It is early 2014. A leading global skincare manufacturer,
Health & Beauty Co. (HBC), has been losing market share in
the hand and body lotion market. While the firm still leads its
competitors in market share in this segment of personal care,
it seeks to stem further share erosion and, to that end, has
recently developed a strategy to recover market share through
rebranding, advertising, and repackaging. The situation is
especially critical since a large competitor is believed to be
launching a new skincare product in the near future.
Your task as senior financial analyst is to draft the capital
expenditure proposal related to the new packaging proposal.
Information to support you in this task follows. You should
complete the firm’s capital expenditure template included in
Appendix 1.
BACKGROUND:
The U.S. skincare market has been growing at an average
rate of 4% over the past three years and is estimated to reach
$11 billion in 2018. This market includes facial, body, and
hair care, as well as other makeup segments. HBC holds
a leadership position in the hand and body lotion market
but needs to evolve to meet consumers’ growing needs and
compete with an ever-increasing number of competitors.
Recent market research by HBC revealed that consumers
perceive the current packaging as outdated: old, generic,
dull, and cheap looking. It also lacks a contemporary and
premium look compared with some of the main competitor’s
products. HBC is in the process of rebranding these product
lines, and newly developed packaging will play a pivotal role
in the plan to rebrand and reposition the product. The new
packaging aims to convey the brand image of modern, up-todate, high-quality, everyday use, and good value.
Preliminary investigation comparing the existing and
proposed packaging revealed the following:
1. The proposed packaging will keep the brand fresh and
relevant while maintaining the brand heritage and appeal
to existing and future consumers.
2. The project:
a. Provides the opportunity to simplify an overcomplicated and confusing pack line-up by reducing
the current portfolio of sizes.
b. May lead to improved margins since there is the
potential to raise prices on the newly packaged items.
The current gross margin of the product is 69%.
3. Overall, the new pack design is a cost-effective pack with
package unit prices lower than that of the current brand
pack.
4. The brand team believes that incremental sales growth
is achievable through the combination of new brand
positioning, advertising, and packaging. Feedback from
several large retailers consulted on the new packaging
was consistently positive.
Repackaging a Global Brand:
The new packaging would require the purchase of molds and
assembly equipment (useful life of six years on all) as follows:
Cap/Pump molds $1,590,000
Change part 260,000
Pump assembly 570,000
In addition, the firm will incur start-up expenses related
to partial case returns and other items. It is assumed that
major customers will be able to manage down their inventory
levels with the assistance of the transitions team. Minimal
returns will come from large retailers including WalMart and
Kmart due to their quick inventory turnover. It is anticipated
that most returns will come from drug retailers as they shift
products to the new packaging and remove unsold product
from the shelves.
Partial case returns net of salvage value $1,800,000
Label conversion costs 700,000
Freight charge/launch year expenses 400,000
Other miscellaneous 300,000
The redesign calls for cutting SKU’s from 79 to 49. No
volume loss is anticipated from this since the transition team
will actively manage shelf space on a customer-by-customer
basis to minimize loss of shelf presence. The SKU reduction
is estimated at $119,000 per year since the new package
design is less expensive per unit.
The brand’s current long-term strategic role is to
maintain share and grow at category levels. Sales in the
most recent year were $139.5 million. Without the redesign,
sales are forecast to remain flat at historic levels. With the
redesign, management believes that sales can grow at the
rate of the skincare category—forecast at 4% per year for the
next five years—and there will also be incremental growth
related to recovery of market share of 2% in Year 1, 1% in
Year 2, 0.5% in Year 3, and 0% thereafter.
The gross margin will remain at 69% of net sales.
The incremental marketing and development cost is a
one-time $700,000 for market research and development.
Management thought the project should be evaluated using
a discount rate of 7% based on the firm’s weighted average
cost of capital (WACC) and the perceived riskiness of the
project. The tax rate is 27%.
calculate the payback