CARDON CARPET MILLS, INC.

EXECUTIVE SUMMARY United States consumers and businesses spend about $50 billion annually for floor coverings. The largest category of floor coverings is carpet and rugs, followed by resilient coverings (vinyl), hardwood, ceramic tile, and laminates. Cardon Carpet Mills, Inc. is a privately held manufacturer of a full line of medium-to-high-priced carpet primarily for the residential segment. The company markets its products under the Masterton and Chesterton brand names. Based on the present state of the industry and performance in 1999, it pleased the directors. The business recorded a profitable sales growth 3.6 percent and net profit margin gained 4 percent respectively. Given recent developments within the floor covering industry, Robert Meadows the president of Cardon Carpet Mills, Inc. was considering the possibility of establishing distribution centres or wholesale operations for the company. Thus, Suzanne Goldman, a special assistant to the president was given a task to prepare a position paper for the president. Nevertheless, Goldman received unfavourable feedback from the companys wholesaler who did not agree with the proposal.

INDUSTRY BACKGROUND Wholesale and retail distribution in the U.S. carpet and rug industry has gone through a lot of instabilities since the 1980s. There have been three major competitive trends that occurred within the industry. The first trend to occur happened in the mid 1980s when the larger carpet and rug manufacturers began to eliminate the margins paid to wholesalers by bypassing them and selling directly to retailers. Similar manufacturers continued their use of wholesalers due to their lack of capital. By 1990, a majority of the carpet and rug sales for residential carpet and rug sales were distributed through company distribution centres to retailers. This altered the industry. The next trend that occurred was in the early 1990s with the emergence of retail buying groups. They would combine their purchases in order to obtain quantity discounts from manufacturers. The last change took place when Shaw Industries, the carpet and rug industry leader, began to open and operate its own retail stores and commercial dealing network. This action led to Shaw Industries being dropped by big stores such as Home Depot and several buying groups. A couple years later Shaw Industries sold its retail stores and was picked up again by Home Depot. As a result of all these efforts

was an upward trend in dollar sales over the past decade but marginal profitability for the industry.

ANALYSIS a) Carpet and Rug Industry Sales and Trends In 1999, the U.S. carpet and rug industry recorded sales of $11.69 billion at manufacturers prices. Carpet and rug sales were estimated to be $17.9 billion, represented an increase about 7 percent in sales from 1998. Referring to Exhibit 1 ( page 432 ), it is estimated that carpet and rugs commanded 68.1 percent of total U.S. floor covering sales in 1999, down by 2.7 percent in 1998, and down from 71.1 percent of total sales recorded in 1997. Other floor covering types such as hardwood, ceramic tile and laminate had enjoyed an increasing in market shares. In addition, U.S. carpet and rug manufacturers have experienced a decline in sales outside the United States. Since 1980, the export market for U.S. made carpet and rugs has become highly competitive. The U.S. companies supplied 51 percent of the worlds carpet in 1970, but the sales had declined to 45 percent in 1999. This poor performance was due to the lack of marketing efforts and the industry had failed in communicating effectively to consumers about the value added of their products besides unable to differentiate their product quality from other floor coverings. The carpet and rug industry as a whole only spends 2.1 percent of its sales on consumer advertising, less than other manufacturers of consumer durable products such as household furniture and household appliances which spend 4.2 percent and 2.5 percent of sales respectively for advertising.

b) Competitors In the mid-1980s, the U.S. carpet and rug industry was undergoing a tough times. The declining demand for carpet and rugs, excess manufacturing capacity and losses profit margins reduced the number of carpet and rug manufacturers from more than 300 in the mid1980s to about 100 companies in early 2000. This is due to consumers were changing their preferences to other floor covering types such as hardwood, ceramic tile and laminate. According to Exhibit 1 ( page 432 ), hardwood recorded an increment by 1.9 percent, ceramic tile also increased by 4.4 percent and laminate showed an improvement by 3.2 percent of

U.S. floor covering market shares from 1994 to 1999 respectively. These scenarios then lead to mergers, acquisitions and bankruptcies among manufacturers. Since 1995, mergers and acquisitions reflected a push to build further economies of scale in the production and distribution of carpet and rugs. By 1999, it was estimated that 10 companies in the industry produced 91 percent of carpet and rug sales in the United States. The U.S. industry sales leader is Shaw Industries, with sales of $4.1 billion in 1999. The company also has the distinction of being the largest carpet and rug manufacturer in the world.

