Harvard business publishing Essay

In mid-September of 2010, Emily Harris, vice president of upstart inheritance hoot follows doing divergence, was weighing throw proposals for the bon tons upcoming capital letter calculateing meetings in October. Two proposals stood place based on their potential to strengthen the divisions advanced product lines and drive future increase. However, due to constraints on financial and man get alongrial resources, Harris k new-made it was possible that the firms capital budgeting committee would decline to approve twain ascertains. She in like manner knew that new-fashioned heritages licensing and retail classs would promote compelling depicts of their own. Consequently, Harris had to be fain to recommend one of her projects over the other.The wench IndustryRevenues in the U.S. toy and game industry totaled $42 billion in 2008 and were projected to increase by 4.6% per year to $52.5 billion by 2013. The market was divided into two broad segments video games (48 %) and usanceal toys and games (52%). The scrap segment was further divided into infant/preschool toys (14.5%), dolls (14.1%), show updoor & sports toys (12.3%), and other toys & games (59.1%) including arts and crafts, plush toys, action figures, vehicles, and former(a) days electronics. The U.S. market for toys and games was dominated by large global enterprises that enjoyed economies of scale in design, production, and distribution. Revenues were highly seasonal the largest merchandising season in the United States coincided with the winter holiday period. Within the toy and game segment, U.S. retail gross sales of dolls totaled $3.1 billion in 2008 and were projected to grow by 3% per year to $3.6 billion by 2013.The doll category embarrassd large, soft, and mini dolls, as well as doll clothing and other accessories. The phenomenon of age compression the tendency of early dayser children to acquire dolls that had tradition separatelyy been designed for older young ladys reduced growth in the baby-doll sub-segment. Competition among doll amazers was vigorous, as a small number of large producers targeted similar demographics and marketed their dolls by means of the same media. Lasting franchise mensurate for a branded line of dolls was rare the enormous conquest of Barbie dolls was an obvious exception. More recently and on a much smaller ________________________________________________________________________________________________________________ HBS Professor Timothy Luehrman and HBS MBA Heide Abelli prepared this case solely as a basis for class discussion and not as an endorsement, a source of primary data, or an illustration of effective or ineffective management. This case, though based on real events, is fictionalized, and any resemblance to actual persons or entities is coincidental. There are occasional references to actual companies in the narration.Copyright 2010 Harvard Business School publish. To order copies or request permissi on to reproduce tangibles, call 1-800-545-7685, import Harvard Business Publishing, Boston, MA 02163, or go to http//www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, mappingd in a spreadsheet, or transmitted in any pee or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of Harvard Business Publishing. Harvard Business Publishing is an affiliate of Harvard Business School.Purchased for use on the MSc Business Valuation, at empurpled College London. Taught by pack Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. custom permitted only within these parameters otherwise fulfil entropyrmationthecasecentre.orgeducational material supplied by The Case CentreCopyright encoded A76HM-JUJ9K-PJMN9IOrder reference F211857 forward-looking heritage annulus Company life-size(p) Budgeting4212 newfound Heritage Doll Company Capital Budgetingscale, New Heritage as well as had creat ed a durable franchise for its line of heirloom dolls. But the popularity of closely doll lines waned after a few years.New Heritage DollsBy 2009, New Heritage had grown to 450 employees and generated approximately $245 million of receipts1 and $27 million of in operation(p) profit from three divisions production, retailing, and licensing. The production division, discussed further below, designed and produced dolls and doll accessories. The retailing division offered a comical intergenerational experience for grandmothers, mothers, and daughters, centered upon the character histories and storylines of the companys dolls and delivered through an online website (42%), a mail-order paper catalog (33%), and a network of retail stores (25%). In fiscal 2009, the retailing division generated roughly $190 million of revenue and $4.8 million of operating(a) profit.The licensing division was started in 1998, and represented the companys newest and most profitable division. It sought-afte r(a) to extend the New Heritage brand and capitalize on high levels of customer loyalty by selectively licensing the companys doll characters and themes to a variety of media that r severallyed thefirms target demographic of toddler to pre-teen girls. In fiscal year 2009 the licensing division generated $24.5 million of revenue and $14.5 million in operating profit.New Heritages Production DivisionProduction was New Heritages largest division as measured by total assets, and easily its most asset-intensive. Approximately 75% of the divisions sales were made to the companys retailing division, with the remaining 25% comprising private label goods construct for other firms. tabularise 1 summarizes the divisions various sources of revenue and operating income. Table 1Production Division DataRevenue ($ millions)Operating Income ($ millions)New Heritages dolls and accessories were offered under limpid brands with different price points, targeting girls between the ages of 3 and 12 yea rs. The companys baby dolls were generally priced from $15$30, and were offered to younger girls in earlier stages of development. These dolls typically came with a birth certificate and a short individualised history. Dolls in the higher-end of this category in collectived technology that produced a limited amount of speech and motion. For the 1 The division revenue figures include approximately $95 million of internal sales within divisions which are eliminated when considering merge revenue for the company.BRIEFCASES HARVARD BUSINESS PUBLISHINGPurchased for use on the MSc Business Valuation, at purple College London. Taught by James Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. Usage permitted only within these parameters otherwise contact infothecasecentre.orgEducational material supplied by The Case CentreCopyright encoded A76HM-JUJ9K-PJMN9IOrder reference F211857The New Heritage Doll Company was founded in 1985 by Ingrid Beckwith, a retired psychologist speci alizing in child development and the grandmother of two young girls. Dr. Beckwith believed the dolls produced by the major toy companies did little to develop girls imagination or foster a authoritative self-image, so she created a line of dolls with alone(predicate) storylines and whole somewhat themes. Dr. Beckwiths dolls struck a chord among mothers and grandmothers who also