Capstone Business Simulation 2020: Practice Round 4 IFMR

For the last round, my comments here are going to be back to basics. This is at the heart
of your business and is as basic as a Hans Christian Anderson fairy tale. Allow me to narrate
the Capstone Business Fairy Tale:
• Once upon a time I took over as the CEO of a large reputed company. I swore and still swear
to nurture and grow it as I would my own son.

• I understand that without a compelling vision for my company, I would always be susceptible to
make choices that are not in the company's long term interest. That vision helps provide me
strategic direction. And my vision is rooted in my DNA : who am I, what do I like to do , what do
I want to do (my DNA, strengths and passions). I formulate a clever strategy that draws on my
resources and competencies to help me create competitive advantage. I also make sure I
deploy my resources in a fashion that I can actually deliver and execute my strategy.

• I want to gain market share (or at worst not lose it). I do this by….

• Selling more (giving the customers what they want and doing it better than the competitors).
But I want to sell profitably.... hence I....

• Maintain healthy margins (a large gap between cost and price). Therefore, I...

• Utilize my assets optimally (I never rent a 8 room condo when a 3 room apartment will do) and
I ritually reduce and control my costs.I am keenly aware of the tradeoffs and the S Shaped
curve (diminishing returns) in business decisions and cleverly choose the slopes that are the
most attractive. I also price cleverly so as the avoid leaving money on the table. My mantra is
profit maximization. I understand that bad sales forecasts and large unsold inventories killed
many a promising firm.

• During all this flurry of activity, I keep a watchful eye on the interests of firm’s lenders and
stock holders. I can't put one at risk at the cost of the other. I realize and anticipate clearly the
sources, magnitude and velocities of cash coming and going out of my firm (there is so much
happening across functions!). Thanks to the Accounting and Finance electives that I went
through attentively at my world renowned campus, I know well that cash is the veritable life
blood of my firm. With that in mind, I always err on the side of caution when it comes to financial
matters. Also, I clearly see what levers effect what metrics and I drive accordingly.

• I do all the above while keeping a keen eye on the market segments as they grow and I notice
new entrants/ exits/ moves. I am always wary of my competitors and I cleverly run scenarios to
anticipate where to deploy resources/ exploit / exit, etc. Being from a premier B’School I've
learnt well the importance of analysis and logic. I love to run numbers with my best friend Excel.
Sometimes, I try and do this at just an hour before the deadline for submission. That doesn't
leave me much time to consult my trusted friend Excel or my Csuite. Also, I sometimes think I
have a golden gut. Alas, those years yield pretty bad results for some reason and my stock
price plummets.

• I love the word strategy - it gives me a good smoke to hide behind when I make bad decisions.
But I now realize that execution is rather important. Without walking my talk my strategy is just
baloney. I recollect the words of a large hedge fund manager who said, "I'm a fund manager
Capstone Business Simulation 2020: Practice Round 4 IFMR

because I've got a fund to manage. Imagine what I'd do I couldn't get enough investors
(customers) to buy my product. Strategy is great. But I've got to sell, sell and sell. I can't be a
fund manager without a fund!” I think this makes patent sense.

Industry and Team Specific Points

C120370

General: Four years is a reasonably long time in for both a business and a manager in
today’s dynamic and competitive landscape. Is your strategy playing out as planned? Did
you have a strategy in the first place? Are you able to implement it? If not, why not?

Low sales for Andrews and Erie and low margins for Erie and Ferris. Negative profits for
Baldwin and Erie. Chester leads the industry in terms of cumulative profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: Andrews, Chester, Digby, Erie and Ferris had a rise in stock
price of $4/share, $7/share, $32/share, $$9/share and $13/share respectively. Baldwin had a
fall in stock price of $7/share. Remember, your company had its shares trading at $34.25 when
you took over as CEO four years ago.

Chester leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Baldwin, Chester, Digby and Ferris had a rise in market share of 1.1%, 0.8%, 3.2%
and 2.1% respectively. Andrews and Erie had a fall in market share of 2.7% and 4.5%
respectively.

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?
Capstone Business Simulation 2020: Practice Round 4 IFMR

The highest sales and market share were seen for Ferris. This was around $211M and 21.14%
respectively.

The lowest sales belonged to Andrews with market share of 13.32% and sales of $133M. So
Team Andrews lost more than 3% market share in 4 years. This was mainly due to four reasons
–

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
Capstone Business Simulation 2020: Practice Round 4 IFMR

are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Baldwin and Erie had bottom lines in red. The reasons for this are –

 Low Contribution Margin for Erie

 High Unsold Inventory and the attendant carrying cost for Erie.
 High SG&A compared to sales for Baldwin. But this is an investment and would pay off
in the later rounds.
 High investment in TQM for Baldwin. But this is also an investment and would pay off in
the later rounds.
 High interest expense for highly leverage companies like Erie. However, they could be
gearing for higher growth here. We have to wait and watch….

Contribution Margin: Erie and Ferris need to improve their margins. Increase automation
levels of the plant, spend to reduce material and labor costs in TQM and on productivity in the
HR Module for the labor costs. Remember, margins in Capstone should preferably be above
30%.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
Capstone Business Simulation 2020: Practice Round 4 IFMR

o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Emergency loan is current debt. It will automatically get plugged into
"current debt due this year". Borrow maximum from long and short term debt and raise funds
through stock issues and sale of surplus plant to ensure your 31 Dec closing cash (bottom
left row on Finance sheet of Capstone) balance is a healthy figure (attempt 1-2 months of
sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
Capstone Business Simulation 2020: Practice Round 4 IFMR

just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.

Plant Size and Utilization: Baldwin needs improvement in plant utilization. Your plant has a
two shift capacity. Use it more optimally.

Forecasting and Inventory: Chester and Erie have high inventory levels. Inventory carrying
cost is 12% of the unit variable costs. This reduces profits. Unsold inventory also reduces cash
in hand and can pave the way for an emergency loan. Please produce only the quantity you are
sure to sell. Reduce the inventory levels in the next round.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
Capstone Business Simulation 2020: Practice Round 4 IFMR

of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Daze leads the industry. Eve has low market share in this
segment.
 Low End Segment: Feat leads the industry. Ebb and Bead have low market share in
this segment. Acre, Ebb and Bead have inappropriate age (too low) for the segment
(Age has an importance of 24% in this segment).
 High End Segment: Dixie leads the industry. Dope, Bond, CORONA and Echo have
low market share in this segment. Bid, Dope, Bond and Echo need improvement in their
position (performance and size) in the segment (Ideal position has an importance of 43%
in the segment). Dixie, Bid, Cid, Adam, Dope, Bond, CORONA and Echo are overpriced
(outside the price range). CORONA needs increased levels of awareness. Adam need
improvement in accessibility.
 Performance Segment: Foam leads the industry. Damn and Bold have low market
share in this segment. Aft has too high MTBF (MTBF has an importance of 43% in the
segment). Dot, Eno, Damn, Bold and Aft need improvement in their position
(performance and size) in the segment (Ideal Position has an importance of 29% in the
segment). Edge, Eno, Aft, Damn and Bold are overpriced (outside the price range). Bold
has inappropriate age (too high) for the segment. Damn needs increased levels of
awareness. Coat, Aft and Bold need improvement in accessibility.
 Size Segment: Cure leads the industry. Bald and Chip have low market share in this
segment. Bald needs improvement in its position (performance and size) in the segment
(Ideal Position has an importance of 43% in the segment). Buddy, Dune, Agape, Egg,
Bald and Chip are overpriced (outside the price range). Bald and Chip need increased
levels of awareness. Cure, Agape and Chip need improvement in accessibility.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Only Chester and Erie don’t come
within this range.