c) The Company As stated before, Cardon Carpet Mills, Inc. is a privately held manufacturer of a full line of medium-to-high-priced carpet primarily for the residential segment. Contract sales to institutions and businesses are also made but it accounts for only 28 percent of company sales and occur principally in the south-eastern United States. Besides that, the company also had no export sales. Currently, the company distributes its line through seven floor covering wholesalers located throughout the United States. These wholesalers then supplied 4,000 retail accounts including department stores, furniture stores, and floor covering specialty stores. The distribution records revealed that 80 percent of residential segment sales were made through 50 percent of its retail accounts. For marketing activities, the company commonly advertised its business through shelter magazines and newspapers. The emphasis in advertisements was on fibre type, colours, durability and soil resistance. The company was very particular in producing high quality advertisement because it represents the image of the company besides to attract and gain high confidence from the consumers. In order to have a close relationship with wholesalers and retail accounts, the company employed two regional sales coordinators who acted as a liaison with wholesalers, assisted in managing the cooperative advertising program, and made periodic visits to large retail accounts. They also responsible for handling contract sales for institutions and businesses. The company also had long-term relationships with its seven wholesalers. Two had represented the companys products for over 30 years, four had been with the company for 20 to 25 years, and one had been with the company for 10 years. These wholesalers also maintained extensive sales organizations with the average wholesaler employing 10

salespeople. As a result, on average retail accounts received at least one sales call per month. By building a good long-term relationship with the wholesalers, it benefited the company in term of the wholesaler already know the market and retail accounts. In addition, the company also already have its own consumers thus it can reduce their expenditure on penetrating new accounts and market.

ISSUES There are several issues that Cardon Carpet Mills, Inc. should take into consideration in order to sustain and expand its business in the industry. The issues are: 1. Wholesaler sales representatives performed a variety of tasks. The sales representatives were not only responsible in sales activities, but they also have to check inventory and carpet samples, arranging point-of-purchase displays, handling retailer questions and complaints, and taking orders. It was spent about 25 percent of an average salespersons time on non-selling activities. According to Goldmans evaluation of the sales program also revealed that 40 percent of each onehour sales call was devoted to selling Cardon Carpet Mills carpeting, while the rest 60 percent was devoted to selling noncompeting products. This finding was frustrating because the company management felt that the sales representatives should devoted their time more on selling the companys product line. 2. Reduction in its price to wholesalers. There was pressured from several wholesalers to reduce the products price in order to accommodate retailer pricing demands. This is due to an increasing number of their retail accounts had joined regional retail buying groups and were seeking price breaks comparable to those made possible through their group purchases. Thus, the company agreed to consider a reduction in its price to wholesalers that could be passed on to retailers. The reduction in its price means that the profit margin of the company will be lesser and this is not good for the business growth. 3. To choose whether go direct or through distribution. Currently the company was relied on its manufacturers to sell the product to retail accounts. But, with the recent developments in the industry and its competitive position, the possibility of establishing its own distribution centres or wholesale was raised by the board of directors. Thus, Suzanne Goldman needs to evaluate and

examine both options meticulously so that the best decision could be made for the company.

ALTERNATIVES 1. Status quo. Based on the companys sales growth, it recorded a profitable sales growth of 3.6 percent and the net profit margin of 4 percent respectively. In addition, the companys cash flow was more sufficient to fund its present initiatives. It shows that currently the company experiencing good performance in the business. Referring to the company financial statement in year 2000 (Exhibit 3; page 436), total company sales were recorded $75 million with a net profit before tax of $3 million. This positive figure shows that the company was enjoying a success in industry market shares. Moreover, Cardon Carpet Mills also had a good long-term relationship with its seven wholesalers who helped them in selling its products throughout the United States. Two of them had represented the companys products for over 30 years, four had been with the company for 20 to 25 years and one had been with the company for 10 years. All these wholesalers supplied 4,000 retail accounts including department stores, furniture stores, and floor covering specialty stores. The wholesalers also responsible in maintaining extensive sales organization with retail accounts in order to ensure to keep a close relationship with them. Besides that, the wholesalers also had a lot of experiences in the industry thus Cardon Carpet Mills did not have to struggle to maintain the business and sustain in the industry. Thus, what Cardon Carpet Mills need to do is to maintain a good long-term relationship with its wholesalers.

2. Expand the business throughout the United States. Besides concentrated its business in residential segment, Cardon Carpet Mills also have an account in contract sales to institutions and businesses. The contract sales contributed about 28 percent of company sales and occur primarily in the southeastern United States. In fact, the company also had no export sales. If the company intends to enhance its total sales and profit margin, they should consider expanding its market shares in contract sales segment throughout United States. Currently, the company had wholesalers already operating in the metropolitan areas Chicago,

Denver, Los Angeles, New York City and Philadelphia. Thus, the company should take this advantage by selling its products of contract sales segment to all these areas. This is due to that the companys wholesalers will provide....

