Answer

The case, Anwar Aluminum Works, is based on an actual situation that occurred. The case has been specifically chosen due to its links to entrepreneurial issues and problem solving in the areas such as relevant costs, sensitivity analysis, breakeven, return on investment and payback. 1. Calculate the projected contribution margin rates for each product order 2. Identify all the potential cash flows associated with each of the two product orders and break them down indicating whether each one is fixed or variable and whether it is a recurring cost or a one-time cost.  3. Perform a quantitative assessment: a. Prepare an incremental analysis for each of the two customer orders, including the incremental cash inflows and outflows from operations for each order. b. determine the return on investment and the payback period in years for each scenario based on your calculations.

ANWAR ALUMINUM WORKS

Amy Shuh wrote this case under the supervision of Elizabeth M.A. Grasby solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) cases@ivey.ca; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-02-18 It was mid-February 2013, and Michael Crawford had just sat down to review two customer orders for new products. As plant manager for Anwar Aluminum Works (AAW), located in Windsor, Ontario, Crawford knew that operations were nearing capacity and both orders could not be filled simultaneously, based on both customers’ expected delivery dates. Since the customers would want a decision soon, Crawford had to decide which order would be the best one for AAW to accept.

THE METALS INDUSTRY The global metals industry included the manufacturing and mining of all types of metals, such as iron and steel, aluminum, base metals,1 and precious metals. Total revenues generated in this industry were close to $3 trillion in 2012.2 The primary metals industry, a subset of the global metals industry that included aluminum manufacturing, was composed of companies involved with separating metals from ores,3 drawing or rolling metal into sheets, and pouring metal into casts and/or molds. In 2012, the North American primary metals industry reported $230 billion in annual revenues.4 Due to increased urbanization within Asian countries and the continued need for products in developing nations, the primary metals industry had experienced unprecedented demand throughout 2012. The growth of the middle class within these Asian and developing countries had created demand for metal, especially steel, in the automotive and construction industries.5 After steel, aluminum was the second most commonly used metal and was produced more than all other non-ferrous metals combined. 1 Base metals are non-ferrous metals, excluding precious metals. 2 www.icmm.com/trends-in-the-mining-and-metals-industry, accessed January 6, 2014. 3 An ore is a type of rock that contains minerals, including metals. 4 www.icmm.com/trends-in-the-mining-and-metals-industry, accessed January 6, 2014. 5 Ibid. Page 2 9B14B001 THE ALUMINUM INDUSTRY In North America, six of the largest companies generated 60 per cent of the total aluminum manufacturing revenues. The aluminum was either sold directly to the end users, such as car manufacturers, or to metal service centres that bought stock for resale to smaller manufacturers. This customer base did not require traditional advertising. Instead, aluminum manufacturers marketed their products based on their delivered price and quality of product. Often, manufacturers would obtain long-term supply contracts with their larger customers. In 2012, 45 per cent of the demand for aluminum came from motor vehicle and machinery manufacturers. In an effort to cut costs, many aluminum customers moved their manufacturing facilities outside of Canada to take advantage of lower labour costs. Finally, the development of alternative materials, such as ceramics and plastics, posed a threat to aluminum manufacturers since these products were lighter, with durable characteristics that could replace the need for aluminum. Supply and demand determined the price of aluminum. This market price was referred to as the “spot price.” It was the industry norm for aluminum manufacturers to charge its buyers the spot price plus a spread6 for producing an aluminum product or an alloy.7 To maintain profitability in the North American aluminum manufacturing industry, there were several key success factors. The first was the protection against fluctuating prices. Through the trading of futures,8 aluminum manufacturers could mitigate the risk of holding inventory in a market when the selling price could fluctuate by 20 to 25 per cent on a daily basis. Second, improved production efficiency was critical. In order to successfully compete with offshore manufacturers with lower operational expenses, improved efficiencies were essential and were usually achieved by ensuring little production downtime. Additionally, with the rise of energy prices, this efficiency was