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
Capstone Business Simulation 2020: Practice Round 4 IFMR

add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Andrews, Chester, Erie and Ferris are not investing in improving the productivity
of their employees. These can have a considerable favorable impact on your labor bill.

TQM Investments: Andrews, Baldwin and Digby spent well here. These initiatives have a
snowball effect in the later rounds and would pay rich dividends. Other teams, do make
investments in TQM in the competition rounds. There are large business benefits to be accrued
here.

Baldwin - For each initiative, returns for investments follow the shape of an S-curve. That is, if
you spend too little or too much the returns on your investment are poor. If you spend less than
$500,000 in any initiative in a single round chances are you will see little return. An investment
of $1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.

C120371

General: Please reflect. Four years is a reasonably long time in for both a business and a
manager in today’s dynamic and competitive landscape. Is your strategy playing out as
Capstone Business Simulation 2020: Practice Round 4 IFMR

planned? Did you have a strategy in the first place? Are you able to implement it? If not,
why not?

Low sales Digby and Erie and low margins for Ferris. Negative profits for Digby. Baldwin
leads the industry in terms of cumulative profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: Andrews, Baldwin, Chester, Erie and Ferris had a rise in
stock price of $5/share, $17/share, $26/share, $12/share and $11/share respectively. Digby
had a fall in stock price of $6/share. Remember, your company had its shares trading at $34.25
when you took over as CEO four years ago.

Baldwin leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Baldwin and Chester had a rise in market share of 2% and 1.1% respectively.
Andrews, Digby, Erie and Ferris had a fall in market share of 0.5%, 1.1%, 1.4% and 0.1%
respectively.

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?

The highest sales and market share were seen for Baldwin. This was around $214M and
21.63% respectively.

The lowest sales belonged to Digby with market share of 11.75% and sales of $116M. So
Team Digby lost almost 5% market share in 4 years. This was mainly due to four reasons –

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
Capstone Business Simulation 2020: Practice Round 4 IFMR

does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Digby had bottom line in red. The reasons for this are –

 High unnecessary depreciation of plant and machinery due to low plant usage. Why
keep a plant that only gathers dust.
 High SG&A compared to sales. But this is an investment and would pay off in the later
rounds.
 Low Sales

Contribution Margin: Ferris needs to improve their margins. Increase automation levels of the
plant, spend to reduce material and labor costs in TQM and on productivity in the HR Module for
the labor costs. Remember, margins in Capstone should preferably be above 30%.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Emergency loan is current debt. It will automatically get plugged into
"current debt due this year". Borrow maximum from long and short term debt and raise funds
through stock issues and sale of surplus plant to ensure your 31 Dec closing cash (bottom
left row on Finance sheet of Capstone) balance is a healthy figure (attempt 1-2 months of
sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Plant Size and Utilization: Andrews, Digby, Erie and Ferris need improvement in plant
utilization. Your plant has a two shift capacity. Use it more optimally.

Forecasting and Inventory: Baldwin, Chester, Digby and Ferris have stocked out in multiple
segments. Please ensure that you are able to fulfill the entire demand for your products without
having high unsold inventory.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.
Capstone Business Simulation 2020: Practice Round 4 IFMR

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Able leads the industry. Bid and Fat have low market share in this
segment. Bid has inappropriate age (too high) for the segment (age has an importance
of 47% in this segment). Fast, Eat, Baker and Fat need improvement in their position
(performance and size) in the segment. Fat needs increased levels of awareness. (It has
awareness of only 17% and hence 83% of the market does not know about your
product). Daze and Eat need improvement in accessibility.
 Low End Segment: Acre leads the industry. Dell has low market share in this segment.
Ebb and Dell have inappropriate age (too low) for the segment (Age has an importance
of 24% in this segment). Ebb and Dell need improvement in accessibility.
 High End Segment: Big_H leads the industry. Dixie, Furry and Bid have low market
share in this segment. Dixie and Bid need improvement in their position (performance
and size) in the segment (Ideal position has an importance of 43% in the segment). Bid
has inappropriate age (too high) for the segment (Age has an importance of 29% in this
segment). Echo2, Fist and Furry are overpriced (outside the price range). Furry needs
increased levels of awareness. Echo2, Fist and Furry need improvement in accessibility.
 Performance Segment: Bold leads the industry. Edge and Delta have low market share
in this segment. Delta has low MTBF (MTBF has an importance of 43% in the segment).
All products need improvement in their position (performance and size) in the segment
(Ideal Position has an importance of 29% in the segment). Foam and Edge are
overpriced (outside the price range). Coat and Edge have inappropriate age (too high)
for the segment. Foam, Aft and Edge need improvement in accessibility.
 Size Segment: Best_S leads the industry. Buddy, Egg and Dune have low market share
in this segment. Dune and Buddy need improvement in their position (performance and
size) in the segment (Ideal Position has an importance of 43% in the segment). Cure,
Buddy, Egg and Dune have inappropriate age (too high) for the segment (Age has an
importance of 29% in the segment). Cure, Fume and Egg are overpriced (outside the
price range). Egg needs increased levels of awareness. Fume, Agape. Egg and Dune
need improvement in accessibility.

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Andrews, Chester and Erie don’t
come within this range.
Capstone Business Simulation 2020: Practice Round 4 IFMR

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
Capstone Business Simulation 2020: Practice Round 4 IFMR

might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Baldwin and Erie are not investing in improving the productivity of their
employees. These can have a considerable favorable impact on your labor bill.

TQM Investments: Andrews, Baldwin and Digby spent well here. These initiatives have a
snowball effect in the later rounds and would pay rich dividends. Other teams, do make
investments in TQM in the competition rounds. There are large business benefits to be accrued
here.

For each initiative, returns for investments follow the shape of an S-curve. That is, if you spend
too little or too much the returns on your investment are poor. If you spend less than $500,000
in any initiative in a single round chances are you will see little return. An investment of
$1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.

C120372

General: Is your strategy playing out as planned? Did you have a strategy in the first
place? Are you able to implement it? If not, why not?

Low sales for Baldwin. Negative profits for Baldwin and Digby. Andrews leads the
industry in terms of cumulative profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
Capstone Business Simulation 2020: Practice Round 4 IFMR

year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: Andrews, Chester, Digby, Erie and Ferris had a rise in stock
price of $3/share, $20/share, $7/share, $25/share and $38/share respectively. Baldwin’s stock
price remained constant at $1/share. Remember, your company had its shares trading at
$34.25 when you took over as CEO four years ago.

