Whirlpool Europe Analysis

The Whirlpool Europe case provides an opportunity to look at different ways to evaluate
a major IT investment the company is considering. To undertake this analysis we have to
make a few assumptions because the case does not have all the details needed to estimate
benefits and investment cost. However, if you were in a company faced with this
situation, these numbers would be available.

The spreadsheet for Whirlpool contains two worksheets. Worksheet 1 is a net present
value analysis, and worksheet 2 applies an options pricing model to the decision.

Be sure to save a copy of the spreadsheet when you download it because most of the
questions refer back to the original spreadsheet, which you will often change in a
preceding question.

NPV Analysis (Worksheet 1)

The NPV analysis follows the scenario in the case: the company invests for a series of
years, and implements in the West, South Central and North regions in that order. The
spreadsheet has been designed with the first analysis showing the summary of investment
costs and anticipated benefits for the six year time horizon in the case. The spreadsheet
calculates the net present value of each year’s benefits and costs, and subtracts the NPV
of costs from benefits. The table just below this analysis contains variables that you can
change to test the sensitivity of the analysis. The rest of the spreadsheet presents the
details of the assumptions and calculations to arrive at the yearly costs and benefits.

Please answer the following question about the NPV analysis:

1. What are the key assumptions of this analysis?

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2. The current NPV is negative. One way to save money would be to reduce consulting
costs. Please set the average consulting cost per month in cell b33 to $5000. At what
discount rate is the NPV for the project 0?_________

3. Returning the consulting cost to $15,400 per month, at the original discount rate of .
09, what is the impact on NPV if you double the number of employees participating in
the project?
__________

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4. Returning the number of employees participating to 200, what is the impact on NPV if
the consulting fee turns out to be $20,000 per month?
__________

5. Returning the consulting salary to $15,400 per month, what is the impact on NPV of
doubling the number of consultants required each month?

___________

6. Returning to the original staffing levels for consultants, how much more than
estimated do the benefits have to be to make the project attractive? To answer this
question, use the benefits adjustment factor in the “Key Factors to Manipulate” table.

______________

Options Pricing Analysis (Worksheet 2)

The options pricing analysis applies real options theory to the evaluation of an IT project.
Suppose that SAP, sensing some hesitation on Whirlpool’s part, makes the following
offer. Instead of committing to the SAP project in total, SAP proposes to management
that Whirlpool implement 6 to 8 modules of the entire system at a plant in the U.K. The
software company and Whirlpool’s IT staff working together figure the total cost of this
effort including payment to SAP, Whirlpool staff time and consultants, at $4 million for
1999.

At the end of this pilot test, Whirlpool would decide whether or not to proceed with full
scale implementation of SAP in all four European regions. Just as with the earlier
analysis, we have to make some assumptions. Worksheet 2 uses the data from worksheet
1 to restate the costs and benefits for the option which involves only the South, Central
and Northern regions.

On worksheet 2, the analysis uses the Black Scholes options pricing model (OPM) to
calculate the value of this option to make a decision at the end of a pilot test in the West.
For a real option, x in the OPM formula is the expected revenue from the project, and c,
the exercise price, is the IT investment required for the SAP project.

Please answer the following questions about the OPM analysis:

7. What are you buying an option to do?

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8. Given an option cost of $4 million and the value of the option in worksheet 2, should
Whirlpool proceed or abandon the project? ______________
___________

9. Suppose that Whirlpool finds a way to reduce the costs of the project by 5%. Please
change the cost factor in cell G31 to 95%. What is the value of the option now?

________________. Would you proceed with the pilot under these costs? ________

10. Returning the cost factor to 100%, what happens to the value of the option if the risk
free interest rate doubles to 8%?

________

11. Returning the risk free rate to 4%, what happens to the value of the option if the
Whirlpool’s cost of capital goes from 9% to 15%?

________

12. Please return the cost of capital to 9%. Sigma squared is the variance in the rate of
return of the project. The calculations for the variance are in the first table of worksheet
2. Determining sigma squared is one of the most challenging tasks in calculating the
value of a real option. In this example, we suggest asking managers for their best and
worst case estimates of the benefits, given the expected benefits taken from worksheet 1.
Just above the table, there is a percentage number for the range surrounding the expected
returns, which starts at 20%. This says that the worst estimate is 80% of the expected,
and the best is 120% of the expected.

a. What happens to the value of the option if you change the range from 20% to
10%?

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b. What happens to the value of the option if you change it to 30%?

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 c. What do these changes say about the sensitivity of OPM and its applicability to
IT projects?
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In Conclusion

13. Based on the NPV and OPM analyses, would you recommend to Whirlpool Europe
that they undertake the SAP project, conduct the pilot, or abandon the whole project?
Why?

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14. What other factors might influence the decision of Whirlpool management about
investing in SAP in Europe?

