Bergerac Systems: The Challenge of Backward Integration

Group 5: Ashutosh B16013 | Narasimha B16028 | Pulkit B16035 | Sahil B16041 | Samiksha B16042
| Sharodiya B16046

PROBLEM STATEMENT
Veterinary expenditure has been on an increasing trend due to the increase in pet ownership
in the United States. Bergerac is a company producing equipments used for testing pet
patients in the veterinarian clinics. Omnivue is one of the most successful equipments
produced by the company, which is priced at a competitive rate to attract lower and middle
sized veterinarians. The production of Omnivue involves the use of plastics and chemical
reagents supplied by two major suppliers, GenieTech and Elsinore. The management of
Bergerac is planning to take control over its suppliers to reduce the production fluctuation and
overhead costs of the firm. There are two strategic alternatives for the company to implement
its future plans. It can opt for Buying out its supplier thus integrating backwards or by
building it making their own plastic components in their plant.

FALSE ASSUMPTIONS

1. Assumption of Equal Production:

There has been an underlying assumption that Bergerac will produce same amount of
cartridges despite GenieTechs higher capacity to sell to external parties. Additional sales and
contribution resulting from extra capacity to decrease B/E volume (based on existing long-term
contracts). Cost structure due to the acquisition is perceived high, but production of GenieTech
is 2X that of in-house. This shall contribute in the increasing demand of the industry. More
volume increases variable costs, but fixed costs remain relatively unchanged, thus reducing
cost by spreading it over more number of products.

2. Negation of Salvage Value:

Various schools of thought ignore salvage value from selling GenieTech in the future compared
to non-existent salvage value of in-house production in the case of make decision. The capital
locked in the latter option is much higher and risky.

3. Negation of Additional Capacity Expansion and Training Costs:

Bergerac will incur future costs if Bergerac wants to meet growth in demand. The subsequent
calculations show how with the make decision Bergerac wont be able to scale up for the
future. No indication of hiring and training laborers. It will have to undertake extra cost in
training manpower to operate the plant.

Alternatives:
We have performed a financial analysis of the two alternatives to pick the best choice.

S.No
Items Buy In House
.
1 No. of Moulds 8 4
2 Parts per moulds 10 10
3 Cycle Time 75 70
4 Cycle/shift 384 411
5 Parts/Shift 30720 16440
6 Cartridge/Shift 15360 8220
7 Uptime 90% 95%
8 Cartridge/Shift 13824 7809
9 Annual Capacity 10368000 5856750
10 % Utilization 46 81
Utilization of the capacity of the choices is dependent on the number of moulds, cycles per
shift, uptime and cartridges per shift. It turns out to be 46% for buy decision and 81% for In-
house decision at the end of the first year.
 Working Details
In-
Buy
House
Installed Base 7500
Test/Day 2.5
Working day/year 250
Total Cartridge 4687500 4687500
Cost (@$2.55, 1195312 1120312
@2.39) 5 5
Selling Price 4335937 4335937
(@$9.25) 5 5
3140625 3215625
Revenue
0 0
The total cartridges required in 2010 would be 4,687,500. The revenue generated from the
sale is slightly different in both scenarios with high revenues in the case of In-house.

Cartridge Demand
Growth rate 2010 2011 2012 2013 2014 2015
8% 4687500 5062500 5467500 5904900 6377292 6887475
9% 4687500 5109375 5569218 6070447 6616787 7212297
10% 4687500 5156250 5671875 6239062 6862968 7549264
The decision also hinges on the fact that the market is expanding at the rate of 8.5% per year.
The table above captures the demand for cartridges in the next 6 years. The option of buying
looks more suited when we account for growth as the demand could be satisfied with the
acquisition. But with in-house, we need to undertake multiple stages of expansion to keep up
with the possible growth in the industry.

Financial Aspects
In-house Buy
Profit Margins High Medium
ROI Medium Medium
Continuous Revenue Yes Yes
Financial Risk High High
Overall Good Good
Both the decisions look equal when we take into account the financial except that profit
margins are a little higher for In-house as delivery costs are exempted. We can attain yearly
savings of $1,649,131 more by going in-house.

Supply Chain Aspects

In-house Buy
Impact on Component Supplier Negative Negative
Distribution Network / Sales Force Need to Create Available
Cartridge Supplier Support Need to Create Negative
Petrochemical RM Supplier Network Need to Create Available
Supply Chain Risk Not Mentioned Not Mentioned
Overall Not Recommended Moderate (OK)
One of the biggest advantages to buy is that we have an established network of distributors to
sell the cartridges as there is over capacity initially. We are better equipped to deal with
Petrochemical price fluctuations as we have stable partners.

Managerial / Strategic Aspects

In-house Buy
Core Competency / Focus Not Available Acquired
Will have big Will have big
Technology Change in future impact Impact
Core Problem of Petroleum RM Supply Will be Big issue Not Good
Sunk Cost High Medium
Competitors Reaction High Medium
Managerial Risk Will Increase Will Reduce
Overall No May Be
The biggest advantage of buying is the technical know-how of cartridge manufacturing
process. Bergerac could leverage the R&D to keep itself updated with the trends in technology
and also leverage the managerial acumen. Cartridge manufacturing is also not a core
competency of Bergerac and an in-house manufacturing would force it divert its attention and
focus.
There are also certain intangible costs associated with in-house decision as well as Buy
decision.
In-house decision: Inexperience with the process and industry could lead to lower
productivity and technological innovation could take time and finally to set up a standardized
process with sufficient quality checks would only take more time.
Buy Decision: The lock-in period is too high and Bergerac could miss out on the opportunities
to invest elsewhere. Integration of the new company could be a challenge due to potential
conflicts between the old and new staff.
Decision:
Though both the decisions have their merits, we advise Bergerac to buy as the growth
prospects of the industry seem strong and Bergerac cannot afford to lose its focus from its
core competency. The competition in the market is also high and Bergerac does not have time
to set up the in house and stabilize the process till its flawless. It could also be impaired
because of lack of technological prowess and could as well be left behind in case a new
technology emerges.
References:

http://www.businessinsider.com/the-apple-watch-has-been-a-failure-2016-4?IR=T
http://knowledge.insead.edu/blog/insead-blog/innovation-success-how-the-apple-ipod-
broke-all-sonys-walkman-rules-2791
https://channels.theinnovationenterprise.com/articles/82-top-5-reasons-why-the-apple-
watch-is-a-great-business-strategy
https://hbr.org/2015/04/the-apple-watchs-big-pricing-problem
http://mokriya.com/blog/strategy-the-apple-watch/
Steve Jobs by Walter Issacson