Case Study on Masterton Carpet Mills Recommendation. Case Study on Masterton Carpet Mills Recommendation:

The recommendation suggested to Masterton Carpet Mills, Inc., after a review of quantitative and qualitative information as well as directives given is to establish their own distribution centers or wholesale operations focusing on residential business in an effort to maximize profits. This recommendation would allow Masterton Carpet Mills, Inc. to retain the $13.5 million normally spent in the wholesale channel to help finance this endeavor from the companys internal funds as is the company policy. This alternative would also afford Masterton Carpet Mills, Inc. more stability due to the lack of intermediary conflict or instability within the external environment.

Problem Statement:

Given recent developments within the floorcovering industry, Masterton Carpet Mills, Inc., a privately held manufacturer of medium to high priced carpet, is considering the possibility of establishing their own distribution centers or wholesale operations focusing on residential business in an effort to maximize profits.

Facts and Underlying Issues:

Masterton Carpet Mills, Inc. is looking to improve their profit margin in a highly competitive, consolidated industry. In 1999, Masterton Carpet Mills, Inc. lagged behind the industry sales growth, but still managed to be profitable by recording a 3.6% sales increase over the previous year. U.S. consumers and businesses spend approximately $50 billion per year on floorcoverings. The largest category of floorcoverings is carpet and rugs which accounted for an estimated $17.9 billion in sales. The residential segment accounted for 74% or $13,246,000,000 ($17.9 billion x 74%=$13,246,000,000) of the total U.S. sales. This segment is dominated primarily by three companies, Shaw Industries, Mohawk Industries and Beaulieu of America, which control 85% of the U.S. residential carpet and rug market.

Masterton Carpet Mills, Inc. is not inexperienced in the area of direct distribution. They currently directly distribute their contract sales to institutions and business. However, these sales only account for 28% of company sales and occur primarily in the southeastern U.S. Wholesale and retail distribution in the U.S. carpet and rug industry has been subject to much instability since the 1980s. There were three major competitive trends within the industry. 1. The first trend occurred in the mid-1980s when the larger carpet and rug manufactures began to eliminate the margins paid to wholesalers by bypassing them and selling directly to retailers. Smaller manufacturers continued their use of wholesalers because of their lack of capital. By 1990, a majority of the residential carpet and rug sales for residential use were distributed through company distribution centers to retailers, altering the industry. 2. The second trend occurred in the early 1990s with the emergence of the retail buying group. They combined their purchases in order to obtain quantity discounts from manufacturers. This led to the projected decline of the share of wholesaler floorcovering sales from 26% in 1995 to 23% in 2000.

3. The last change took place when Shaw Industries, the carpet and rug industry leader, began to open and operate its own retail stores and commercial dealer network. This action led to Shaw Industries being dropped by stores such as Home Depot and several buying groups. Four years later Shaw sold its retail stores and was again found in Home Depot.

1,200 of Mastertons retailers are members of buying groups. They represent one third of the companys residential segment sales. Upon news of Mastertons investigation into the possibility of directly distributing to retailers, a wholesaler threatened Suzanne Goldman with the mass exodus of all wholesalers upon the opening of the first company warehouse.

Assumptions:

We assume that sales are at the same level as in fiscal 2000. All calculations are based on the assumption that should we decide to proceed with the direct distribution into retail accounts all wholesalers would leave, as threatened, with the first warehouse operation opening; however, it is also assumed that we would keep all 4000 current retail accounts and sales would remain the same (Appendix 6). Calculations are also based on the assumption that the

number of weeks worked in a year is 50 (52 weeks V 2 weeks vacation = 50 weeks). We also assume that Masterton Carpet Mills, Inc. is content with current retail market coverage (Appendix 6). The final assumption is that all profit margin gains from the elimination of the wholesalers, $13.5 million (Appendix 5), would be kept by Masterton Carpet Mills, Inc.

Analysis:

An analysis of 2 alternatives has been performed considering the possibility of Masterton Carpet Mills, Inc. establishing their own distribution centers or wholesale operations focusing on residential business. The alternatives are as follows:

1. Do Nothing 2. Masterton Carpet Mills, Inc. should establish its own distribution centers or wholesale operations for residential business.

