Case Problem Facts

Case Problem Facts
Introduction

The case problem facts involve manufacture and sale of a soup product in large quantities whereby the soup product is to be manufactured by a firm based in the United States of America and sold to a firm based in Hong Kong who will sell it in various markets in Asia. The two companies involved in this transaction and focused on in the Case Problem Facts are Hen Hao trading company ltd and Grumpbell Soup Company Inc. Hen Hao trading company Ltd. (Hen Hao) is well established distributor of various products in Asia. The company is based in Hong Kong. Hen Hao is said to have developed a large and growing market for food products which it imports from overseas manufacturers mainly based in the United States of America. Hen Hao sells imported products because it does not have the productive capacity, technology and supply of adequate raw materials needed to manufacture the products itself. Hen Hao has strong banking relationships with Hong Kong and Shanghai Banking Corporation (HSBC) in Hong Kong and is owned by a prominent wealthy Hong Kong family.

In the Case Problem Facts, Hen Hao has discovered a large untapped market for a spicy chicken noodle soup product with a certain special aroma and flavour. To tap this market Hen Hao has developed a soup product known as “Oriental Delight” whose proprietary formula was developed by a U.S food laboratory known as Specialty Foods Laboratory Inc. In the Case Problem Facts, Hen Hao seeks a reliable and high quality manufacturer able to manufacturer the specialty soup product according to its quality specifications to ensure that the product appeals to its target market in Asia. Hen Hao seeks a manufacturer who will commit in a contract to supply adequate quantities of the product at a fixed price for at least three years. Hen Hao’s representatives have contacted a reputable old line US based manufacturer of soup products known as Grumpbell Soup Company Inc. (Grumpbell) to manufacturer its Oriental Delight soup product according to the proprietary formula specifications. Grumpbell was founded by Morris Grumpbell over 100 years ago and operated as a family company up to 1999 when it went public through an initial public offering at the local securities exchange. The company manufactures its own brand of soup products which it sells in the USA market and also in some selected countries in Asia.

The Grumpbell family is still a part of Grumpbell Company which is based in Syracuse in New York. The new specialty soup product will be manufactured at the company’s manufacturing facility based in St Paul, Minnesota in the United States of America. The company’s brand name and reputation are important in ensuring its continued success in the market. Grumpbell will therefore have to stretch its manufacturing capacity to accommodate its own products and also products that it has contracted to manufacture for its customers under their own label such as the Hen Hao’s Oriental Delight proprietary product. For purposes of answering the various issues in the Case Problem Facts, I take the position of Hen Hao. The analysis hereafter will focus on identifying and describing the transactional and financial risks facing Hen Hao in this transaction, making specific proposals which will mitigate the risks and finally providing justifications for the proposals.

Transaction and financial risks

There are various transaction and financial risks that Hen Hao faces in this manufacture of goods contract and sale transaction. For better understanding of the transaction and financial risks that Hen Hao faces in this transaction, it is important to understand that it involves transportation, delivery and transfer of title of the soup food product. The soup product will be manufactured in Grumpbell’s factory based in St Paul in Minnesota in the United States of America and then be moved to Hong Kong. The distance is very long and Hen Hao faces the risk of loss of the soup product while in transit since sea transport is risky (Gramlich, 2002). The product could be lost at sea due to a number of causes. The ship ferrying the product could hit an object and sink; it can be attacked by sea pirates or be destroyed in unexpected natural calamity such as a severe sea storm or tsunami. The risk of transporting the soup product is therefore quite real this because sea transportation is very risky (Martin, Mena, Khan & Yurt, 2011).

The other challenge in transporting the soup product is associated with the cost of transportation. This is because the distance to be covered from the factory to the warehouse in the point of delivery and from the point of delivery to Hong Kong is quite long; the risk of having to shoulder high transportation expenses is high. This could make the soup product very expensive since these costs will have to be passed onto the consumer. The law of demand states that the higher the price of a product the low its demand will be (Martin, Mena, Khan & Yurt, 2011). Movement of the product could also experience unforeseen delays due to transportation challenges which could affect product availability at the market by increasing the number of stock outs. Another important aspect is getting regulatory approvals and paying all attendant duties and taxes to be allowed exit and entry into both national jurisdictions. These may increase the cost of importing the product which will also impact on transportation costs. Hen Hao needs to enter into an agreement with Grumpbell to share the costs of transportation reasonably in the spirit of sharing these risks by establishing a point of delivery at some midpoint. This enables the two companies to share transportation risks (Martin, Mena, Khan & Yurt, 2011).