Andrews leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Chester, Digby and Ferris had a rise in market share of 2.3%, 1.6% and 0.2%
respectively. Andrews, Baldwin and Erie had a fall in market share of 1.6%, 2.4% and 0.1%
respectively.

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?

The highest sales and market share were seen for Andrews. This was around $229M and
22.67% respectively.

The lowest sales belonged to Baldwin with market share of 11.88% and sales of $120M. So
Team Baldwin lost close to 5% market share in 4 years. This was mainly due to four reasons –

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Baldwin and Digby had bottom lines in red. The reasons for this are –

 High SG&A compared to sales. But this is an investment and would pay off in the later
rounds.
 High Unsold Inventory and the attendant carrying cost for Baldwin.
 High interest expense for highly leverage companies like Baldwin. However, they could
be gearing for higher growth here. We have to wait and watch….

Contribution Margin: Baldwin, Chester and Digby need to improve their margins. Increase
automation levels of the plant, spend to reduce material and labor costs in TQM and on
productivity in the HR Module for the labor costs. Remember, margins in Capstone should
preferably be above 40% at this stage.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Ferris has an emergency loan. Please keep enough cash balance to
cater to fluctuations in the business. The reasons are –

Ferris – For a cash outflow of $49.4M (dividends + retirement of current debt), you raised
$16.3M through sale of plant. Remember assets = liabilities plus equity. Where will the cash
come from? See note in red below:

Emergency loan is current debt. It will automatically get plugged into "current debt due this
year". Borrow maximum from long and short term debt and raise funds through stock issues and
sale of surplus plant to ensure your 31 Dec closing cash (bottom left row on Finance sheet
of Capstone) balance is a healthy figure (attempt 1-2 months of sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."
Capstone Business Simulation 2020: Practice Round 4 IFMR

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.

Plant Size and Utilization: Baldwin and Erie need improvement in plant utilization. Your plant
has a two shift capacity. Use it more optimally.

Forecasting and Inventory: Baldwin has high unsold inventory levels. Inventory carrying cost
is 12% of the unit variable costs. This reduces profits. Unsold inventory also reduces cash in
hand and can pave the way for an emergency loan. Please produce only the quantity you are
sure to sell. Reduce the inventory levels in the next round.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.
Capstone Business Simulation 2020: Practice Round 4 IFMR

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Eat leads the industry. Cid has low market share in this segment.
Baker is overpriced (outside the price range thereby diminishing demand). Remember,
price has an importance of 23% in this segment).
 Low End Segment: Acre leads the industry. Bead has low market share in this
segment. Acre, Cedar and Bead have inappropriate age (too low) for the segment (Age
has an importance of 24% in this segment).
 High End Segment: Adam leads the industry. Cid has low market share in this
segment. Except Chait, all products need improvement in their position (performance
and size) in the segment (Ideal position has an importance of 43% in the segment). Fist
and Cid have inappropriate age (too high) for the segment (Age has an importance of
29% in this segment). Echo and Bid are overpriced (outside the price range).
 Performance Segment: Aft leads the industry. Foam, Bold and Coat have low market
share in this segment. All products need improvement in their position (performance and
size) in the segment (Ideal Position has an importance of 29% in the segment). Bold is
overpriced (outside the price range). Foam and Coat need improvement in accessibility.
 Size Segment: Agape leads the industry. Dune and Cure have low market share in this
segment. Egg, Fume and Dune need improvement in their position (performance and
size) in the segment (Ideal Position has an importance of 43% in the segment). Egg,
Buddy and Epic are overpriced (outside the price range). Cure needs improvement in
accessibility.

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Only Baldwin does not come within
this range.

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Ferris is not investing in improving the productivity of their employees. These can
have a considerable favorable impact on your labor bill.

TQM Investments: Erie spent well here. These initiatives have a snowball effect in the later
rounds and would pay rich dividends. Other teams, do make investments in TQM in the
competition rounds. There are large business benefits to be accrued here.

For each initiative, returns for investments follow the shape of an S-curve. That is, if you spend
too little or too much the returns on your investment are poor. If you spend less than $500,000
in any initiative in a single round chances are you will see little return. An investment of
$1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.

C120373

General: Four years is a reasonably long time in for both a business and a manager in
today’s dynamic and competitive landscape. Is your strategy playing out as planned? Did
you have a strategy in the first place? Are you able to implement it? If not, why not?

Low sales and margins for Baldwin. Negative profits for Baldwin, Digby, Erie and Ferris.
Baldwin and Ferris had low margins and a huge emergency loan – caused by huge
unsold inventories blocking up cash. Chester leads the industry in terms of cumulative
profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
Capstone Business Simulation 2020: Practice Round 4 IFMR

year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: Andrews, Chester and Digby had a rise in stock price of
$6/share, $6/share and $0.9/share respectively. Baldwin, Erie and Ferris had a fall in stock
price of $7/share, $4/share and $14/share respectively. Remember, your company had its
shares trading at $34.25 when you took over as CEO four years ago. Ferris distributed
dividends when their company was in a loss. Is it logical?

Chester leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Chester, Digby and Erie had a rise in market share of 1%, 0.1% and 2.9% respectively.
Andrews, Baldwin and Ferris had a fall in market share of 1.6%, 1.4% and 1.1% respectively.

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?

The highest sales and market share were seen for Chester. This was around $209M and
21.37% respectively.

The lowest sales belonged to Baldwin with market share of 13.44% and sales of $131M. So
Team Baldwin lost more than 3% market share in 4 years. This was mainly due to four reasons
–

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Baldwin, Digby, Erie and Ferris had bottom lines in red. The reasons for this are –

 Low Contribution Margin for Baldwin, Erie and Ferris

 High unnecessary depreciation of plant and machinery due to low plant usage for Digby.
Why keep a plant that only gathers dust.
 High Unsold Inventory and the attendant carrying cost for Baldwin and Ferris.
 High interest expense for highly leverage companies like Baldwin and Ferris. However,
they could be gearing for higher growth here. We have to wait and watch….

Contribution Margin: Baldwin, Erie and Ferris need to improve their margins. Increase
automation levels of the plant, spend to reduce material and labor costs in TQM and on
productivity in the HR Module for the labor costs. Remember, margins in Capstone should
preferably be above 30%.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Baldwin and Ferris have emergency loans. Please keep enough cash
balance to cater to fluctuations in the business. The reasons are –

Baldwin - The reasons for your emergency loan were large cash outflows arising from:

 You have large unsold inventories of over $77M. That is causing a cash flow crisis by
blocking cash. This also imposed 12% (almost $9.2M as inventory carrying costs) and
depressed profits
 Previous years' emergency loan of $26M which was repaid in the current year.