Currently, Masterton Carpet Mills, Inc. is lagging behind in sales growth, but managing to remain profitable. They are a small manufacturer in a large, highly competitive industry. The first alternative is to do nothing and continue to use the current wholesale distribution method. For a basis of comparison the following criteria have been evaluated to achieve the total estimated wholesale distribution cost of $18,070,049: wholesaler margins, cost of servicing wholesalers, and the accounts receiving carrying costs (Appendix 4). Through a 25% wholesale markup, there is presently $13.5 million spent at the wholesale level. The margin of $13.5 million paid out to wholesalers could be retained by Masterton Carpet Mills, Inc. to fund the change in the distribution channel using internal capital. This would satisfy conditions set forth by Robert Meadows, President of Masterton Carpet Mills, Inc. and company policy to finance programs from internal funds except for capital expansion. The cost of servicing the current wholesalers is $3,240,000 which is 6% of sales ($54 million x 6% = $3,240,000). Given that it typically takes 90 days for Masterton Carpet Mills, Inc. to collect its retail accounts receivable and that accounts receivable carrying costs are 10% of sales, the total cost is $1,330,049 (Appendix 5). If Masterton Carpet Mills, Inc. continues the use of wholesalers, $18,070,049 will continue to be spent in that segment of the distribution channel (Appendix 4). The second alternative is for Masterton Carpet Mills, Inc. to establish its own distribution centers or wholesale operations focusing on residential business. Using criteria such as

warehouse expenses, salaries of sales representatives and sales managers, cost of sales administration, inventory carrying costs, accounts receivable carrying costs, and transportation expenses the estimated costs for this endeavor total $14,196,561 (Appendix 4). Expenses for one warehouse located in each of seven metropolitan areas, Houston, Chicago, Denver, Los Angeles, New York City, Philadelphia, and Richmond is calculated to be $700,000 each and total warehouse expenses are expected to reach $4,900,000 ($700,000 x 7 = $4,900,000). If Masterton Carpet Mills, Inc. maintains the same retail proliferation currently offered through the wholesale channel presently used, $2,240,000 should be spent on the salaries of 32 sales representatives and an additional $320,000 should be spent on the salaries of 4 overseeing managers if each sales manager manages eight individual sales representatives (Appendix 6). The total spent on sales administration, which is 40% of the salaries of the total sales force and management costs per year, total $1,024,000 ($2,240,000 x $320,000 = $2,560,000 x 40% = $1,024,000). The cost to carry inventory and accounts receivable total 10% each of sales. With the current desired inventory turnover of 4 times per year, inventory carrying costs would total $1,350,000 and accounts receivable carrying cost would be $1,662,561 (Appendix 6). Transportation expenses equal 4% of sales and total $2,700,000. The total estimated cost of Masterton Carpet Mills, Inc. movement into direct distribution would be significantly less expensive, with $14,196,561 spent in the distribution to retail accounts, than maintaining the current wholesale distribution. With $16,625,000 in networking capital (Appendix 5) this venture could be financed using internal funds. However, with the threat of mass exodus by wholesalers this issue also is time sensitive. An immediate and complete detioriation of the wholesale channel would prevent a slow, integrated movement to direct distribution and would likely cause a major loss in sales hindering Mastertons ability to efficiently integrate to direct distribution.

Have a little read: ... A Case Study on Masterton Carpet Mills Recommendation: The recommendation
suggested to Masterton Carpet Mills, Inc., after a review of quantitative and qualitative information as well as directives given is to establish their own distribution centers or wholesale operations focusing on residential business in an effort to maximize profits. This recommendation would allow Masterton Carpet Mills, Inc. to retain the $13.5 million normally spent in the wholesale channel to help finance this

endeavor from the companys internal funds as is the company policy. This alternative would also afford Masterton Carpet Mills, Inc. more stability due to the lack of intermediary conflict or instability within the external environment. Problem Statement: Given recent developments within the floorcovering industry, Masterton Carpet Mills, Inc., a privately held manufacturer of medium to high priced carpet, is considering the possibility of establishing their own distribution centers or wholesale operations focusing on residential business in

Discussion of the case will be structured by answering the following questions: If you were Suzanne Goldman, what recommendation would you give to Robert Meadows?
1. How might we characterize the carpet and rug industry and Masterton's position in the industry? 2. What are the pros and cons of a wholesale vs. company distribution system from a qualitative perspective? 3. What are the economies of the wholesale vs. the company distribution system? Can Masterson Mills afford "going direct?" 4. Can Masterton Mills "afford" losing potential sales if wholesalers drop their line before a change,if any, is implemented?

Instructor's general observations

The focus of this case is the best form of distribution. Numerically this decision is addressed via a very direct "lease vs. buy" type of capital budgeting problem. The data analysis is basic accounting. Take care to identify all the costs, both fixed and variable.

Previous exam material

Look at the second exam for Fall 1997 for an example of tested material on Masterton Mills.