In order to reduce risks associated with transportation of the soup product from the factory in United States of America to the point of delivery and onwards to the Hong Kong warehouses, Hen Hao will determine which party in the transaction will bear the cost of transporting the product at different points. Decisions on the ideal mode of transportation, which party meets transportation costs such as insurance costs, point of delivery for the product, passage of legal title to the product and decision on point at which each party assumes or ceases to bear risk of loss during transportation are important in reducing risk of transporting the product (Czinkota & Ronkainen, 1997). No one single party can reasonably bear the total cost of transporting the product and as such Grumpbell and Hen Hao will need to share risks of transporting the product. By sharing risks Hen Hao will be able to plan accordingly (Martin, Mena, Khan & Yurt, 2011).

Hen Hao faces foreign exchange rate risk in undertaking this transaction. The company faces the possibility of incurring huge losses arising from unexpected fluctuation in foreign exchange currency. The two companies have not decided on the currency that will be used in conducting the business (Kam, Gan & McGraw, 2003). Foreign exchange rate fluctuations pose a real threat to the success of the soup product business for Hen Hao. Adverse fluctuation in foreign currency rates can increase the cost of doing business. When costs increase they will have to be passed onto the consumer. Hen Hao will be unable to compete in the market as a result. Hen Hao should come up with hedging strategies to guard against adverse foreign exchange rate risk fluctuations (Kam, Gan & McGraw, 2003).

The other risk is associated with providing reasonable forecasts for the soup product to Grumpbell. Reasonable forecasts will ensure Hen Hao stocks adequate soup products to ensure it meets market needs. If the company orders for far too little it will injure its reputation in the market. On the other hand if it orders for too much of the product than the market can consume, it will be left holding stock that it can’t sell. The excess product risks going bad in the company’s stores if it is held beyond the expiry date (Martin, Mena, Khan & Yurt, 2011). The other challenge is getting a product that exactly meets the quality specifications of a spicy chicken noodle with the aroma and flavour that customers need. Hen Hao faces the risk of buying a soup product that does not exactly meet its quality specifications. The question then would be what will it do with that type of a product and how will it ensure its product is in line with its quality specifications as developed by the US Specialty laboratories Inc. (Martin, Mena, Khan & Yurt, 2011).

The other risk associated with this business is lose of exclusive rights to the specialty formula. Grumpbell could use the same formula to produce a competing product which will sell in Asian countries. Hen Hao stands the risk of losing the specialty formula in the process to Grumpbell who can use it to produce a similar product to compete with Original Delight in Asian markets. Hen Hao therefore needs to contact World Intellectual Property institute to patent its specialty formula before it hands it over to Grumpbell to manufacture it. The patent should have specific provisions which will prevent Grumpbell from producing a similar soup project (Loza, Chotkowski, Stevens & Urbanchuk, 2006). The other risk is the risk of Gumpbell not producing a product that meets quality specifications. Grumpbell might be unable or might just fail to meet quality specifications. This leads to loss of funds used to develop the specialty formula. Hen Hao will thus be unable to exploit the untapped market for spicy chicken noodle soup with a certain type of aroma (Kam, Gan & McGraw, 2003).

Specific proposals for Hen Hao

The first proposal is to ensure Gumpbell undertakes to transport the product from the manufacturing facility in St Paul in Minnesota to the point of delivery and then Hen Hao transports to the receiving port in Hong Kong. The product will then be received and taken over by Hen Hao once it is received at the point of delivery. Gumpbell in the arrangement will meet insurance costs related to freight and insurance costs for transportation. Gumpbell will also meet insurance costs for insuring against loss or damage of the product at sea before it gets to the point of delivery. Gumpbell will also meet all duties and other tariffs while the product is on USA soil. Once the product is received at the point of delivery then Hen Hao will meet all costs associated with transportation and importation of goods into Hong Kong (Loza, Chotkowski, Stevens & Urbanchuk, 2006).

The other proposal is that Hen Hao should only take responsibility at the point of delivery of the product which will be at the Port of Long Beach California, 100 Dock Street, Building 20, and Long Brach California where Hen Hao’s warehouse is located. Hen Hao will receive the product if it complies with the receipt dates in the purchase order and quality specifications. Gumpbell shall transfer title to the product to Hen Hao at the point of delivery. Hen Hao shall receive the bill of lading from Grumpbell and upon scrutinizing it accept title to the product if its satisfied that all conditions have been met (Martin, Mena, Khan & Yurt, 2011).

