Written Executive Communication

CLAYTON INDUSTRIES
Case Report

Submitted to

Dr. Payal Mehra

Indian Institute Of Management, Lucknow

Submitted on 24th November

Submitted by

Nitesh Raj
PGP26220, Section D

1|Report on Clayton Industries

Contents
Introduction: ........................................................................................................................................... 3
A brief introduction of Clayton Industries and their business operations.............................................. 3
Description of Problem ........................................................................................................................ 3
Evaluation of alternatives ........................................................................................................................ 4
Alternative I - Revive the compression chiller line ................................................................................ 4
Alternative II – Changing the product line by shifting from compressor chillers . .................................. 6
Alternative III – In depth study of the overall business processes for a period of 6 months .................. 9
Final Evaluation Matrix between Alternative 1 and Alternative 2 ....................................................... 10
Tentative Plan of Implementation...................................................................................................... 10
References ............................................................................................................................................ 11

Table of Figures
Figure 1 - Comparison between Debt-to-Equity Ratio of Clayton SpA and Industry .................................. 4
Figure 2 - Comparison between ROE of Clayton SpA and Industry............................................................ 5
Figure 3 - Comparison of EBIDTA of Spanish and Italian Subsidiaries ........................................................ 6
Figure 4 - Comparison of EBIDTA Margins of Spanish and Italian Subsidiaries .......................................... 7
Figure 5 - Comparison of Current Ratios of Spanish and Italian Subsidiaries ............................................. 7
Figure 6 - Comparison of Asset Turnover ratio of Spanish and Italian Subsidiaries.................................... 7

2|Report on Clayton Industries

 Memo Report
To: Dan Briggs, CEO, Clayton Industries
Simonne Buis, President, Clayton Europe

From: Peter Arnell, Country Manager, Clayton SpA

Date: 25th November, 2010

Subject: Recommendations for a plan of action for Clayton SpA’s revival and future growth strategies

Introduction:
A brief introduction of Clayton Industries and their business operations
Clayton industries were founded in the year 1938, at Milwaukee. The company specializes in manufacturing
window mounted chillers. The company made numerous acquisitions in throughout Europe. This came in the form
of various acquisitions of companies such as Corliss, a UK based company with core competence in heating,
ventilation and air conditioning, Fontaire, a fans and ventilation Equipment Company and few other companies.

Description of Problem
The company faces many challenges while operating in Europe. The market for air conditioners is well developed
as consumers view Air conditioners as a symbol of American extravagance. However, the company did reasonably
well through local brands Corliss and Fontaire.

Simonne Buis took over the reins of Clayton in 2001 and immediately adopted a two pronged approach to gain
competitive advantage. The focus was either to slash costs or build scales or both. Clayton started finding going
tough post 2008-09 because of the global recession. Its sales declined and quite markedly in Italy

By 2009 the revenue of the company had fell over 19 % which was not as per the intended plan of the company. In
wake of such a performance the country CEO of Italy, Arnell decided to close down some of the facilities as well as
reducing the labour force.

Apart from recession there are several other factors that are adding to the company’s troubles. The company due
to its uncompetitive product profile found itself struggling in markets outside Italy. The poor sales and rising input
costs hurt both the bottom line as well as the top line of the company. The company faced labour union problems,
and it was very difficult to fire anyone owing to the norms of Italy. To top it the company also has a high wage bill
and a very limited customer base in Italy.

The company also faced stiff competition from Asian firms in other markets of Europe, which provided better value
for money products to the customers. Overall the company faces a problem of high prices of its products with no
tangible or intangible value associated. The company is thus confronted by the upward task of restructuring its
product line, reducing costs and build scale.

3|Report on Clayton Industries

Evaluation of alternatives
Target
a. To increase the market share of Clayton SpA from 7% to 15% within 4 years (“Four in Four” objective).
b. To reduce Days Receivables, Days Inventory by 10 days and Headcount by 10% (“10/10/10” objective).