All this caused a huge outflow (and blocking) of cash that you did not have:

Ferris - The reasons for your emergency loan were large cash outflows arising from:

 You spent (wrote out cheques) for $6M for plant. Assets increased but you did not fund it
adequately with debt and equity. Where will the cash come from?
 You have large unsold inventories of over $45M. That is causing a cash flow crisis by
blocking cash. This also imposed 12% (almost $5.4M as inventory carrying costs) and
depressed profits
 You bought back (retired) long term debt of $0.15M
 You paid dividend of $1.7M
 Previous years' current debt of $9M which was repaid in the current year.
Capstone Business Simulation 2020: Practice Round 4 IFMR

All this caused a huge outflow (and blocking) of cash that you did not have:

Emergency loan is current debt. It will automatically get plugged into "current debt due this
year". Borrow maximum from long and short term debt and raise funds through stock issues and
sale of surplus plant to ensure your 31 Dec closing cash (bottom left row on Finance sheet
of Capstone) balance is a healthy figure (attempt 1-2 months of sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.

Plant Size and Utilization: Digby needs improvement in plant utilization. Your plant has a two
shift capacity. Use it more optimally.

Asset Turnover: Baldwin needs to work their assets harder. They are the only teams to have
their asset turnover below one.

Forecasting and Inventory: Baldwin and Ferris have high inventory levels. Inventory carrying
cost is 12% of the unit variable costs. This reduces profits. Unsold inventory also reduces cash
in hand and can pave the way for an emergency loan. Please produce only the quantity you are
sure to sell. Reduce the inventory levels in the next round.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.
Capstone Business Simulation 2020: Practice Round 4 IFMR

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Cake leads the industry. Baker and Fast have low market share
in this segment. Eat, Able, Baker and Fast need improvement in their position
(performance and size) in the segment.
 Low End Segment: Acre leads the industry. Dell has low market share in this segment.
Bead and Dell have inappropriate age (too low) for the segment (Age has an importance
of 24% in this segment). Cedar and Aman need improvement in their position
(performance and size) in the segment. Bead needs improvement in accessibility.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 High End Segment: Cid leads the industry. FT3, FT2, Bayer and Fist have low market
share in this segment. Cid, Echo, Adam, Bid, FT3, FT2 and Fist need improvement in
their position (performance and size) in the segment (Ideal position has an importance of
43% in the segment). Fist has inappropriate age (too high) for the segment (Age has an
importance of 29% in this segment). Adam, FT3 and Bayer are overpriced (outside the
price range).
 Performance Segment: Coat leads the industry. Foam and Bold have low market share
in this segment. Aft has too high MTBF (MTBF has an importance of 43% in the
segment). Foam and Elude need improvement in their position (performance and size) in
the segment (Ideal Position has an importance of 29% in the segment). Aft and Bold are
overpriced (outside the price range). Dot, Foam and Bold need improvement in
accessibility.
 Size Segment: Cure leads the industry. Buddy and Dune have low market share in this
segment. Egg, Fume and Dune need improvement in their position (performance and
size) in the segment (Ideal Position has an importance of 43% in the segment). Egg has
inappropriate age (too high) for the segment (Age has an importance of 29% in the
segment). Agape and Buddy are overpriced (outside the price range). Egg, Fume,
Buddy and Dune need improvement in accessibility.

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Only Baldwin and Ferris don’t
come within this range.

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Andrews and Digby are not investing in improving the productivity of their
employees. These can have a considerable favorable impact on your labor bill.
Capstone Business Simulation 2020: Practice Round 4 IFMR

TQM Investments: Chester spent well here. These initiatives have a snowball effect in the later
rounds and would pay rich dividends. Other teams, do make investments in TQM in the
competition rounds. There are large business benefits to be accrued here.

Ferris - For each initiative, returns for investments follow the shape of an S-curve. That is, if you
spend too little or too much the returns on your investment are poor. If you spend less than
$500,000 in any initiative in a single round chances are you will see little return. An investment
of $1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.

C120374

General: Is your strategy playing out as planned? Did you have a strategy in the first
place? Are you able to implement it? If not, why not?

Low sales and margins for Chester. Negative profits for Chester and Erie. Chester had
low margins and a huge emergency loan – caused by huge unsold inventories blocking
up cash. Erie had an emergency loan. Baldwin leads the industry in terms of cumulative
profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: Andrews, Baldwin, Digby and Ferris had a rise in stock price
of $14/share, $19/share, $18/share and $12/share respectively. Chester and Erie had a fall in
stock price of $27/share and $2/share respectively. Remember, your company had its shares
trading at $34.25 when you took over as CEO four years ago.

Baldwin leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Andrews, Baldwin, Digby and Erie had a rise in market share of 0.8%, 0.2%, 4.2% and
4.3% respectively. Chester and Ferris had a fall in market share of 8.5% and 1% respectively.
Capstone Business Simulation 2020: Practice Round 4 IFMR

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?

The highest sales and market share were seen for Baldwin. This was around $251M and
24.74% respectively.

The lowest sales belonged to Chester with market share of 6.15% and sales of $62M. So
Team Chester lost more than 10% market share in 4 years. This was mainly due to four reasons
–

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
Capstone Business Simulation 2020: Practice Round 4 IFMR

 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Chester and Erie had bottom lines in red. The reasons for this are –

 Low Contribution Margin for Chester

 High SG&A compared to sales for Erie. But this is an investment and would pay off in
the later rounds.
 High Unsold Inventory and the attendant carrying cost for Chester.
 High interest expense for highly leverage companies like Chester. However, they could
be gearing for higher growth here. We have to wait and watch….

Contribution Margin: Chester needs to improve their margins. Increase automation levels of
the plant, spend to reduce material and labor costs in TQM and on productivity in the HR
Module for the labor costs. Remember, margins in Capstone should preferably be above 30%.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Chester and Erie have emergency loans. Please keep enough cash
balance to cater to fluctuations in the business. The reasons are –

Chester - The reasons for your emergency loan were large cash outflows arising from:

 Net cash flow from operations is a negative $60.5M.

 You have large unsold inventories of almost $75M. That is causing a cash flow crisis by
blocking cash. This also imposed 12% (almost $9M as inventory carrying costs) and
depressed profits

All this caused a huge outflow (and blocking) of cash that you did not have:

Erie – Your net cash flow from operations is a negative $16.9M. This reduced your net cash
position. See note in red below:

Emergency loan is current debt. It will automatically get plugged into "current debt due this
year". Borrow maximum from long and short term debt and raise funds through stock issues and
sale of surplus plant to ensure your 31 Dec closing cash (bottom left row on Finance sheet
of Capstone) balance is a healthy figure (attempt 1-2 months of sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
Capstone Business Simulation 2020: Practice Round 4 IFMR

you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.

Asset Turnover: Chester needs to work their assets harder. They are the only teams to have
their asset turnover below one.