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15. Considering your answers to both 13 and 14 above, what is your final
recommendation to Whirlpool? Invest in the project, or do not invest in it?

a. Invest b. Do not invest

Assumptions

The case contains some financial information, but not enough to develop the spreadsheets
above without making some assumptions, especially about benefits from the proposed
ERP system. We have made a number of assumptions and developed the spreadsheet so
that you can concentrate on the investment decision, not on figuring out the numbers. If
you were in a company and had the responsibility to analyze a proposed IT investment,
you would be able to talk to other managers, different vendors and consult historical
records to come up with benefits and costs.

For anyone interested, here are the assumptions and calculations on the spreadsheet:

WHIRLPOOL CASE: Value Of ERP Investment

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NPV Analysis:
This document is intended to provide a description of the assumptions used in the
calculations as well as a step-by-step explanation of the analysis in spreadsheet.

A) Calculations for revenue margin improvements

Benefits from ERP implementation are coming from three streams: 1) Inventory Savings,
2) Revenue and margin improvements (these were not given explicitly in the case and
had to be calculated), and 3) other expense savings.

1) Calculations for Inventory savings

In the case, aggregate inventory savings has been projected to be $34.3 M (pg. 3).
To find region-wise, per year savings, exhibit 3 was used.

Case mentions that DSI will improve by 12 days in all the regions. However this
reduction will occur in phases. For example, in 2000 there will be 3 days
reduction (i.e. 20% improvement).

We multiply Inventory value per day (i.e. 1221) with the number of days saved
(3) and thus arrive at the savings in that region, for that year. Finally adding the
savings from all the regions we get the total savings for that year.

Benefits from revenue and margin improvements come from the profit increases due
to:
2) Increase in products sold:
Case states that product availability will improve due to the implementation
(projected/targeted availability =92%) and 25% of this increased availability will
be converted into sales (refer page 3 and exhibit 4). [Assumption is that without
ERP implementation, total units sold in future would have been constant i.e. at
the same level]

We first calculate – “Total expected % increase in availability”, which is

projected/targeted availability (92%) – current availability (varies for regions)

Now, we have a table showing “Percentage Availability Improvement by Wave”.

This table shows the % of the “total expected % increase in product availability”
that the company would realize in any particular year. For example, if in region 1
we expect to see a 18.5% (92%-73.5%) increase in product availability then
25% of this 18.5% would be realized in 2000, 40% in 2001, and 35% in 2002.
Thus we can find out % increase in product availability in a particular year, in a
region.

We multiply the current units sold (in a year, in a region) with these percentages
to come up with the increase in terms of quantity/units of product. [An
assumption here is that we are selling 100% of available products so that we can
use “units sold in 1997” figures to find the increased product availability.]
As the result of these calculations we get Table “Additional product available”

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An important point to remember is that the increase in product availability is
cumulative i.e., if there was an increase of 100 units in 2000 and 150 units in
2001 then effectively we have an increase of 250 units by year 2001.
Thus, by cumulating the products available we get table “(Cumulative)
Additional product available” in the spreadsheet.

Now, we use the sales conversion forecast (i.e., 25% of this increased availability
will be converted into sales) to arrive at table “(Cumulative) Additional product
SOLD”. [Multiply the sales conversion factor to the additional products made
available by ERP implementation.]

We find “Addition Revenue from Increased Availability” by multiplying the

additional product sold by the unit price (average). Unit price has been calculated
by dividing the total revenue in 1997 in all regions by the total number of units
sold in all regions and it comes out to be $201.

As per the situation described in the case, the profit made on all these products is
due to the ERP implementation. To calculate the profits we have to take into
account the profit margin in 1997 and the subsequent increase in profit margin.
Note: Profit margins are also cumulative (like additional product availability). For
example, if profit margin in 1997 was 12%, additional margin in 2000 is .06 and
additional margin in 2001 is .25, then the total profit margin in 2000 was 12.06%
(12+.06) and in 2001 was 12.31% (12.06+.25)
[We are adding the profit margin improvements (instead of multiplying a base
percentage to find the actual increase as we did in case of product availability)
because our assumption is that the margin improvement percentages (exhibit 5)
are absolute increments (i.e., not as a percentage of current margin percentage).
For example, if current margin is 12% and improvement in 2000 is .06%, we have
assumed that total profit margin in 2000 would be 12.06%]

These steps give us the profit increase due to increase in products sold (Table
“Additional Profit from Incr. Avail. (also taking into account the increase in profit
margins)” shows the result.
Ultimately, we get the total profit for each year (name this row –“A”) by adding
the profit contribution of each region.

3) Increase in profit margins (due to ERP)

In the subsequent years (from 2000) the profit margins are increasing due to ERP
implementation. This will have an impact on profits from the existing sales
revenue. To calculate this additional profit, we multiply "number of units sold at
present" (i.e. in 1999, before ERP implementation) by "(cumulative) increase in
profit margin". [The profit margins will be cumulative. i.e., total increase for year
2= increase in year 1 + increase in year 2. For an explanation refer to the profit
calculation analysis above].

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Thus, we get table “Addition Profit from Increased Profit Margin on the existing
(base) sales”. We get the total profit for each year (name this row –“B”) by
adding the profit contribution of each region.

To find out the total profits, we add row “A” and “B” and this gives us the
“Revenue and Margin Improvements”