Executive Summary
The veterinary care industry has been growing steadily in the past three years with an average of 8.37% growth rate per annum. The spending in the industry has grown from $11.1 Billion to $14.11 Billion from 2008 to 2011. The growth in this industry can be attributed to the increased level of pet ownership and a trend of humanization of pets which has led to increased owners’ willingness to pay to take care of their pets. Due to this increase, veterinarians need more in-house lab equipment to provide for this increased amount of care. 40% of the veterinary practices in the United States have the necessary in-house equipment to cater to this, therefore, this is imperative for Bergerac to remain competitive in quality and price terms. From 2007 to 2009, while Bergerac’s revenues grew 37.4% and gross profits grew 34.5%, operating income and net income have not increased proportionally due to the significant increase in operating expenses.
To cater to this market, Bergerac introduced their OmniVue instrument, a highly accurate, simple to use and competitively priced product, targeted towards small and medium veterinary clinics. However, the cartridge production of the OmniVue instrument requires reagents, which are supplied to them by multiple third party chemical suppliers. Any volatility in the supply of these reagents leads to negative feedback from customers and damages Bergerac’s brand and potentially harm future demand. Due to the capacity constraints for their suppliers, it was difficult for them to react to unexpected demand spikes which led to production delays. This has resulted in Bergerac having to carry more inventory and finished goods and thereby incurring additional costs while still not being able to meet its demand.
By taking advantage of vertical backwards integration, Bergerac could attain the flexibility to meet the demand of their OmniVue instrument. By establishing an internal source of inputs (cartridges) Bergerac can align its specific input requirements more accurately than it could by relying on third party suppliers. This is because the efficiency of the manufacturing process and ultimately the quality of the final goods, will be improved by minimizing the sources of potential miscommunication between Bergerac and its suppliers. To make this decision to vertically integrate, we must take into account a set of assumptions which include: the potential costs incurred by the firm by stock-outs due to insufficient supply by outside suppliers is greater than the costs to manufacture in-house, second, Bergerac will attain higher savings in-house rather than buying from GenieTech or any of its other suppliers. After the decision to vertically integrate, Bergerac can either: acquire GenieTech, one of its major suppliers, invest in cartridges manufacturing in-house, or one of the hybrid strategies. However, neither of these options would reduce their vulnerability to oil prices and supply as oil is an external factor impacting all plastic suppliers. After conducting our financial evaluation, we have determined that the best decision for Bergerac would be to vertically integrate backwards by acquiring GenieTech. However, strategically, the best decision for Bergerac would be to invest the $5.75 million, which it would cost to acquire GenieTech, to instead invest in in-house cartridge manufacturing and further improve its core business.
Strategic Analysis
From a strategic standpoint, the acquisition of GeonieTech is the best course of action for Bergerac, assuming that the shareholders of GenieTech would approve of this acquisition. Resulting from this acquisition Bergerac would be able to drastically improve their production process by (1) gaining instant access to 8 in-house cartridge production machines. (2) Gaining instant access to the machine operators, reducing the associated training costs of building of an in-house production plant. (3) Reducing setup time, effort & spending (product testing & machinery installing) associated with the Parsippany plant. This would subsequently lead to a leaner and more efficient production process.
Although Bergerac only needs four of the eight machines to fulfill their own consumption needs, the other machines will continue to operate to fulfill the needs of other GenieTech customers. This production strategy will allow Bergerac to diversify its stream of income and generate additional cash flows that could potentially be allocated to Research & Development to increase Bergerac’s production efficiency.
Furthermore, the additional four machines currently not used for Bergerac’s own consumption needs will allow the company to quickly increase its future production based on demand. This is a highly important factor when considering Bergerac’s high expectations for future growth (9%, see GenieTech exhibit). Based on our projections, this extra production capacity would allow Bergerac not to purchase additional machines until 2015 as it can pivot machines currently used to service outside customers towards its own needs. Moreover, the company would be less likely to miss out on any potential earnings resulting from increased cartridge demand as a production ramp up could happen instantly. Analyzing the strategic implications of a GenieTech acquisition relating to cartridge production, it is obvious that it will give Bergerac a competitive edge in its industry.
Moving on to other strategic considerations of acquiring GenieTech, it is worth considering the implications and consequences of future industry-wide trends. More specifically, when calculating the NPV of the two alternatives (build or buy) we ignored the impact of a future industry shift on the current value-add of acquiring GenieTech. For instance, if other lab-equipment providers switched to a cheaper cartridge alternative, this would limit Bergerac’s flexibility result in immediate obsolescence of its newly acquired equipment.
Another strategic consideration is a hybrid alternative which can include a long term contract with an array of volume clauses. A long-term contract between GenieTech and Bergerac would grant the supplier a steady stream of cash flows and a reduced, per unit, cost for the buyer. Furthermore this contract would shield Bergerac from the industry-wide volatility of cartridge supply. As a result, Bergerac can satisfy its demand more reliably and with a lower lead time. A strategic alliance with a cartridge supplier could also be considered.
Financial Analysis
When looking exclusively at the results from our calculations, we concluded that acquiring GenieTech would be more profitable for Bergerac when compared to in-house production. Even though McCarthy’s conclusion had been different, we realized three aspects that he did no take into account accordingly: growth rate of cartridges, time value of money and the additional revenue that would come from GenieTech’s acquisition. Taking these factors into account, we completed a discounted cash flow analysis to determine whether integration or in-house production have the highest return metrics. We decided to use Net Present Value (NPV) and Internal Rate of Return (IRR) as the metrics, as together the two metrics allow us to estimate total cash flows and also the percentage return.
To obtain the two metrics, some assumptions had to me made. First of all, we assumed a growth rate of 9%, considering industry analysts projected growth of 8% to 10% for the market. Secondly, we assumed a discount rate of 12%. In addition, we assumed that there were no more capital expenditures and no outside suppliers would be needed. Lastly, to take into account economies of learning of Bergerac producing it in-house, we must make assumptions on the savings obtained in terms of estimated capacity utilization and labor productivity multiplier. Capacity utilization was estimated at 60% year 1 and 80% year 2 and labor multiplier was 90% year 1 and 100% year 2. Savings realized in terms of capacity utilization should take into account starting up issues that the new plant would face which GenieTech would have already experienced and learnt from. Labor multiplier should take into account that overtime labor will become more efficient and understand procedures and demand schedules. These factors were not taken into account by McCarthy however are important as most new plants starting up face start up issues. This led to his analysis taking a slightly over-favorable view of the build side. GenieTech’s acquisition has an NPV of $8,393,420 and an IRR of 40%. In contrast, the in-house option has an NPV of $3,666, 437 and an IRR of 25%.