imperative. Third, to achieve minimal production downtime, production scheduling and inventory control and management were crucial. Fourth, as the industry had become more automated, it was also critical that workers were trained to operate the computer-controlled systems. Last, to compete with offshore manufacturers’ prices, North American manufacturers needed to develop and offer more specialty products, beyond sheets (of aluminum), and applications to gain a competitive advantage.9 ALUMINUM ALLOY MANUFACTURING PROCESS The production of aluminum alloy began by separating, through a melting process, the aluminum metal from the ore. Once completed, various metals were added to the aluminum to produce the alloy. Changing the chemical characteristics at various stages of the production process produced the differences in alloys. Variance in the strength and durability of the aluminum product further depended on the heat treatment utilized throughout the production process. This complex method of metal production had been enhanced by modern production technology that allowed for better control of the production factors, such as the amount of heat and chemicals used. Throughout the manufacturing process, an estimated 20 to 40 per cent of operational costs stemmed from usage of utilities, specifically electricity. 6 A spread is the profit equal to the difference between the purchase price and the selling price. 7 An alloy is a metal made by combining two or more metallic elements to give a greater strength. Aluminum alloys are alloys in which aluminum is the predominate metal. 8 “Futures” refers to the financial contract that obligates the buyer to purchase an asset at a predetermined future date and price. This helps the buyer ascertain the price of the commodity sold at the determined date. 9 Primary metals manufacturing –– quarterly update 12/17/2012, 2012. First Research Industry Profiles (Dec 17). Page 3 9B14B001 After its production, the aluminum alloy was poured into an alloy cast billet (a cylinder of aluminum with varying lengths and diameters). To become malleable,10 the billet was heated and then extruded11 through a die to give it a cross-sectional and often hollow shape. At this point, either a heat treatment or quenching (the rapid cooling) was conducted in order to maintain the materials’ physical properties. (See Exhibit 1 for the extrusion process and Exhibit 2 for examples of finished extrusion-manufactured aluminum pieces.) ANWAR ALUMINUM WORKS Vincent Johnson, a leading American industrialist and businessman, founded Anwar Aluminum Works (AAW) in 1946 after the acquisition of three aluminum-manufacturing facilities from the U.S. government. Since its inception, AAW’s operations were based in its main expertise of aluminum metallurgy.12 After several geographical expansions since 1959, AAW had grown its operations to a total of 16 manufacturing facilities with 2,600 employees across North America by 2012. As a publicly traded company on the NASDAQ,13 AAW reported fiscal 2012 revenues of US$1.36 billion and a profit of US$85 million.14 AAW served four key markets: automotive, general engineering, aerospace and high-strength products, and other industrial products. The firm prided itself on its ability to maintain long-standing relationships with customers and to be their preferred supplier. In an effort to continue its competitiveness in the market, AAW reduced manufacturing costs into the 2012 fiscal year through the implementation of more efficient manufacturing practices, aimed at eliminating waste throughout its operations. AAW’s main competitors included regional market players and large international conglomerates. Some of AAW’s competitors boasted larger financial resources, greater efficiencies with regard to technologies, and the ability to purchase raw materials at a lower price. In an effort to rise above these competitors, AAW focused on differentiating itself by offering technical expertise and a wide variety of exceptionally high-quality products. AAW WINDSOR AAW’s Windsor, Ontario, production facility was the firm’s only Canadian manufacturing plant. This 350,000-square-foot plant used the extrusion process of aluminum manufacturing for the automotive industry. The Windsor location was chosen strategically for its close proximity to several auto manufacturers in the regions of southern Ontario and Detroit, Michigan. Crawford, a professional engineer, had been working for AAW for 10 years. As the plant manager, Crawford was the key liaison between the manufacturing operations and the sales force. He was always balancing the tension between keeping operational expenditures as low as possible, while maximizing the potential revenue of the plant. At the end of the day, Crawford was accountable to AAW’s corporate office for the profit and loss statement of the Windsor operations. The plant’s raw material input for its operations consisted primarily of aluminum and scrap aluminum, purchased in bulk at discounted rates from third-party suppliers. This plant’s main advantage was its 10 “Malleable” is a term used to describe a metal’s ability to be easily shaped or formed through the addition of pressure. 