Alternative I - Revive the compression chiller line

Key Steps involved
Manufacturing plan-
1. $5 million investment in the next 12 months in the existing manufacturing facility
2. Addition of new features in compression chiller which would bring them at par with other Asian
counterparts.
3. Technological improvement resulting in higher efficiency for the compressor.
4. Utilize Economies of scale to reduce Average Cost.
5. Increased substitution of labor by capital to utilize lower marginal cost of capital versus higher marginal
cost of labor.
Sales and Marketing plan-
1. Brand Diversification - Collaboration with local European brands to improve Brand perception.
2. Market Expansion - Leverage sales and distribution channels of other European arms of Clayton industries
to explore newer markets.
3. Market Penetration - Increased spending in Advertising to improve customer awareness about the new
features and reduced carbon foot-print of the product.

Financial Analysis and Forecasting

Debt-to-Equity (D/E) ratio – As per the balance sheet of Clayton SpA for the period 2004-2009 we observe that
there has been a huge erosion in shareholder’s equity. This can be mainly attributed to poor financial performance
of the company during recession which has resulted in huge losses. This erosion in the equity in the period of time
has been compensated by increase in long-term debts and current liabilities of the company. The D/E ratio for the
year 2004 was 1.16 which was comparable to the industry average of 1.17. The current D/E ratio is -4.89 since the
equity has turned negative. This is an alarming situation for the company.
By implementing Alternative 1, initially the D/E ratio will be adversely affected but in the long run the profitability
of the company will improve resulting in improved D/E ratio. This situation would result in high risk aversion of
banks to finance the expansionary plans of the company. Raising money from shareholders

Clayton SpA
Debt-to-Equity Ratio Other Europe
6.00
5.00
4.00
3.00
2.00
1.00
0.00
2004 2005 2006 Year 2007 2008 1H09

Figure 1 - Comparison between Debt-to-Equity Ratio of Clayton SpA and Industry

4|Report on Clayton Industries
Return on Equity (Sales/Total Shareholder Equity) - As per the balance sheet of Clayton SpA for the period 2004-
2009 we observe that the return of equity has gradually withered to negative values. This is a grave matter of
concern for the company as the company will face difficulties in raising debt and also in raising money through
shareholder equity.

By implementing Alternative 1, we expect to reap high profits by the second year of operations onwards which will
gradually improve the retained earnings of the company. These will in-turn improves the Return on Equity.

Return on Equity
35.00
Clayton SpA
30.00
Other Europe
25.00
%age of
RoE 20.00
15.00
10.00
5.00
0.00
2004 2005 2006 2007 2008 1H09
Year

Figure 2 - Comparison between ROE of Clayton SpA and Industry

SWOT Analysis
Strength Weakness

New Leadership under Arnell
Would be very difficult for the company to move

Plan involves making technological changes in in the top 4 company by revenue
the products
High initial investment required
Opportunity Threat

Compression chiller market is worth $20 bn
Low cost products from Asian Companies

Opportunity in Crisis, and Austerity measures
Rising Price of Raw Material
essential for the company

PROS and CONS Analysis

PROS
1. Implementation of the strategy suggested by the
Italian management who thoroughly understand
the industry constraints.
2. The size of the compression chiller industry 20
billion dollars. The compression chillers comprise
of 85% of the total market.
3. New methods of the new leadership can be put
to test in this crisis.
4. Fits Brigg’s belief of “opportunity in crisis”
5. Peter Arnell has been handpicked by Buis, which
would ensure greater cooperation by the top
management.
CONS
1. Investment of $5 million would be difficult
considering the condition of the balance sheet
(Clayton lost $24.2 million in the last six months)
2. The improvement initiatives might not result in
substantial cost advantage for the company.
3. The initiatives taken might not result in
immediate cash flow for the company.
4. Considering a condition of oligopoly in the chiller
manufacturers, the company might find it very
difficult to catapult in the top 4 players.
5. Briggs is unlikely to be supportive

5|Report on Clayton Industries

Alternative II – Changing the product line by shifting from compressor chillers
to absorption chillers.