On foreign exchange risk, Hen Hao will use derivatives to hedge against risks associated with adverse fluctuations in foreign currency. The most commonly used hedging strategies include forwards and futures contracts (Atkinson, 2004). With these contracts, Hen Hao is assured that it will guard against foreign currency fluctuations which will ensure that future cash payments for products are fixed to prevent adverse changes (Loza, Chotkowski, Stevens & Urbanchuk, 2006). Hen Hao will guard itself from Risk of Loss of the soup product during transportation by ensuring that it accepts liability only at the point of delivery. Hen Hao will not be held responsible for loss of product at sea or in the air until it receives the product at the point of delivery. By getting a patent for the specialty soup, Hen Hao could move to court if it suspects and gets evidence showing that Grumpbell is manufacturing and selling a similar product as its specialty product (Martin, Mena, Khan & Yurt, 2011).

Purchase order is another important consideration in mitigating risks. It is the duty of Hen Hao to complete a purchase order in good time to give Grumpbell adequate time to produce the soup product. Grumpbell’s facility at St Paul in Minnesota in the United States of America produces Grumpell’s own soup brands and also brands of other customers in their own labels. Giving Grumpbell adequate time will enable Grumpbell to adjust its capacity to take in more orders and increase its capacity. This will help reduce risks associated with receiving incomplete orders which has serious financial implications (Martin, Mena, Khan & Yurt, 2011).

Hen Hao shall present quarterly forecasts to Grumpbell to ensure Grumpbell manufactures the right quantities at the right time. This will enable Hen Hao to make distribution arrangements to prevent stock outs at its distributors or hold too much stock which increases the risk of stock going bad and having to be thrown away after it expires. Hen Hao will carry out research in its target market to determine how much soup product will be consumed in each quarter (Loza, Chotkowski, Stevens & Urbanchuk, 2006). This will form the basis of filling purchase orders. Grumpbell will make sure that the purchase orders are filled on time and delivered in reasonable time to ensure Grumpbell is able to manufacture the quantities of soup product demanded (Martin, Mena, Khan & Yurt, 2011)

To meet quality specifications, Hen Hao will ensure that the product is subjected to quality tests before transfer of title to the goods is affected. This will ensure Hen Hao takes over high quality products according to its specifications. Hen Hao is to ensure that testers are drawn from the specialty formula developers. The cost of carrying out the quality tests to be met by Grumpbell (Loza, Chotkowski, Stevens & Urbanchuk, 2006).

Justification of the proposals

The proposal to ensure Gampbell bears the cost of transportation to the point of delivery is meant to spread risk of transportation among the two parties. The point of delivery is actually at some midpoint which will enable the two firms to share risks associated somewhat equally. The risks born by the two firms are similar and the idea of a point of delivery will only assist in sharing the risks instead of leaving them to one party (Aulakh, Jiang & Pan, 2010). Hen Hao will decide on the mode of transport once it receives the product at the point of delivery. Hen Hao will also plan on the transportation costs thereafter. These include freight and insurance costs from the point of delivery to Hong Kong’s warehouse in Hong Kong. Hen Hao will bear insurance costs from the point of delivery to the final destination. At the point of delivery, Hen Hao will meet costs of custom clearance in the United States of America. These costs will also include export tariffs involved in importing the product to its final destination in Hong Kong. Gumpbell on the other hand will take care of insurance and freight costs from the manufacturing facility to the point of delivery at Long Beach. This will ensure that the two parties share risks in transporting the product (Loza, Chotkowski, Stevens & Urbanchuk, 2006).

The point of delivery will help Hen Hao to receive products, test them for quality and accept only if the products meet its requirements. Once the product is received then Hen Hao will shoulder the cost of transporting it to the final destination. Hen Hao will assume responsibility at the point of delivery after which it will undertake to keep it at its warehouse pending clearance from the United States of America’s custom authorities. This helps Hen Hao to make prior transportation arrangements to reduce costs and also ensure timely delivery and receipt of the product. Gumpbell will therefore not deliver the product at a destination of its choice as would have happened had the delivery point not been identified. The point of delivery will enable the two parties to transfer the title to the goods to each other and assume responsibility for risks associated with this type of business (Aulakh, Jiang & Pan, 2010).

By using derivatives to hedge against foreign currency fluctuations, Hen Hao will make the most sensible business idea ever. Unexpected foreign currency fluctuations can wipe out Hen Hao’s competitive advantage in the market and reduce both the top and bottom line. Adverse weakening of the Hong Kong dollar against the US dollar will put a huge strain on Hen Hao’s finances to meet market demand for the soup product. The company will be forced in such a scenario to pay more to receive the same quantity of product. Freight and insurance charges will also increase etc. This will force Hen Hao to increase the cost of the product in its Asian market which will make it very uncompetitive (McVey, 1989).

