Whirlpool Corp: Ways of Improvement the Effectiveness - Assignment Example

Introduction Whirlpool Corporation is the worldwide leader in the home appliance industry with a 13% share of the European market. It operated 11 manufacturing plants producing 6,900 SKUs. It moved the finished goods to 2 central distribution centers and then to 12 regional distribution centers to reach customers. In each major European market, Whirlpool had a country sales office which handled sales generation and forecasting, order processing, billing and collection. They served 2 types of customers – direct consumers who purchases appliances for their homes and contractors who needed built-in appliances for new home constructions and kitchen remodeling. Success in these 2 markets depended on product quality, price, availability, and on-time delivery. Currently, with the wide scope of Whirlpool’s operations, it has disjointed information systems implemented in the various business units which hamper the company’s success in meeting its customer and operations requirements. To remedy this, Whirlpool is evaluating the plan to implement a company-wide enterprise resource planning system, called Project Atlantic. The cost of Project Atlantic is sizeable both in financial and non-financial terms. A rigorous capital investment appraisal, both quantitative and qualitative need to be conducted before embarking on the project (Case Resource). Question 1: Summarize the main factors that Whirlpool Corp needs to take into account when deciding whether to invest in the enterprise resource planning (ERP) systems named Project Atlantic. Your summary should include: • The BENEFITS to be gained from the system • The COSTS likely to be incurred by its implementation and maintenance • The RESOURCES to be used in its implementation and maintenance Whirlpool Corp’s Project Atlantic is an undertaking to design and implement an enterprise resource planning (ERP) system that would allow the company to better serve its consumer and contract markets for appliances, as well as reduce its inventory by 12 days of sales. Enterprise resources are the manpower, machines and materials necessary for business operations and which have to be properly allocated and utilized to achieve business objectives. The main factors that Whirlpool Corp needs to take into account to decide whether to invest in Project Atlantic are the benefits that can be derived from the project; the costs of design, implementation and maintenance; whether benefits outweigh the costs and when will the company get payback from the ERP systems; how long will the process of designing and implementing take and what external and internal resources are necessary; and what changes need to be undertaken by the company to enable the new systems to fit in, how will these changes affect concerned employees, and how shall changes be handled in the least obtrusive way (Wailgum, 2008). The benefits expected from Project Atlantic include: Working capital reduction through reduction of the number of days of inventory by making the supply chain transparent and efficient; Revenue and gross margin increase through increase in product availability through a more visible supply chain more visible and integrating sales forecasting and inventory management; Cost savings through simplification of customer orders processes and the accounting function - reducing the number of order desk employees and finance employees; reduction of warehouse space due to the decrease in inventory levels; reduction of customer returns; reduction of bad debt expenses and information systems expenses Increased efficiency in the distribution process by allowing country sales offices to monitor products throughout the supply chain; Allow the company to build products to specific orders from contractors Projected Atlantic is expected to reduce 12 days of inventory in each wave of implementation yielding a total of USD 34.3 million inventory savings. It is also expected to improve product availability which will increase sales equivalent to 25% of the improvement and increase company profitability by the second year of implementation with a 0.25% increase in margins. Expense savings are expected at close to USD 5 million by the third year of implementation and around USD 3.5 million per year hence. The costs projected to be incurred with the implementation and maintenance of Project Atlantic include: Capital expenditures for capital equipment and software licenses; Implementation costs for employee training; creation, testing and documentation of new business processes; installation of the ERP software; engagement fees of external consultants; On-going operational costs for the management and maintenance of the new information systems, and license maintenance fees until the system is replaced. Capital expenditures for Project Atlantic are at USD 24.8 million, cost of consultants are at USD 6.5 million, task-force at USD 1.8 million and on-going maintenance costs are estimated at USD 3.4 million annually including license maintenance fees. The resources needed for the implementation and maintenance of Project Atlantic include: The enterprise resource planning (ERP) systems hardware and software; External consultants who will assist in the design, development and implementation of the systems; Company employees who will be involved in the design, development, implementation and use of the systems; Financial resources needed to undertake the project. Whirlpool Corp needs to improve operating effectiveness and efficiency in the marketing, operations, logistics and finance areas to increase revenues and profitability and realize cost savings from operations. Project Atlantic aims to achieve these improvements and its implementation has to be decided on based on an evaluation of the factors detailed above to ensure that the benefits outweigh the costs, both financial and otherwise. Question 2: Analyse the spreadsheet i.e. at 9% and 40%. On the basis of your analysis, would you recommend Whirlpool