anticipated profitability we calculate 25 million this will last probably about 15 years (but we will calculate 3 years), but it is expected to generate an additional annual profit of 20%, roughly 40 million. At the end of the 3 years Starrett could sell the warehouse for about 7.5 million. Using the IRR we can determine we should return about 28% (Investopia.com).
0 = -$25,000,000 + ($40,000,000)/(1+.2431) + ($40,000,000)/(1+.2431)2 + ($40,000,000)/(1+.2431)3 + $7,500,000/(1+.2431)4 Looking at the NPV and IRR we can see that this investment will bold well for the company, if all goes according to plan and sales increase. If the company suffers additional profit losses, the initial addition of this warehouse could be a real loss. But if you look at the three year future you can see a high return of 28%, so over time the company should see gains from the warehouse.