By making transfer of title to the Product a legal concept; have significant financial management consequences. Hen Hao under the proposal becomes the owner of the product when title is transferred from Gumpbell to Hen Hao. Once title is transferred, hen Hao takes complete control of the Product; its further movement and mode of transportation; inventory control; financing of the inventory and/or establishing a letter of credit or other financial instruments for payment. Hen Hao also undertakes customs clearance, import procedures, insurance and storage and protection of the Product as most desired by Hen Hao as from point of delivery onwards (Aulakh, Jiang & Pan, 2010). Total control by Hen Hao over the Product after its transfer of title significantly minimises and mitigates Hen Hao’s risk as the Product is moved to its final destination and into the distribution system of Hen Hao at its premises in Hong Kong (Wichmann, 2006).

A patent is a very important document in this case. Grumpbell could very easily manufacture a similar product using the same formulae and sell it in the same Asian markets that Hen Hao is targeting. This product would easily compete in the vast Asian and lock out the possibly more expensive Hen Hao’s product. A patent will therefore enable Hen Hao to scoop its initial investment in research and development of the new product and also enable it to make some gains from it. It will also stem possible disputes between the two parties and possible long running court battles which have major financial consequences (Aulakh, Jiang & Pan, 2010).

The transfer of risk of loss liability occurs when Gumpbell transfers title to the goods at the point of delivery. Although Hen Hao assumes risk of loss in transit from the point of delivery onwards to the point of destination at Hong Kong, the company shares transportation risk with Gumpbell. Gumpbell shoulders the risk of loss during transportation from the manufacturing facility to the point of delivery (Calderon-Rossell, 1979). During this time Gumpbell meets all freight and insurance costs and also pays custom charges and import tariffs that pave way for the goods to be moved from manufacturing facility to point of delivery. Once the goods reach the point of delivery, Hen Hao’s representatives inspect them using the bill of landing to ensure the quantities match purchase order specifications and whether their quality specifications have been adhered to. In the event Grumpbell has not met quality specifications, Hen Hao could reject the product thereby forcing Gumpbell to take it back. This has serious financial consequences to Grumpbell and Hen Hao (Aulakh, Jiang & Pan, 2010). In the event the product meets quantity specifications as stated in the purchase order and is of high quality then Hen Hao can decide to accept it. Gumpbell then transfers the title to the goods to Hen Hao who then assumes ownership and take responsibility for risk of loss during transit to Hong Kong destination. Hen Hao thereby shoulders the responsibility of meeting freight charges and other licensing and tariff charges which then allows it to move the goods from the point of delivery to Hen Hao’s warehouse in Hong Kong. After transfer of title to the goods Hen Hao then manages the risks associated with transportation of the goods to the point of destination at Hong Kong. The sharing of risks is a way of ensuring fairness in the sale agreement and ensures each party plays a role in the success of the other party’s business (Aulakh, Jiang & Pan, 2010).

Placing purchase orders early enough will help Grumpbell to organize itself and stretch its capacity to meet Hen Hao’s demands. The purchase orders must be quite specific as to the quantity, delivery time, and consideration in terms of pricing and other related detail. This will reduce incidences where Grumpbell delivers incomplete orders or Hen Hao has to take up small uneconomical product quantities (Sawhney & Sumukadas, 2005). In fact the manufacture of sale agreement should specify the minimum and maximum product per time. This will prevent a situation where uneconomical products in terms of units are produced and delivered at the point of delivery. The quantity should be adequate enough to ensure that it enables Hen Hao to break even and transport economically (Sawhney & Sumukadas, 2005).

Forecasts will assist Hen Hao to control the amount of stock of the soup product it will hold at any given point in time. Since the soup product has an expiry date holding excess stock exposes the company to loss due to stock going bad due to expiry of the holding date. Holding too little stock exposes the company to having stock out periods when the product is out of the market because it has sold out everything. Ensuring that only optimal stock is held at any given point in time is therefore very important (Pache, 1998).

Quality tests will be undertaken which will ensure only high quality products are held by Hen Hao. This will ensure demand is sustained and grows. High quality products will enhance the reputation of Hen Hao in its market. By ensuring Grumpbell meets the costs of quality testing will make Grumpbell to be committed in ensuring they follow product specifications in future (Baldia, 2007).

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