Motor Manufacturing Business Simulation - Case Study Example

Introduction Business simulation has been considered as an important technique in business to analyze and forecast the situation or condition. One ofthe forms of business simulation techniques is the scenario-based simulation under which the management of the company creates a scenario of the product being launched or a scenario of the conditions that the existing product or service of the company would be facing. Business simulation is helpful in critically identifying and analyzing important factors that could influence the firm’s operations and its profitability. This report is based on the launching of Spartan Cars on the European Market and as the idea of the cars has been proposed by the management, this report will analyze how the Spartan Cars having two models have performed in European market in their first five years’ time period. The report will analyze the profitability of the company and the costs that are associated with the cars. The financial ratios of the introduction of the cars will also be discussed and analyse whether the ratios are attractive for investors or not. The report will also recommend future actions for the management so that the introduction of the cars in the European market is successful. Analysing the performance One of main factors that have been used to analyse the performance of the project is the financial performance (Gitman, 2003). The financial performance of the project looks attractive as the company expects high sales as the products have been introduced in the market. The sales of the products, i.e. both the models of Spartan cars have increased as the products have been introduced in the market. However after the third year the sales of both the products declined and from then onwards, however, in the fifth year, the revenues increased a bit. The cost per unit of the sales remained very much the same in the first two years however as the sales increased in the third year, the cost per unit sale of the product reduced as the fixed costs has been distributed to more number of units. However in the fourth year after the introduction of the Spartan Cars, the sales of the car reduce. But then in the next year the sales increased. There can be several reasons for the reduction in demand of the car and some of the most important ones would include; new models of cars would be available, people would become used to Spartan Cars, change in preferences and buying behaviour of the consumers and thus consumers would be looking for something new and fresh, or even advancement in technology could be one of the factors that encouraged people to look for more advance cars. So, with the reduction in sales of the company, the cost per unit of the cars would increase as the fixed cost will be distributed to lower number of cars. The gross profit margin is the ratio that is calculated after subtracting the cost of sales from the total sales (Friedlob & Plewa, 1996). Gross profit margin reduced as the sales increased in the third year, however as the sales reduced in the years to come, the gross profit margin reduced as well. The gross profit margin reached as low as 13.87% in the fifth year indicating that the revenues or the sale price of the products have been changed as the profits from each of the product sold has been reduced. The following table shows the prices of both the models over the period of five years: The following table reflects the revenues and costs of the Spartan Cars as estimated by the management: The operating expenses of the company also varied in the passage of five years. The fixed overheads of the company initially increased in the first three years as the sales of the company increased. The increase in the fixed overheads influenced the operating profit of the company. The operating profit increased but it decreased after the third year. In the fifth year of its operations, the project incurred an operating loss of 327.37 million. A similar pattern has been shown by the operating profit margin which is defined as the ratio of operating profit to total revenues (Kaplan, & Atkinson, 1998). As the operating profit margin has been high in the first three years, however as the sales started decreasing, this negatively affected the operating profit margin as well. The operating profit margin reduced from 16.22% to 5.86% from third year to fourth. Moreover, the operating profit margin further slipped in the fifth year as the company incurred a loss and, thus, the operating profit margin reached to -9.09%. The market share of both the models; model 1 and model 2 have been increasing since the time the products have been introduced in the market. However after the third year, the market share of both the models started slipping and, thus, the management had to come up with something to maintain the market share. The following graph shows the market share of both the models of the company in five years and it can be seen that the market share started reducing but then the steps taken by the management helped in increasing the market share in the fifth year. As the market share started slipping, the management was proactive to identify it and take actions. The most important action that the management took as the market share started slipping was that they reduced the price of the products and this has been one of the main reasons that have resulted in the loss in the fifth year. The management identified the reduction in demand in the fourth year and they believed that by reducing the price of the cars, the sales could be increased and the profitability could be further enhanced. The price of the Model 1 and Model 2 have remained 19,995.00 and 37,995.00 respectively from the first year till its fourth year however as the sales