Forecasting and Inventory: Chester has high inventory levels. Inventory carrying cost is 12%
of the unit variable costs. This reduces profits. Unsold inventory also reduces cash in hand and
can pave the way for an emergency loan. Please produce only the quantity you are sure to sell.
Reduce the inventory levels in the next round.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
Capstone Business Simulation 2020: Practice Round 4 IFMR

the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Baker leads the industry. Box and Fame have low market share
in this segment. Baker, Cake and Fame need improvement in their position
(performance and size) in the segment.
 Low End Segment: Bead leads the industry. Endgme and Cedar have low market
share in this segment. Ebb has inappropriate age (too low) for the segment (Age has an
importance of 24% in this segment). Cedar needs improvement in its position
(performance and size) in the segment. Cedar needs improvement in accessibility.
 High End Segment: Doc leads the industry. Adam has low market share in this
segment. Except Doc and Dixie, all products need improvement in their position
(performance and size) in the segment (Ideal position has an importance of 43% in the
segment). Cid has inappropriate age (too high) for the segment (Age has an importance
of 29% in this segment). Acid and Adam are overpriced (outside the price range). Cid
need improvement in accessibility.
 Performance Segment: Bold leads the industry. Covid and Coat have low market share
in this segment. Coat has low MTBF (MTBF has an importance of 43% in the segment).
All products need improvement in their position (performance and size) in the segment
(Ideal Position has an importance of 29% in the segment). Coat is overpriced (outside
the price range). Coat has inappropriate age (too high) for the segment.
 Size Segment: Buddy leads the industry. Cure has low market share in this segment.
Buddy and Cure need improvement in their position (performance and size) in the
Capstone Business Simulation 2020: Practice Round 4 IFMR

segment (Ideal Position has an importance of 43% in the segment). Cure has
inappropriate age (too high) for the segment (Age has an importance of 29% in the
segment). Agape and Cure are overpriced (outside the price range). Cure needs
improvement in accessibility.

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Baldwin, Chester and Digby don’t
come within this range.

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

Capstone Business Simulation 2020: Practice Round 4 IFMR

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Chester and Ferris are not investing in improving the productivity of their
employees. These can have a considerable favorable impact on your labor bill.

TQM Investments: Baldwin and Erie spent well here. These initiatives have a snowball effect
in the later rounds and would pay rich dividends. Other teams, do make investments in TQM in
the competition rounds. There are large business benefits to be accrued here.

For each initiative, returns for investments follow the shape of an S-curve. That is, if you spend
too little or too much the returns on your investment are poor. If you spend less than $500,000
in any initiative in a single round chances are you will see little return. An investment of
$1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.
Capstone Business Simulation 2020: Practice Round 4 IFMR

C120375

General: Four years is a reasonably long time in for both a business and a manager in
today’s dynamic and competitive landscape. Is your strategy playing out as planned? Did
you have a strategy in the first place? Are you able to implement it? If not, why not?

Low sales and margins for Erie. Negative profits for Erie. Digby leads the industry in
terms of cumulative profits.

Profits usually fall in the fourth round due to start of the TQM Module. Since these
initiatives are paid for from operations; they appear on your income statement, leading to
reduced profits in the current year. Although some immediate benefits follow from this
year's expenditures, you should expect payback to take between 18 months and three
years.

Stock Price and Market Cap: All teams had a rise in stock price. Remember, your company
had its shares trading at $34.25 when you took over as CEO four years ago.

Digby leads the industry in market cap.

Remember: change in stock price from one year to the next is an indicator for the long term
growth potential of the company.

If the stock price is increasing, the company will enjoy easier access to new equity via profits
and stock issues, which in turn can be leveraged with additional bonds, and the combined
capital can fund plant improvements and new products.

If the stock price is falling, it becomes increasingly difficult to obtain new investment capital,
either equity or debt. Eventually the company’s ability to make improvements comes to a halt.

Sales: Baldwin, Chester and Ferris had a rise in market share of 1.5%, 0.9% and 2%
respectively. Andrews, Digby and Erie had a fall in market share of 2%, 1.3% and 1.2%
respectively.

The market size is fixed; it’s up to the individual teams to capture more market share.

The sales for Round 0 were about $101M with a market share of 16.67% for all the teams. Had
you maintained the same 16.67% market share your sales in Round 4 would be in the region of
$170M?

The highest sales and market share were seen for Chester. This was around $225M and 23.2%
respectively.

The lowest sales belonged to Erie with market share of 9.71% and sales of $94M. So Team
Erie lost almost 7% market share in 4 years. This was mainly due to four reasons –

 They did not spend on upgrading and improving their products. This shows that
organizations which do not improve/ change/ innovate are bound to go out of the race.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Failure to provide the customers what they want can be fatal. Please see the perceptual
map below:

 They did not spend well on awareness and accessibility (2 of the 4P’s). Customers
cannot buy your products if they do not know about them (lack of awareness) or if they
are not available (lack of accessibility to your product).Examples of lost sales due to
poor customer awareness (low promo spends) and lack of availability (poor channel
management) abound in every industry.
 They did not launch new products fast enough and had far fewer products than
competing companies. More products invariably help slice up the market to your
advantage and translate to higher market share. Can Maruti have the market share it
Capstone Business Simulation 2020: Practice Round 4 IFMR

does, if it had only two models of cars instead of 12cars that it has? (Ertiga, Dzire,
Celerio, WagonR, AltoK10, Swift, Omni, Eeco, VitaraBrezza, Gypsy and Alto800)
 They failed to capture markets by entering early and creating strong defensible
positions.

Profits: Erie had bottom line in red. The reasons for this are –

 Low Contribution Margin

 High Unsold Inventory and the attendant carrying cost.
 Low Sales

Contribution Margin: Chester and Erie need to improve their margins. Increase automation
levels of the plant, spend to reduce material and labor costs in TQM and on productivity in the
HR Module for the labor costs. Remember, margins in Capstone should preferably be above
30%.

Contribution margin is defined as:

Sales - (Direct Labour + Direct Materials + Inventory Carry)

Sales

It is reported on Page 1 of the Capstone Courier as an aggregate average of each team's

product portfolio. A good benchmark for contribution margin is 30%. A product-by-product
margin computation is available on the Income Statement portion of your company's annual
reports.

Margins are driven by both price and cost. Check to see which of these problems you have:

 Are your prices too low? "Variable Margin" is the margin that you make on each unit. It
is defined as:
o Price - (Direct Labour + Direct Materials)
Price
o
From your variable margin you pay for depreciation, R&D, promotion, sales,
admin costs, etc. A good benchmark for variable margin is 38%. You will find
Contribution Margins on the Production Sheet in your Capstone software.
 Are your MTBF ratings set too high? MTBF ratings affect material costs. Check the
MTBF ratings of each product against the "Customer Buying Criteria" on pages 5-9 of
the Courier. Are they higher than they need to be? Example: If the MTBF range is
12,000-17,000, and it is the 4th buying criteria (as it is in the Low End segment), there is
little benefit in having MTBF set higher than the minimum. The Low End customer is
saying to you that given a choice between reliability and price, they prefer price.
Capstone Business Simulation 2020: Practice Round 4 IFMR

 Is your positioning too advanced? Material costs at the leading edge of a segment are
$4 higher than at the trailing edge. If the customer values price more than positioning,
sacrifice positioning.
 Is your labour content too high? Labour content is the percentage of Cost of Goods
(COG) consumed by labour expense. For example, if COG is $10, and labour costs are
$4, your labour content is 40%. You can reduce labour content with automation. To a
lesser degree, you can also limit labour content by eliminating overtime and by
negotiating for a more favourable labour contract. A good benchmark for labour content
in Capstone is 30%.
 Are you dropping price to increase market share? If so, recognize that Capstone
customers have no loyalty based upon past purchases, and they endure no switching
costs. Customer behaviour is driven by product attributes, awareness, and accessibility.
 Are you dropping price to respond to competition? Check your competitor's
margins. Are they making money? Losing money? If they are losing money, resist the
temptation to follow them. While your unit volume will fall, it is more important to stay
profitable. Thank your competitor for losing money. They will soon discover that they
cannot sustain the losses and will want to raise their price. If you have lowered yours,
the industry will be trapped in a price war. On the other hand, if you discover that they
are making money because they have attacked their cost structure and are passing
along savings to customers, you have a serious problem. Address your costs,
differentiate so you can maintain your price, or get out of the segment.