Corporation to proceed with the implementation of the proposed ERP system? Explain how you have used the information in the spreadsheet model to arrive at your recommendations. A cash flow is “a measure of a company's financial health. Equals cash receipts minus cash payments over a given period of time; or equivalently, net profit plus amounts charged off for depreciation, depletion, and amortization” (Investor Words, 2008). The incremental cash-flow principle is a “project financing concept that the only cash flows relevant to the valuation of a project are the incremental cash flows resulting from it” (Business Dictionary, 2008). In the Incremental Cash-Flows and Valuation for Project Atlantic, the first line item is Capital Expenditure and contains figures for cash outlays for capital equipment and software licenses for the project represented in negative amounts. The next item is Revenue and positive amounts represent cash receipts upon implementation of the project. Note that no Revenue is posted in 1999 because the project is still in the design and development stage during this year and revenues for 1999 are not attributable to Project Atlantic. Cost of goods sold, operating expenditures and depreciation expense are all expenses necessary for generating revenue and are normally represented as negative amounts. Note that an operating expenditure figure is present for 1999 because this expense is necessary during the design and development phase of the project. Note also that the operating expenditure figures for 2005-2007 show positive amounts signifying that cost savings have overtaken expenditure for those years. Revenue minus the expenditures equals taxable earnings. To arrive at the figure for the remaining cash from operations, the tax rate of 40% is applied on taxable earnings and depreciation added back since this is a non-cash entry. A negative figure for cash flow from operations indicates that at the specific time (e.g. 1999 and 2000), the project is short of cash or that more expenses are incurred than revenue being generated. To arrive at the actual cash remaining, the “cash-flow” item adds the negative value of capital expenditure, the negative or positive value of cash-flow from operations, and the positive value of reduction in need for inventory. The spreadsheet shows positive cash-flows starting in year 2001. The discounted cash flow is a method of valuing a project using the concepts of the time value of money. Future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and may incorporate judgments of the uncertainty of the future cash flows. (Wikipedia, 2007). In the spreadsheet, a 9% discount rate is used which yields an internal rate of return equal to 34.78%. This IRR may then be compared with other project IRRs with similar objectives as Project Atlantic to determine if Project Atlantic is the better project to undertake. With the discount rate being borne by the company at 9% and an IRR of 34.78%, the company can surmise that interest rates would have to rise a long way before the project becomes non viable. Based on the Incremental Cash Flows and Valuation for Project Atlantic, the recommendation is to pursue the project. Generally speaking, since the rate of interest being considered is less than the IRR, the net present value of the project is sure to be positive, meaning that at the future points in time, the project is in a status of discounted cash inflow, rather than outflow, and would add value to the company. Moreover, the payback period for the capital investment occurs between 2002 and 2003, well within the 5 year norm for risk-averse managers (Williamson, 2003). Question 3: The spreadsheet model can be used to help test the sensitivity of the projected costs and benefits of the investment to externally driven changes. Suppose instead of the values given in the spreadsheet the following values were amended: • Cost of capital (discount rate) = 15% • Tax rate = 50% • Shorter time horizon is envisaged reflecting the dynamics of technology: benefits and costs beyond 2004 should not be taken in account. Make all three changes and review the combined effects on the potential return on the ERP investment. What would you recommend Whirlpool do given the changed circumstances. How have your recommendations been influenced in light of the changes (i.e. Q2 to Q3) Sensitivity analysis is a technique used to determine how different values of an independent variable will impact a particular dependent variable under a given set of assumptions. It is very useful for determining the impact of a variable on the outcome if its value is changed from what was previously assumed (Investopedia, 2008). To help check the sensitivity of projected costs and benefits for Project Atlantic due to external changes such as increases in cost of capital and tax rates, the revised spreadsheet above was prepared. The combined effect of increasing the cost of capital from 9% to 15% and the tax rate from 40% to 50%, would obviously produce lower discounted cash flows. However, in year 2001, negative earnings (or loss) after taxes US$ -1.275 M is more than the negative earnings after taxes in the previous scenario (i.e., US$ -1.529 M) because less taxes had to be paid with the bigger loss. Moreover, cash flow from operations for 2001 increased because lesser loss was offset by the depreciation add-back. Since the discount rate increased, the discount factor decreased leaving more cash at the end of that period, 2001. The higher discount rate and tax rate reduces the cash flow for each period but at those rates, the fact that left-over cash exists tend to show that the project continues to be viable. With project time shortened by three years, the internal rate of return is reduced from 34.78% to 26.82%. As in the previous scenario, since the rate of interest being considered (i.e., 15%) is less than the IRR, the net present value of the project, again, is sure to be positive, with a state of discounted cash inflow at future times of the project and