Professional Documents
Culture Documents
Bill Locke
July 28, 2008
Situation Audit
2000, Merton began to evaluate the idea of opening its own distribution center.
During times of economic growth, sales grow more quickly. This may be due to more
homes being purchased, and homeowners having more disposable income to spend on their
homes. The price of raw materials is positively correlated with the cost of floor coverings; when
the price of materials increases, so does the cost. Advances in technology have allowed
development in new types of synthetic materials used in products to meet consumer needs. As
styles and tastes change within the industry, different types of floor covering will see a growth or
decline in sales. A legal issue that many manufacturers need to be aware of is that the synthetic
materials should be flame-retardant, preventing a fire from quickly spreading over the floor.
The carpet and rug sales industry, which consists of approximately 100 manufacturers,
had sales of almost $12 billion and $18 billion at manufacturer’s and retailer’s prices,
respectively in 1999. Sales increased 7% over the past year, which was segmented between
contractors and retailers. Retailers currently account for 74% of sales. The top ten companies
within the industry produce 91% of sales, while the top three dominated the industry, amassing
85% in sales. The largest companies are Shaw Industries, Mohawk Industries and Beaulieu of
America; Shaw is currently the worldwide leader in sales. Shaw consumes 22% of the market
alone, while Mohawk lags slightly behind at 17%. Some competitors have an advantage by
selling their products directly to retailers to cut costs, while others sell through floorcovering
wholesalers. Several manufacturers sell other floor coverings other than carpeting, allowing
them to hedge some of their costs. During the 1990s, Shaw began operating its own retailer to
compete with other companies. The initiative failed, due to other retailers and wholesalers
switching brands as Shaw tried to increase competition. Carpeting is seen as a commodity
The industry sells its product predominantly through wholesalers and retail distributors.
Since the 1980s, manufacturers have shifted their focus from selling their products through
wholesalers directly to retailers. Purchases typically are based on price, with many retailers
forming buying groups in order to obtain price discounts by combining their purchases. Buying
groups have managed to obtain a lot of buying power, forcing wholesalers and manufacturers to
sell their carpeting at lower prices. The three largest buying groups, CarpetMax, Carpet One and
Abbey Carpets, accounted for $3 billion in sales. CarpetMax, Carpet One and Home Depot
registered 45% of all floorcovering sales by 1999. The market has consolidated considerably,
where 40% of the retailers are members of a buying group, a mass merchandise retailer, or home
center chain.
Merton sells premium priced carpeting primarily to the wealthier residential segment of
the industry. Merton specializes in having durable, soil resistant carpeting that has a long
lifespan. Under the names Chesterton and Masterton, the company’s sales were $75 million in
2000, 72% of which were attributed to residential markets. The company amassed a net profit
before tax of $3 million, while only accounting for 0.4% of the market. Merton distributes its
line through seven floorcovering wholesalers, who supply 4000 different retail accounts. The
wholesalers are spread across the Midwest, as well as the East and West Coasts. Half of the
company’s retail accounts provide 80% of overall sales. The company has strong relationships
among its wholesalers, many of which have served the company for more than 20 years. Merton
currently employs two regional salespeople to work with the wholesalers, assisting in advertising
and managing accounts. Merton primarily advertises its products through shelter magazines and
newspapers, where it focuses on the qualities and features of its carpeting. The company has
also had much success with retailers through its cooperative advertising program.
Currently, Merton has an opportunity to change its distribution methods. The company
could drop some of its wholesalers and begin selling directly to retailers. Merton, however,
would be late to enter this market, since most of the larger companies already have direct
distribution. The company has healthy relationships with its wholesalers, who are very loyal to
Merton carpeting. Though carpeting and rugs dominate the floorcovering industry, sales have
been declining for the past six years. Other types of floorcovering, including hardwood and
ceramic tile, have seen an increase in sales over the same time period. Critics have evaluated
that due to the lack of marketing of new innovations, the industry has suffered in sales. Since
price has become the determinant in most purchases, buying groups and retailers have squeezed
profit margins from manufacturers and wholesalers. Though margins are thinning, dollar sales
have risen as a result of manufacturers focused on cost reduction. As larger markets and
economies of scale open, companies have an opportunity to bypass their wholesalers and sell
An assumption can be made that carpet and rug sales will continue to decline within the
floorcovering industry. Since Shaw had significant losses due to its venture in opening its own
retailers, it would also be reasonable to assume that other manufacturers do not have their own
retail stores.