Key Steps involved

Manufacturing plan
1. Changing the plant setup to manufacture absorption chillers.
2. Transfer of technology from Spain to Italy which would boost the overall capability of Clayton Industries.
3. Lower involvement of labour would ensure substitution of labour by capital as per the isocost line.
4. Company would reduce it carbon foot prints by manufacturing these chillers, and gain on the carbon
credits due to such chillers.
5. The company would reduce its overall cost due to lower manufacturing expenses, and also hedge against
adverse commodity cycles.

Sales and Marketing plan

1. Brand Diversification – The Company can get into product distribution pacts with various other companies
in the same niche market.
2. Market Expansion - The sales channel can improve by deriving synergies between the associated
companies.
3. Market Penetration - No new marketing expenditure would be required as this product would be a part of
the successful range of product line, manufactured in Spain.

Financial Analysis and Forecasting

EBIDTA and EBIDTA Margin: As per the balance sheet of Clayton SpA for the period 2004-2009 we observe that,
there had been a huge decline in the Overall EBIDTA and the EBDITA margins. The overall EBIDTA margins of the
company have shrunk from a healthy 20 % to a negative figure. Whereas the Spanish business of absorption
chillers maintaining an EBIDTA of around 10 % even during the recessionary phase. Severe oligopoly ensures that
the company would face continued pressures on both top line and bottom-line. This makes the opportunity cost of
diversifying into absorption chillers, adversely lucrative.

Figure 3 - Comparison of EBIDTA of Spanish and Italian Subsidiaries

6|Report on Clayton Industries

 % Margin for EBITDA
25
20 Clayton SpA
15 Clayton SA
% Margin 10
5
0
-5
2004 2005 2006 2007 2008 1H09
-10
-15
-20
Year

Figure 4 - Comparison of EBIDTA Margins of Spanish and Italian Subsidiaries

Current Ratio (Current Asset/Current Liability): The ratio is a good indicator of the liquidity concerns of the
company. Higher values of the current ratios are favorable for the organization. We find a continuous decline in
the current ratio of the company. This can be mainly attributed to the shrinking EBIDTA which is reducing the
assets. Whereas the company is forced to increase its debts on account of its poor financial performance in recent
years. Whereas we find the current ratio is constant at 1.3 for the Spanish subsidiary of Clayton industries.

2.00

1.50

Current 1.00
Ratio
Clayton SpA
0.50

0.00
2004 2005 2006 Year 2007 2008 1H09

Figure 5 - Comparison of Current Ratios of Spanish and Italian Subsidiaries

Asset Turnover ratio: The asset turnover ratio has moved in line with the industry benchmark, but since the
company has not been able to transform a good asset turnover ratio into consistent profits, the company needs to
change the product line it is operating in. Changing over to absorption chillers seems to be an obvious option.

Asset Turnover
1.40
1.20
1.00
0.80
0.60
0.40 Clayton SpA
0.20 Other Europe
0.00
2004 2005 2006 2007 2008 1H09
Year

Figure 6 - Comparison of Asset Turnover ratio of Spanish and Italian Subsidiaries

7|Report on Clayton Industries

SWOT Analysis
Strength

Well established technology of the Spanish
Company

Good time to enter the Absorption chiller Market
Opportunity

High growth rates for absorption chiller

Advantage in terms of green technology
PROS and CONS Analysis
PROS
1. Absorption chillers a fast-growth segment as there
is a huge demand for eco friendly chillers.
2. Spanish company can offer already proven
technology for the absorption chillers.
3. The company can easily become a market leader
in this niche segment.
4. The existing line can be phased out gradually
which will ensure a smooth transition from the
current product line to the new one
5. The current move will ensure the company attains
st
the 1 mover advantage in this segment.
8|Report on Clayton Industries
Weakness