Emergency Loans: Emergency loan is current debt. It will automatically get plugged into
"current debt due this year". Borrow maximum from long and short term debt and raise funds
through stock issues and sale of surplus plant to ensure your 31 Dec closing cash (bottom
left row on Finance sheet of Capstone) balance is a healthy figure (attempt 1-2 months of
sales).

In case of emergency loans, raise max funds from long term and current debt to repay
this emergency loan. Curtail your production in the next round in the segments where
you have high unsold inventories. Remember to upgrade the specs of your products: the
old inventory gets a free ride to the new specifications.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy."

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Plant Size and Utilization: Andrews, Baldwin and Digby need improvement in plant
utilization. Your plant has a two shift capacity. Use it more optimally.

Asset Turnover: Erie needs to work their assets harder. They are the only teams to have their
asset turnover below one.

Forecasting and Inventory: Erie has high unsold inventory levels. Inventory carrying cost is
12% of the unit variable costs. This reduces profits. Unsold inventory also reduces cash in hand
and can pave the way for an emergency loan. Please produce only the quantity you are sure to
sell. Reduce the inventory levels in the next round.

To make sure your forecasting and inventory mgmt is within reasonable limits check for the
following two conditions:

 Is your company satisfying at least 95%; of the demand they generate across the entire
product line. Actual Total Industry Unit Sales/Potential Industry Unit Sales >= 95%.(on a
per team basis)

 Is your company carrying more than 90 days of inventory: defined as Total Unit
Inventory/Total Units Sold<=25%.

CHECK FORSTOCK OUTS. You may have under-produced and turned away customers.
Examine the ACTUAL VS. POTENTIAL graphs for each segment analysis in the simulation
reports. This will indicate how badly your stock out hurt you.

CHECK FOR EXCESSIVE INVENTORY LEVELS. On the Production Analysis (page 4),
compare "Units Sold" with "Units in Inventory". Inventory should be less than 1/6th of unit sales.
Inventory consumes cash, drags down your performance measures, and in extreme cases
drives emergency loans. Inventory carry overheads chew into profits. Typical problems include:

 Overly optimistic sales forecasts. Previous year customer demands (and segment
growth rates) are listed for each market segment pages. Compare your sales forecast
figures against segment demand. Were sales expectations unrealistic? For example, if
the segment demand ceiling was 3 million units, and there are six teams with products in
the segment, a "fair share" starting point is 500 thousand units per team. If you have a
better than average product, your sales will be higher. Below average products produce
below average demand. But unless your product is dramatically better or worse than the
other products in the segment, you demand will be somewhere between 50% and 150%
of average. This is discussed further in the help files on the website under "How do we
develop a unit sales forecast?"

 Do not confuse the relationship between sales forecasts, production schedule,

and production capacity.

o Sales Forecasts only affect proformas. They are a tool - not a management
"decision." When you enter a forecast, you force the software to use your number
Capstone Business Simulation 2020: Practice Round 4 IFMR

to drive the Income Statement. When the simulation is processed on the web
site, actual sales depend upon the actions of your competitors.

o Production Schedule (on the Production spreadsheet of the student software) is

the actual production for the year. This is added to the starting inventory.
Production occurs in monthly increments.

Production Capacity is the size of the factory. If the Capacity is 500 thousand, you can produce
up to one million units by running 100% overtime. All units produced above 500 thousand will be
affected by time-and-a-half overtime charges. You buy or sell capacity, or simply leave it idle
and unused.

Segment Wise Product Analysis: How are your products faring?

 Traditional Segment: Cake leads the industry. Fast and Fleet have low market share in
this segment. Baker has inappropriate age (too high) for the segment (age has an
importance of 47% in this segment). Daze, Fast and Fleet need improvement in their
position (performance and size) in the segment. Eat needs increased levels of
awareness. (It has awareness of only 48% and hence 52% of the market does not know
about your product). Baker and Eat need improvement in accessibility.
 Low End Segment: Feat leads the industry. Acre, Eff and D_New have low market
share in this segment. Except Feat, all products have inappropriate age (too low) for the
segment (Age has an importance of 24% in this segment). Eff and D_New need
increased levels of awareness. Ebb, Bead and Eff need improvement in accessibility.
 High End Segment: Cid leads the industry. Aksa, Bid and Bee have low market share
in this segment. Fight, Adam, Aksa, Bid and Bee need improvement in their position
(performance and size) in the segment (Ideal position has an importance of 43% in the
segment). Adam and Bid have inappropriate age (too high) for the segment (Age has an
importance of 29% in this segment). Dixie is overpriced (outside the price range). Bee
needs increased levels of awareness. Cid, Dixie, Bid and Bee need improvement in
accessibility.
 Performance Segment: Coat leads the industry. Bold and Aft have low market share in
this segment. Bold, Foam and Aft need improvement in their position (performance and
size) in the segment (Ideal Position has an importance of 29% in the segment). Dot and
Bold are overpriced (outside the price range). Foam, Bold and Aft have inappropriate
age (too high) for the segment. Coat, Dot and Bold need improvement in accessibility.
 Size Segment: Cure leads the industry. Buddy and Cute have low market share in this
segment. Agape and Buddy need improvement in their position (performance and size)
in the segment (Ideal Position has an importance of 43% in the segment). Fume, Agape
and Buddy have inappropriate age (too high) for the segment (Age has an importance of
29% in the segment). Dune, Fume and Buddy are overpriced (outside the price range).
Cute needs increased levels of awareness. Dune and Buddy need improvement in
accessibility.
Capstone Business Simulation 2020: Practice Round 4 IFMR

Financial Management: The ideal leverage in Capstone is in the range of 1.8 to 2.8 for
maximum credit on the balanced score card measurement. Andrews, Digby and Erie don’t
come within this range.

How is leverage important? In Capstone® Leverage is defined as Assets/Equity. (It is

sometimes defined as Debt/Equity, but in either case, Leverage is addressing the question,
“How much of the company assets are funded with debt?”) The higher the Assets/Equity ratio,
the more debt is in the mix.