11 Extrusion is the process of shaping the metal by pushing it through a die. 12 Metallurgy is the science that deals with procedures used in extracting metals from their ores, purifying and alloying metals, and creating useful objects from metals. 13 The NASDAQ is a U.S. marketplace for buying and selling securities; it acts as the benchmark for U.S. technology stocks. 14 AAW Annual Report 2012. ability to mix certain alloys specifically requested by each customer. An alloy mix consisted of pure aluminum, known as “prime” and purchased by AAW at the market price, as well as scrap pieces for which AAW paid less than market price. AAW negotiated with scrap suppliers for payment in 30 days from the time of sale to AAW. AAW’s primary aluminum suppliers offered AAW 20 days to pay for its purchases from the time of sale to AAW. The firm strived to maximize profits on the alloy, due to its lower prime aluminum content and higher percentage of scrap aluminum input. TWO NEW ORDERS Renfrew Automotive On February 12, 2013, Renfrew Automotive (Renfrew), a major firm in the automotive manufacturing industry, approached AAW Windsor with an offer for a new, high-strength aluminum product to be used in the development of an automotive part. Based on the demanding mechanical properties required for the product, Renfrew requested a specific alloy that would meet the desired fit, form and function. The annual volume of the sale would be 180,000 pieces, each weighing two pounds, for an expected two-year time horizon. Based on the specific alloy formulation, Renfrew would pay AAW Windsor the price of aluminum at the market rate plus a spread of $0.75 per pound.15 Renfrew would pick up the end product twice monthly; however, Renfrew’s orders and scheduling could fluctuate as much as 25 per cent, requiring AAW Windsor to maintain an average of 15 days’ worth of inventory of the product at all times. AAW had a policy of offering credit terms to customers of net 45 days, but Renfrew would pay upon delivery due to the specialized nature of its product order. AAW Windsor determined the alloy mixture most appropriate for this order would be a mix of 50 per cent prime aluminum and 50 per cent scrap aluminum. The scrap aluminum could be purchased at a $0.06 per pound discount from the current market price of aluminum. Due to product-quality control, the projected manufacturing press recovery would be 80 per cent; therefore, based on the order’s expected annual volume of 360,000 net pounds, 75,000 pounds would have to be cast every two months to extrude 60,000 net pounds. Since this product would be a new alloy developed specifically for Renfrew, it would cost $80,000 for the specialty cast moulds to be used in the manufacturing process. As well, there would be $20,000 spent annually for replacement cast moulds and maintenance costs on the equipment. The specialty moulds were expected to have a five-year useful life and would be depreciated using the straight-line method. Crawford had anticipated spending five percent of his time over the next six months overseeing the initial manufacturing of this order for this new customer. Evers Manufacturing The following day, February 13, 2013, AAW Windsor received a request from Evers Manufacturing (Evers), a smaller niche automotive manufacturer. Evers’ order would consist of 400,000 pieces, at one pound each, annually for two years. This alloy mix would consist of 10 per cent prime aluminum and 90 per cent scrap aluminum. Based on the commonality of the product, the customer spread was projected at $0.60 per pound. Evers would pick up the order monthly, but based on the product’s niche use, the amount picked up could vary as much as 50 per cent. The alloy to be developed was a more common formulation, so AAW Windsor would need only a $2,000 investment in new moulds for the manufacturing process. Additionally, no other maintenance costs would be required, but it was estimated that $2,500 in additional labour costs would be needed annually. This basic manufacturing would also demand only a 92 per cent manufacturing press recovery. As a result, it was decided to hold 30 days’ worth of this order at all times. AAW Windsor noted that Evers would take advantage of AAW’s credit terms to customers of net 45 days. CONCLUSION Crawford was quite pleased with AAW Windsor’s recent performance, especially with respect to keeping plant utilization at a relatively high level. Faced with two new customer orders, he wondered how he could use the remaining plant capacity to maximize profitability. Crawford sat down to review the alternatives, both qualitatively and quantitatively, and he would make a decision once his analysis was complete.

 

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