Problem/Decision Statement
As retailers become more price-conscientious, Merton has seen slow growth in sales with
its premium-priced carpeting. Wholesalers have had declining profit margins due to the pressure
from buyer groups, which in turn has caused Merton to have lower sales. Merton has struggled
to cut costs, since wholesaler expenses account for 6% of sales. Sales representatives were
devoting only 40% of each of their sales calls to sell Merton’s products, while spending the rest
of the time selling noncompeting products. Inventory costs are rising as well, since inventory
turnovers are at fiver per year, while management feels that four per year is sufficient.
Identification of Alternatives
Merton has contemplated the idea of selling its products directly to retailers in order to
decrease costs. The company would need to open seven warehouses to maintain all 4000 of its
accounts, as well as hire more salespeople. By cutting its ties with its wholesalers, Merton could
distribute directly to retailers and possibly increase its market exposure. Instead of opening its
own distribution center, Merton could reduce its prices to wholesalers to ease pressures from
buyer groups. These savings would then be reflected in the price to consumers to increase sales.
Criteria
In order for Merton to make a decision, the company must look at the potential costs.
Merton also needs to analyze how its decision will impact its relationship with its current
wholesalers. Should Merton become a direct distributor, the company would have to consider
how its retail accounts will respond by communicating directly through Merton instead of its
wholesalers.
Analysis
If Merton decided to shed its wholesalers, the company will have several costs associated
with starting their own distribution center. The company would need to hire 31 salespeople and
four managers to handle all retail accounts (see Appendix A.) This will increase expenses by
almost $2.5 million. Merton would also incur $700,000 in fixed operations costs for each of its
seven distribution centers. Transportation, inventory and accounts receivable costs would amass
almost $16.3 million in additional expenses throughout the seven warehouses. Total expenses
would be $39.3 million, a 50% increase from the 2000 fiscal year (see Appendix C.) Inventory
turnover would decrease from 5 to 4.28, which would be more favorable to company executives.
These costs are based on the assumption that Merton would inherit the direct sales from its
wholesalers. To account for changes in distribution methods, sales would decrease by 30% due
to a decrease in prices. Merton cannot continue charging the same price to retailers as its
wholesalers did. By decreasing costs, the company could still compete with other wholesalers
while keeping a significant amount of its retailers. Merton would most likely lose many of its
accounts due to the changing distribution method. Merton may lose as many as 20% of its
accounts from the switch, decreasing its projected sales and cost of goods sold. According to
Appendix B, 30% of the company’s retailers are in buying groups, so there is potential for a
Merton would realize a gross profit margin of 46% by creating its own distribution
warehouses. Cost of goods would decrease due to the lost accounts, creating a larger profit
margin for the company. The net profit margin would decrease to 2%, a 50% decline from 2000.
This decline would be caused by the additional costs incurred by Merton. If the company does
not need all 31 employees due to the lost accounts, it could generate a larger profit margin from
the layoffs. It is important to note that although the number of retail accounts may decline, all
employee costs should be within the budget to account for unforeseen changes. Merton would
be able to meet the minimum of wholesale sales of $7 million within each of its warehouses.
The $7 million sales volume would be economically viable, allowing Merton to continue
operations. The average sales of more than $11 million in each distribution center would be
wholesalers. The wholesalers are negotiating with competitors, awaiting a mass withdraw if
Merton decides to drop its wholesalers. A mass exodus would leave Merton unable to distribute
its products to retailers. Since many of the wholesalers have done business with Merton for
more than 20 years, Merton may receive a very negative reputation among other wholesalers and
buying groups. This ill-will could be detrimental to Merton’s sales, with the company losing
many accounts. Merton’s wholesalers may create a worse scenario by enticing retailers not to
purchase from Merton. In order for Merton to retain its accounts, it must avoid create hostility
with its retailers. Retailers may also switch brands of carpeting, thus in turn dropping all
advertising done with Merton. Since 50% of Merton’s retail accounts represent 80% of
residential sales, Merton could potentially lose more than $54 million. This is a significant risk
Recommendation
Merton should not open its own distribution warehouses. Though the company would be
able to cut its cost of goods sold and increase its gross profit, Merton would lose more than $1.5
million from operations. Too many unknown costs exist from opening distribution centers,
including how retailers will react. Retailers will more likely be swayed by wholesalers, who
would be able to provide retailers in buying groups steeper discounts. The buying groups may
lose a significant amount of buying power when dealing exclusively with Merton, while may
lead to a loss of sales from the groups. Merton would lose its cooperative advertising campaign
with many of its retailers, forcing the company to spend an additional $300,000 annually (see
Appendix D.) Merton would put itself into a similar position as Shaw when they tried opening
their own retail stores, and could potentially lose all of its business if it bypassed its wholesalers.