Using Assets/Equity, a Leverage of 2.0 means half the assets are financed with debt and half
with equity. Read it as, “There are $2 of assets for every $1 of equity.” A leverage of 3 reads as,
“There are $3 of assets for every $1 of equity.”

It is easy to see why too much Leverage can cause problems. As debt increases, loans
become more expensive. The company becomes high risk, and lenders eventually decline to
lend the company money.

On the other hand, companies with a competitive advantage usually have a larger asset base
than their competitors. For example, a broad product line implies a larger plant. A highly
automated facility implies a large investment. Growing the company’s asset base quickly
calls for prudent use of debt.

Here is an example. Suppose Andrews has assets of $100 million, and Baldwin $125 million.
Assume that each team is utilizing their assets productively. An observer will bet on Baldwin
because its larger asset base translates into more products or more productivity. Now suppose
that Andrews is leveraged at 2.0, and Baldwin at 2.5. If so, they both have $50 million in equity.
By leveraging its equity, Baldwin gained an advantage.

Too little leverage can also indicate weakness, provided that investment opportunities
exist. Think of it this way. When a company retires debt, it is saying to stockholders, “We are
out of ideas for investments. The best we can come up with is to save you the interest on debt.”
This will not impress stockholders, who are looking for a high return on their equity (ROE). An
investor expecting a 20% ROE will be unhappy learning that their money was used to reduce
debt at 10%.

ROS * Asset Turnover *Leverage = Price/Sales * Sales/Assets * Assets/ Equity = ROE. If the
company can somehow hold its margins and productivity constant, increasing leverage
improves ROE.

If leverage is falling, here are some things to suggest to the company.

1. Decide upon a policy towards leverage. For example, “Our leverage will be 2.5.” Adjust your
leverage before saving your decisions. (Issue/retire debt, issue/retire stock, pay dividends.)

2. Find investment opportunities. For example, if the market is still growing, and you are already
at a high plant utilization, you will need to add some capacity each year. Or perhaps you can
Capstone Business Simulation 2020: Practice Round 4 IFMR

add a new product. Fund these investment opportunities with a mix of debt and equity
consistent with your policy.

3. In the latter rounds of Capstone® you are likely to become a “cash cow”. You discover that
you have excess working capital that cannot be put to good use. In the real world management
might get into new businesses, but in Capstone® there are no such alternatives. In this case,
make your stockholders happy by buying back stock or paying dividends to maintain the
leverage.

Keep an eye on your Bond Rating: The bond ratings are, from best to worst, AAA, AA, A,
BBB, BB, B, CCC, CC, C, DDD.Bond ratings are driven by leverage. As bond ratings fall,
interest rates climb on both short term and long term debt.

As the bond rating decays, bond holders become reluctant to give the company additional debt.
This sets a limit on the company’s ability to acquire additional assets, particularly automation,
capacity, and new products.

Since leverage is a function of equity, the bond rating is in some sense derived from equity.
Companies can improve their bond rating by adding equity, either as a stock issue or as profits.
The more equity they have, the more debt they can raise, and the bigger their asset base.

Alternatively, companies can improve their bond rating by reducing debt. However, reducing
debt also implies shrinking the asset base. While there are always exceptions to the rule,
shrinking the asset base in a growing market would be limiting to growth.

HR Module: Baldwin and Erie are not investing in improving the productivity of their
employees. These can have a considerable favorable impact on your labor bill.

TQM Investments: Andrews spent well here. These initiatives have a snowball effect in the
later rounds and would pay rich dividends. Other teams, do make investments in TQM in the
competition rounds. There are large business benefits to be accrued here.

For each initiative, returns for investments follow the shape of an S-curve. That is, if you spend
too little or too much the returns on your investment are poor. If you spend less than $500,000
in any initiative in a single round chances are you will see little return. An investment of
$1,500,000 in a single round produces a cost-effective impact, investments over$1,500,000
become dollar for dollar less effective. Finally, for each initiative, an investment over $2,000,000
in a single round produces absolutely no additional benefit.
Capstone Business Simulation 2020: Practice Round 4 IFMR

A Note on Market Share

Generically, you want high overall market share for three reasons:

1. You began with a sizeable fixed asset base. You want to utilize your plant and
equipment to pay for depreciation and service the long-term debt. Idle plant costs
money. As it gathers dust, it also hands you a bill for depreciation, interest, and
eventually the principal on the funds used to buy the equipment. Therefore, so long as
you at least break even, you would prefer to utilize all of your capacity. That implies high
sales volume.

2. You began with a large company doing business in every segment. An investor would
argue that any strategy you develop, including niche strategies, should produce at least
average sales. For example, a focused strategy should produce higher share in the
target segments, enough to compensate for sacrificing positions in abandoned
segments.

3. If you make a sale, a competitor did not. This weakens competition over the long haul.

A Note on Margins

Analyse your margins across three metrics:

1. Contribution Margin Percentage

2. Net Margin
3. ROS or Return On Sales

Why do margins matter? And why focus upon Contribution Margin, Net Margin, and
Return On Sales? To simplify things, let's consider an example where you have only one
product.

REVENUE ($000) Awsum Product Awsum

Sales $30,000 Price $30.00
VARIABLE COSTS Labor $7.00
Direct Labor $7,000 Material $11.50
Direct Material $11,500 Inventory Carry $0.50
Inventory Carry $500 Unit Margin $11.00
Total Variable Costs $19,000 Units Sold 1,000,000
Contribution margin $11,000 36.7%
PERIOD COSTS
Depreciation $2,000
Capstone Business Simulation 2020: Practice Round 4 IFMR

SG&A: R&D $500

Promotion $1,300
Sales $1,100
Admin $300
Total Period Costs $5,200
Net Margin $5,800 19.3%
Other (fees, write-offs) $100
EBIT $5,700
Interest $2,500
Taxes $1,120
Profit Sharing $50
Net Profit $2,030 6.8%

EXAMPLE

Contribution Margin is defined as Sales less Variable Costs. Variable Costs are the expenses
that are tied to the sale of each unit. They are recognized when a unit is sold. Because the
number of units you sell varies with demand, they are called Variable Costs. In the example
above you sold 1 million units. If you had sold 2 million, your Variable Costs would have been
$38 million, but if you sold 500 thousand, they would be only $9.5 million.

In short, you do not know your Variable Costs until the sales numbers arrive.

Period Costs, on the other hand, are not tied to sales. In the example above, you spent $5.2
million on Period Costs whether you sold anything or not. While you could not say what your
Variable Costs were until December 31st, the Period Costs were known on January 1st.

Net Margin is defined as Contribution Margin less Period Costs. Put simply, it is what the
product contributes towards profits.

From the combined Net Margin (normally across all products) you pay the expenses that cannot
be allocated to a product. First comes "Other" (expenses like brokerage fees), then Interest,
Taxes, and Profit Sharing until you are left with a Net Profit.

What is critical here?

Have another look at the example. Notice that all the expenses from the PERIOD COSTS label
down are either fixed or a percentage of profits. The moment you submit your decisions,
everything but Profit Sharing and Taxes is known, and they only occur if you produce a profit.
Those known expenses total ($5,200 + $100 + $2,500 = $7,800) or $7.8 million. If your
Contribution Margin cannot cover $7.8 million, you are destroying wealth instead of creating it.