Abandons existing products

Fresh Investment required, with no certainty of
success.
Threat

Opposition from FILM

The product line has only 15 % of the total
European chiller market
CONS
1. The overall market size for the absorption chillers
is only 15 % and this market is still in its nascent
stage.
2. The company might abandon the current market
of compression chillers prematurely, without
exploring their product’s performance with some
necessary improvements.
3. Short-changes the Italian plan
4. FILM will oppose production phase out
5. Requires very large investment
Alternative III – In depth study of the overall business processes for a period
of 6 months, for coming to a well informed decision.
This option requires more in-depth analysis of the business processes by waiting for a period of 6 months, but this
proposal seems to be impractical because of the fact that company is facing current issues of stagnant cash flows
along with huge debts on the balance sheet doesn’t seem to be a logical step to undertake. The company has also
taken steps to postpone the debt payments. Moreover taking this extra time doesn’t guarantee the company of
anything concrete or different in terms of the options that company has. If there are possibilities of internal
improvement these can be looked into, simultaneously with other improvement initiatives. Waiting would further
lower investor confidence and worsen the current situation

SWOT Analysis

Strength Weakness

Lowest risk option out of the available
Top management wants an immediate turn-
alternatives around solution

Comprehensive analysis of the possible options
Company cannot waste time sitting on its heals
for a turn around.
Opportunity Threat

Can keep the options open to exploit future
Delaying decision for 6 months may involve other
opportunities. costs

Pro and Con analysis:

PROS CONS
1. This option lowers the risk of making a hasty and a 1. Delaying for six months is not cost-free
wrong decision. 2. Arnell set his team in motion.
2. Since the company is under financial constraint, 3. Briggs and Buis want turnaround proposal within a
this option is the most suitable. stipulated time.
3. Offers more time to study options. 4. Such a step wouldn’t show how gutsy leader Arnell
4. Arnell and team can gel well and try to exploit the is, and would portrait him to be someone taking a
operational efficiencies. defensive path.
5. Keeps future options open.

9|Report on Clayton Industries

Final Evaluation Matrix between Alternative 1 and Alternative 2
Company Vision Alternative 1 (Revamp the existing
compression chillers market)
“Four in Four” initiative - Gain Difficult to achieve due to a strong
position in industry top 4 within 4 oligopolistic market
years.
10/10/10 plan – Reduce the Would be difficult to achieve a
inventories and receivables by 10 reduction in headcount owing to
days and headcount by 10% stringent layoff rules. Also since the
option requires fresh investment, so
the financial targets would be even
tougher.
Clearance of debts The company can hope to clear its
debts early as the company will
have immediate cash flows due to
the investments. But this is again
subject to the product performance
Future sustainability Since the compression chillers are
energy intensive, the company
might find it difficult to sell in the
future.
Based on the above table we finally conclude that Alternative 2 is the best strategy to follow, by evaluating all the
constraints in the case and considering the entire current financial status of the company.
Tentative Plan of Implementation
Action Responsibility
Creation of a team, to look into the synergies Simonne Buis, Peter
between Spanish and Italian Firm and appointment Arnell
of a consultant for the same
Estimation of investments to augment the Consultant
production facilities at Italy, by the consultant
Overall plan of augmenting the plant facilities Consultant
Requests for quotations, Ordering and project Consultant and
implementation Supplier
Project closure, performance guarantee test and Supplier of
final acceptance tests Equipment,
Consultant
10 | R e p o r t o n C l a y t o n I n d u s t r i e s
Alternative 2 ( changing the
product line by shifting the product
line from compression chillers to
absorption chillers)
High probability of achieving this
because of first mover advantage
and technological stability
All the three prongs of the plan can
be achieved successfully provided
proper implementation of the
project.
It would be difficult for the company
to get immediate cash flows, but
since the fixed costs would go down
so dramatically, that it makes sense
to produce Absorption chillers.
The future of absorption chillers is
bright owing to environmental
concerns.
Duration Status
1 Week Pending
2 Weeks Pending
3 Weeks Pending
6 Months Pending
2 Months Pending
References
1. www.wikipedia.com accessed on 20th November, 2010

2. www.hbr.org accessed on 20th November, 2010

3. www.claytonindustries.com accessed on 20th November, 2010

4. Philip Kotler and Kevin Kelly. Marketing Management, Pearson Publishing, 13th Edition, 2009

5. Anthony, Financial Accounting, Tata McGraw hills, 10th Edition, 2009

11 | R e p o r t o n C l a y t o n I n d u s t r i e s