Case Study: Arctic, Inc.

Arctic, Inc. Arctic Inc. produces large glass-door refrigeration units for supermarkets and convenience stores. The company has been experiencing a steady rise in demand for its products over the last ten years. Much of this growth stems from the increase in the number of convenience stores over the period. Arctic sees no decrease upcoming in the convenience store business and is concerned about its capacity to keep up with demand. The company currently manufactures only some of the parts used for assembly, purchasing the balance. Arctic is particularly concerned about its capacity to manufacture the compressors that are assembled into the refrigeration units. Arctic has been producing compressors itself since it began operating. Now, with compressor capacity stretched to its limit, Arctic is considering expansion plans. There is a great deal of concern about what projects should be selected and what resources should be acquired for these projects. Company officials and employees are optimists, but Arctic faces a great deal of uncertainty, both with the type of compressor to be used in the future and with the amount of demand for the refrigeration units. Arctic has several major options with regard to compressor capacity, some of which could be combined into a single plan. The options under consideration follow. 1. 2. 3. 4. 5. 6. Expand the current plant capacity. Build a new plant. Subcontract among several vendors. Subcontract with one vendor to provide the needed compressors ("sole sourcing"). Purchase a company that provides the needed compressors. Employ some combination of expansion and manufacturing.

Each plan has advantages and disadvantages tied to costs and other factors. The first two plans maintain production control within Arctic, while Plans 3 and 4 relinquish control to other companies. Plan 5 is a compromise with respect to control, because compressor manufacturing would occur in a different strategic business unit (SBU) within the larger corporation. Both building a new plant and buying a compressor manufacturer would be rather risky, as they would require a large amount of capital input (fixed costs) up front. Plans 2 and 5 would keep the variable costs low, however. Subcontracting, Plans 3 and 4, would have no fixed costs. The major advantage of sole sourcing, Plan 4, is this: By guaranteeing one subcontractor all of the volume, the cost per compressor would be minimized. The major disadvantage should be obvious: If the production is disrupted at the solesource factory, Arctic will have to shut down its assembly operation. Another concern with the solesource option is that, in essence, Arctic will be creating a monopoly and will be at the mercy of this company. To evaluate its options, Arctic is considering different scenarios with respect to demand for the product and the future technology.

Demand grows at a steady rate. Demand stabilizes at the current rate. Demand drops.

The technology scenarios follow.

The technology remains the same. The technology changes.

Combining demand and technology scenarios, there are six (3 x 2) different scenarios that Arctic faces. The company performs a preliminary cost/revenue analysis, and the table below presents the net present value of profits over the next ten years for each option under each scenario.

Demand with Same Technology Option Expand Build new Subcontract Sole source Purchase

Demand with Different Technology

Grow Stable Drop Grow Stable Drop 3.14 2.98 1.45 1.89 3.78 2.65 2.12 1.67 1.72 1.98 2.27 1.12 .11 1.34 1.13 2.45 1.22 2.43 5.23 1.76 1.34 3.21 2.34 2.23 3.14 1.32 1.11 1.25 1.89 .23 1.63 1.88 .25 5.67 1.12

Expand/subcontract 2.25
DISCUSSION QUESTION

1. As uncertain as the profits in the table are, the probabilities of each of the possible scenarios are even more uncertain. Evaluate the options available to Arctic. Should any of the options be eliminated? Is one option truly outstanding, an obvious choice? Should some options be considered for further analysis? The discussion offers implications concerning the probabilities of the demand scenarios. How do they affect the decision?