SaraCorp is a well established industrial component firm. Reflecting its history, the firm produces to order and has a low fixed cost & high variable cost operational structure. The Firm...
SaraCorp is a well established industrial component firm. Reflecting its history, the firm produces to order and has a low fixed cost & high variable cost operational structure. The Firm now wishes to move forward and pursue a very high growth strategy. You have been asked to review the firm from a production perspective and then provide recommendations and guidance to its management.
As your question implies, the rapid growth of a manufacturing business or, more to the point, the success of that growth, depends upon the ability to produce its goods in a timely manner and to distribute those goods effectively. As many business analysts note:
This problem most often strikes on the operational end of a business. Demand for a product will outpace production capacity, for example.
In SaraCorp's situation, rapid growth is both an opportunity and a serious threat. The corporation's low fixed costs--I assume that includes its infrastructure, employees, operating funds and borrowing capacity (liquidity)--result from its decision to produce to order rather than produce to capacity, and these costs will expand commensurately with its growth. It's high and variable operational costs, which are undoubtedly tied to production based on orders and therefore difficult to plan for, may actually reduce as a result of growth because economy of scale comes into play. As production increases and the workforce is stabilized at the appropriate level, the cost of producing an item decreases because the company's manufacturing capability is being used to its capacity.
A good analyst/adviser will focus first on SaraCorp's capacity to expand its infrastructure (which may currently be underused)--that is, its physical plant and its capacity to dramatically increase its manufacturing. If its current fixed costs are low, then the adviser's first concern is whether those low fixed costs can remain low given the expansion. That analysis will focus on the state of the current manufacturing facility and its economics: Is the facility owned outright by SaraCorp? Is it leased and, if so, what are the terms of the lease? Based on the aggressive expansion, can the physical plant meet its new demands without significant capital improvements? If it requires capital improvements, where are those funds coming from? In the area in which the manufacturing facility is located, is a large enough workforce available to meet the demands of the expansion, and is the workforce educated and trained? Is SaraCorp's administrative capability--personnel, human resources, occupational safety, benefits package--sufficient to handle the expansion?
SaraCorp's finances will also be scrutinized closely. Its current low fixed costs will blossom significantly as the expansion unfolds, and the company's liquidity needs will grow exponentially, especially during the initial phase of the expansion, because the company may have to expand its capacity, with a large outlay of capital improvement money, before it reaches a "critical mass" where an expanded customer base is achievable. The company's access to liquidity--daily operating funds--is a critical component of its expansion, and the adviser will focus on the company's borrowing capacity, especially its existing lines of credit, in order to determine whether the expansion is feasible or, more likely, how to expand gradually so as not to jeopardize either the physical plant's capability or the financial underpinnings of the company.
Among several factors, then, an adviser to SaraCorp will most likely spend most of his or her efforts understanding the company's physical capacity to expand and its access to working capital.