declined, the prices were reduced to 17,995.00 and 35,995.00 for Model 1 and Model 2 respectively. Reduction in price would increase the demand of the product, however if the price is too low then it would not result in profits (Arnold, 2008). Therefore, the management should have carefully analysed using sensitivity analysis technique the right price that should be offered. The main purpose of the product is to earn profits, however by reducing the prices the management did not consider the cost associated with the project. Therefore, the management should have carefully evaluated the returns at different prices along with the change in demand and then they should have come up with a price that would have helped in improving the profitability. The other important step that the management took as they identified reduction in market share was that they increased the Research and development expenditure. As the sales started declining in the fourth year, the management started investing more money on research and development activities so that they could come up with another product that could meet the changing needs of the customers and the company would be able to maintain its profitability. With more research and development expenditure, the company increased its cost and thus resulted in losses. The following graph shows the expenditure that the company made in research and development over the period of five years and it can be identified easily that the R&D expenditure has increased drastically in the fifth year. After analysing the financial ratios of the company, it can be found that the company has very high current ratio. This would mean that the company has too many current assets and these assets are not been properly utilised. The current ratio of the company has been increasing most of the time thus it is indicating that most of the assets of the company would have a life of only one year. As the difference between the quick ratio and current ratio is not very high, this is indicating that the company does not have high inventories piled up which is a good thing. But still, the company has too much capital consumed in the form of the current assets. The quick ratio of fourth and fifth year is the same as the current ratio thus it is indicating that the company does not have any inventory or stock piled up. The return on assets is defined as the ratio of total earnings and the total assets of the company (Khan, 1993). Return on assets of the company has been improving in the first three years, but then it started slipping. The return on assets could have been further improved, if too much of the capital has not been consumed in the current assets. Also as the year-end profits of the company started declining from the fourth year, the return on assets is calculated using the net profit therefore the return on assets also reduced after the third year despite of reduction in total assets. Recommendations Spartan Cars as they have been introduced received positive response from the market and it followed a similar pattern as of the product life cycle i.e. the product as it is introduced it receives mild response from the market however as it grows the demand is increased as the demand of the Spartan Cars increase in the second year. Then the product reaches it maturity in the third year where it achieves sufficient level of sales, however, after the maturity the products started declining as the sales declined in the fourth year. The following diagram shows the product life cycle: (Quick MBA) Comparing the product life cycle, with the sales of the Spartan Cars in the first four years, a similar kind of pattern can be achieved and it has gone through similar phases: As the product reaches the decline stage, the management becomes conscious whether the product would remain in the market or not and therefore they tend to at times overreact (Kotler, 2009). The same is the case with the Spartan Cars as the management at the time identified that the product is reaching its decline stage they reduced the price. The reduction in the price was a good step considering the decline of the sales of the product. However, the management should have properly and carefully analyse the decision to reduce the price. As the management reduced the prices, the profitability of the company suffered and the company was not able to achieve operating profits. Therefore it would have been good if the management had conducted a sensitivity analysis and should have identified the right price of the product that could have increased the demand of the product and at the same time would have helped the company to achieve profits as well. As the sales of the products have been declining, the management could have taken other steps as well. For instance, the company could have conducted market research and identify the changes in consumer behaviour and preferences and then they could have modified to product to meet their needs. This would have allowed the company to meet the needs of the market with a new model and at the same time it would have also allowed the company to remap itself in the product life cycle. REFERENCES Arnold, R. (2008). Economics. Mason, South-Western Cengage Learning. Friedlob, G., & Plewa, J. (1996). Understanding Balance Sheets. New York: John Wiley & Sons. Gitman, L. (2003). Principles of Managerial Finance. Boston: Addison-Wesley Publishing. Kaplan, R., and Atkinson, A. (1998). Advanced Management Accounting. New Jersey: Prentice-Hall. Khan, M. (1993). Theory & Problems in Financial Management. Boston: McGraw Hill Higher Education. Kotler, P. (2009). Marketing Management. Pearson: Prentice-Hall. Quick MBA. The Product Life Cycle. Available at http://www.quickmba.com/marketing/product/lifecycle/ [Accessed 22nd July, 2012] Read More