would add value to the company. An effect of the higher discount and tax rates though, is that a longer payback period on investment happens. Instead of payback between the fourth and fifth years, the new scenario shows payback between the fifth and sixth years. This payback period which happens beyond the fifth year may be a deterrent for a positive decision regarding Project Atlantic for conservative managers looking at high costs of capital and tax rates before project implementation. On the overall, the analysis tends to show that Project Atlantic would be viable at discount rates between 9% to 15%, tax rates between 40% to 50% and project times between 4 to 7 years. Question 4: To complete your analysis of the decision making situation facing Whirlpool Corporation, identify the kinds of non-financial information that the company should take into account. Explain your reasoning. With the objectives set by Whirlpool Corp, it will undertake Project Atlantic if the value of the benefits to be gained will outweigh the costs involved in the project. The previous questions attempted to determine the viability of Project Atlantic in terms of capital investment appraisal using popular financial methods. The systematic and objective approaches of financial analysis support the recommendation that Project Atlantic should be pursued. However, the process of innovation is more “intuitive, creative, chaotic and prone to risk of failure” (Case Resource), rather than linear, rational and certain. Factors other than financial information need to be considered before taking a decision and even before complex financial analyses are conducted, such as technical, social, political and economic information. Aside from profitability issues which can be demonstrated by quantitative methods, strategic applicability; political, social, cultural and environmental issues; and operations technology concerns have to be inspected and checked for compatibility, rather than conflict with the proposed innovation. The specific goal of Project Atlantic to increase sales to consumer and contract markets and reduce inventory should be checked against the overall corporate strategy. Operational changes that the project will bring on should be checked for impact on political, social and cultural aspects. The projected benefits from workforce reduction in the order processing and accounting functions may not be realizable due to the aforesaid factors. Since Project Atlantic is an IT innovation, additional IT-related factors also need to be considered. These are the intangibility of costs and benefits, the hidden outcomes of IT investments and the changing nature of IT (Case Resource). The ERP system technology and the technology supplier that will be selected for implementation of Project Atlantic should be carefully chosen for considerations of long-term viability, stability, and ability for migration to newer technologies. In terms of other stakeholder issues, factors to be considered include flexibility for the future, quality of environment, operational effectiveness and employee satisfaction. Aside from its specific goals, Project Atlantic is supposed to make life easier for employees in production, assembly, sales & marketing, order processing, distribution, accounting and other functions. This projected benefits should be checked through simulations or other means to determine if it is actually so. The results of the analyses of both non-financial and financial appraisal will define whether a clear cut recommendation can be made. In instances when the recommendation is finely balanced the appraisal serves as the supporting document for the reasons why decisions are made. Conclusion The importance of detailed appraisal of huge capital investments cannot be minimized as it affects the long-term successful performance of any organization. It is the very instrument for making sound strategic financial decisions dealing with past and future investments. For business managers, investment decisions must be weighed against future revenues that will be generated and the value or cost of the investment. Economics managers value investments against income and interest rates while finance managers look into company liquidity, cash flows and returns on investment. On top of it all, HR and operations managers look into the effects of projects for which investments are made, on the workforce and the political, social and cultural environments. Whirlpool Corp currently faces inefficiencies and lack of effectiveness in the various ways it conducts its business, hindering or minimizing its capabilities to achieve strategic goals in terms of increased market share and cost reduction, as well as customer and employee satisfaction. Project Atlantic aims to correct the inefficiencies and improve business processes that will ensure Whirlpool’s achievement of its strategic goals. But because of its substantial costs and the requirements for its complex implementation, detailed appraisal of Project Atlantic’s plan, design, development, implementation and maintenance have to be undertaken to make sure that benefits will outweigh the costs. Reference List Cash Flow. InvestorWords.com. Retrieved July 27, 2008 from http://www.investorwords.com/768/cash_flow.html Incremental Cash-Flow Principle. BusinessDictionary.com. Retrieved July 27, 2008, from http://www.businessdictionary.com/definition/incremental-cash-flow-principle.html Sensitivity Analysis. Investopedia.com. Retrieved July 27, 2008 from http://www.investopedia.com/terms/s/sensitivityanalysis.asp Wailgum, T. (2008). ABC: An Introduction to ERP. Getting Started with Enterprise Resource Planning. CIO. Retrieved July 27, 2008 from http://www.cio.com/article/40323/ABC_An_Introduction_to_ERP Wikipedia. (2007). Discounted Cash Flow. Retrieved July 28, 2008 from http://en.wikipedia.org/wiki/Discounted_cash_flow Williamson, D. (2003). Capital Budgeting: The Key Numerical Techniques. Retrieved July 28, 2008 from http://www.duncanwil.co.uk/invapp.html Read More