In the big picture, you cannot have a decent ROS unless your Net Margin Percentage is good,
and you cannot have a good Net Margin Percentage unless your Contribution Margin
Capstone Business Simulation 2020: Practice Round 4 IFMR

Percentage is healthy. In Capstone®'s industry, this translates to a 10% ROS, 20% Net Margin,
and 30% Contribution Margin.

Finally, consider your detailed Income Statement in your Annual Report. Typically, some of your
products are producing healthy margins, while others are slim to negative. Your task is to
improve the margins on the poor performers. Are Period Costs too high? Are Sales, and
therefore the Contribution Margin, too low?

A note on Profits
Because the industry is growing, profit expectations from your company grow too. Here is a
broad guide for profit expectations from Wall Street for your firm:

Year 1 $6 million
Year 2 $8 million
Year 3 $10 million
Year 4 $12 million
Year 5 $16 million
Year 6 $21 million
Year 7 $27 million
Year 8 $35 million

You want your profits to be as high as possible. If your profits are not where you’d like to see
them, please begin by analysing your margins:

1. If your ROS is above 5%, chances are the problem is rooted in below average Sales.

2. If your ROS is below 5%, but your Net Margin Percentage is above 20%, you either
experienced some extraordinary "Other" expense like a write-off on plant you sold, or
you are paying too much Interest (If TQM is enabled, you may also have spent heavily
on TQM initiatives).

3. If your Net Margin Percentage is below 20%, but Contribution Margin is above 30%, the
problem is heavy expenditures on Depreciation (perhaps you have idle plant) or on SGA
(perhaps you are pushing into diminishing returns on your Promo and Sales Budgets).

4. If your Contribution Margin is below 30%, the problem can be traced to some
combination of Marketing (customers hate your products), Production (your labor and
material costs are too high), or Pricing (you cut the price too much).
Capstone Business Simulation 2020: Practice Round 4 IFMR

A note on Emergency Loans

In the real world emergency loans do not exist. When you run out of cash, you have "a liquidity
crisis", "Chapter 11", or simply "Bankruptcy" on your hands. Capstone® gives you every benefit
of a doubt, and every opportunity to come up with the money to pay your bills, but if you are out
of cash on December 31st, "Big Al" arrives to give you just enough cash to bail you out and
bring the Cash account to zero.

Emergency loans are closely linked to your working capital policy and forecasting abilities. Most
loans are rooted in two mistakes:

1. An unexpected and dramatic expansion in inventory;

2. Funding plant expansion with "excess" working capital. Or worse, forgetting to fund the
plant improvements at all.

One can argue that the Emergency Loan category should offer nothing for small emergency
loans. After all, if your heart stops beating, blood stops flowing, and you are dead. If Cash no
longer flows through your company, it is dead, too.

Emergency loans are listed on Page 1 of the Capstone Courier. The simulation gives you every
benefit of a doubt, but if you are out of cash at the end of the year, "Big Al" arrives to give you
just enough cash to bail you out -- at a 7.5 percentage point premium, of course. In the real
world we often refer to emergency loans as "a liquidity crisis", "Chapter 11", or simply
"Bankruptcy." If your company has an excessive emergency loan, check to see which of
the following problems you have:

1. When you saved your decisions, did your Proforma Balance Sheet project negative cash? If
so, your emergency loan was unnecessary. In Capstone you can always raise adequate cash
via stock issues, new bonds, or short term debt. Of course, this is not true in the real world, but
it is a necessary aspect of our simulated environment. Your task is to learn how to dig your way
out of this hole. Here are some guidelines:

a. Raise all the money via stock issues that the spreadsheet will allow. Note that the
spreadsheet presents a ceiling called "Max Issue". Do not exceed the number in "Max Issue".
(You can enter a bigger number and the spreadsheet will accept it, but when your decisions are
processed on the website you will actually receive the value in "Max Issue.")

b. Raise all the money via bond issues that the spreadsheet will allow, or enough to make your
Performa Cash balance positive. Do not exceed the number labeled "Maximum Issue This
Year". (Like the stock "Max Issue," you can enter a bigger number, and the spreadsheet will
accept it, but when your decisions are processed you will get "Maximum Issue This Year.")

c. If your Performa Cash balance is still negative, borrow sufficient Current Debt to bring Cash
into the black. Current Debt is your last choice because it is your most expensive money, but
Capstone Business Simulation 2020: Practice Round 4 IFMR

even it is less expensive than an emergency loan. Note that the Current Debt principal is due at
the start of every year, but you have the option of reborrowing or "rolling" the debt.

d. If you have large quantities of inventory on any product, identify which segment it falls within
on the Perceptual Map. Find the price guidelines for that segment. Price to sell within those
guidelines. You need to convert that inventory back into cash. Cut back on production as
appropriate.

e. Take a critical look at your plant capacity. If your product lines are running at less than 100%
utilization, sell the excess capacity.

f. If you are planning to retire a product line, now is the time. Sell the capacity. If you have
inventory, however, and think you can sell it, keep one unit of capacity. This makes it possible to
sell the inventory instead of liquidating it at 50% of its value.

g. In the Help files in your software or on the website, find the item "How do we develop a unit
sales forecast?” Follow the guidelines to prepare a realistic sales forecast and enter it on the
Marketing spreadsheet.

h. Examine your Performa Income Statement. If any product shows a negative "Net Margin",
you must address the problem. If necessary, do not make or sell the product. Do not sell a
product at a loss.

2. If your Performa Balance sheet showed a positive cash balance when you saved your
decisions, check the following:

a. Was there a very large increase in inventory? Check your Annual Report's Cash Flow
statement. Did inventory increase dramatically? If so, turn to the Production Analysis (page 4).
Was it one product, or are you carrying moderately large inventories on several products? If it is
a single product, you have a serious but short term problem. The solution is to cut back on
production until the inventory is sold. This may take several years depending upon the cause of
the problem. On the other hand, if you are carrying moderately large inventories on several
product, the root problem is overly optimistic forecasting. In the Help files in your software or on
the website, find the item "How do we develop a unit sales forecast?". Follow the guidelines to
prepare a realistic sales forecast and enter it on the Marketing spreadsheet.

b. Did you buy plant and equipment and forget to fund it? If so, fund it now by matching the
investment with a combination of stock and bond issues. Your emergency loan has been
classified as Current Debt and is due on January 1st. If you do not fund your investment, you
could get another emergency loan to pay for the previous emergency loan.

To diagnose your emergency loan, examine your Cash Flow statement. It represents the net
flow of money into and out of your checking account. A positive number indicates an inflow, a
negative number an outflow. For example, find the "Inventory" line. If your inventory position
increased compared to last year, you had to pay for the additional inventory, and that resulted in
a cash outflow. On the other hand, if you sold all of your old inventory, that represented a cash
inflow.
Capstone Business Simulation 2020: Practice Round 4 IFMR