rejected the dated, clichd images portrayed by the popular dolls of the day.New Heritage Doll Company Capital Budgeting 4212New Heritage outsourced much of its production to a select number of arrive manufacturers in Asia. To get wind product quality and safety, the company maintained a fulltime staff to oversee material sourcing, production, and quality manoeuvre on site at each of its manufacturing partners. Manufacturing activities that required precise tolerances or proprietary sufficees, along with all the creative elements (design and product prototyping, for example), were handled in-house at th e companys headquarters facilities in Sacramento, California.Educational material supplied by The Case CentreCopyright encoded A76HM-JUJ9K-PJMN9IOrder reference F211857Capital Budgeting at New HeritageNew Heritages capital budgeting process retained some of the informality that characterized the companys early years as an innovative startup. As the company grew, deliberate steps were taken to decentralize some of the project approval process and increase spending authority at the division level. However, large and/or strategic spending proposals were look backed at the corporate level by a capital budgeting committee consisting of the CEO, CFO, COO, the controller, and the division presidents. The committee examined projects for consistency with New Heritages business strategy and sought to balance the demand and priorities of each division against practical financial and organizational constraints. The committee also sought to understand project interdependencies and the potentia l for a devoted investing to strengthen the whole company, not solely the division proposing it.New Heritages capital budget was set by the board of directors in consultation with pass by officers, who in turn back sought input from each of the divisions. The capital and operating budgets were linked historically, the capital budget comprised approximately 15% of the companys EBITDA. The committee had limited discretion to expand or contract the budget, according to its view of the quality of the investment opportunities, competitive dynamics, and general industry conditions. Before being considered by the committee, projects were described, analyzed, and summarized in self-contained proposal documents prepared by each division. These contained business descriptions, at to the lowest degree 5 years of operating and interchange flow forecasts, spending requirements by asset category, personnel requirements, calculations of standard investment metrics, and identification of key project risks and milestones.Financial AnalysesFinancial analysis began with operating forecasts developed with oversight from New Heritage operating managers. Revenue projections were derived from forecasts of future prices and volumes. Fixed and variable tolls were estimated separately, by expense category. Forecasts of functional capital requirements were likewise vetted by line managers, who paid particular attention to a projects requirements for various types of inventory. Forecasts for obstinate assets and related depreciation charges were developed in cooperation with analysts reporting to the controller.HARVARD BUSINESS PUBLISHING BRIEFCASESPurchased for use on the MSc Business Valuation, at Imperial College London. Taught by James Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. Usage permitted only within these parameters otherwise contact infothecasecentre.org$75$150 price range, New Heritage produced a line of heirloom-quality dolls and accessories. Thes e were designed to appeal to older girls and to convey a sense of cultural and family tradition among grandmothers, mothers, and daughters. The heirloom dolls had more refine accessories and personal histories. Finally, the company offered a line of high-end dolls based on fictional celebrities, each associated with a charitable cause andembracing more contemporary fashion trends. These dolls targeted girls in the so-called tween age range of 812 years, and also were priced from $75$150. Like the heirloom dolls, celebrity dolls also came with more elaborate stories and accessories.4212 New Heritage Doll Company Capital BudgetingNew Heritage assigned discount place to projects according to a subjective assessment of each projects risk. High-, mean(a)-, and low-risk categories for each division were associated with a corresponding discount rate set by the capital budgeting committee in consultation with the corporate treasurer. Assessments of each projects risk were made at the di vision level, but subject to review by the capital committee. Factors considered in the assessment of a projects risk included, for example, whether it required new consumer acceptance or new technology, high levels of fixed costs and hence high breakeven production volumes, the predisposition of price or volume to macroeconomic recession, the anticipated degree of price competition, and so forth. In 2010, medium-risk projects in the production division received a discount rate of 8.4%. High- and low-risk projects were assessed at 9.0% and 7.7%, respectively.Projects that created mensurate indefinitely, granted continuing investment, were treated as going concerns with a perpetual life. That is, NPV calculations included a terminal value computed as the value of a perpetuity growing at a constant rate. However, to preserve an element of conservatism, the capital committee generally insisted on comparatively low perpetual growth rates press down than New Heritages historical gro wth and lower than near-term growth forecasts for a relegaten division. investiture Opportunities in the Production Division Emily Harris was reduceed on two of the production divisions most attractive current proposals. The first involved expanding the successful pair off My Doll Clothing Line to include matching allseason clothing for tween girls and their favorite dolls. The second involved a new hatchway, the Design Your proclaim Doll line, which employed web-based doll-design software to let userscustomize a dolls features to the customers specifications. couple My Doll Clothing Line ExpansionThe jib My Doll Clothing line originally consisted of a few sets of matching doll and child clothing and accessories for warm weather. It quickly became successful after the daughters of a few celebrities were spotted and photographed liveing items from the line, and girls magazines included some of the line in whats hot to wear sections. Given recent publicity, Marcy McAdams, the b rand manager responsible for the line, believed the timing was perfect to expand. Specifically, McAdams proposed to create an All Seasons battle array of apparel and gear covering all four seasons of the year.She expect the new offerings to be at least as profitable as the existing line, since its current popularity would make it possible to maintain premium prices. She also hoped to take advantage of off-peak discounts offered by some suppliers and contract manufacturers as they tried to smooth their capacity utilization. In the same fashion, McAdams argued the expansion would help reduce, or at least not exacerbate, the seasonality in New Heritages sales and earnings.BRIEFCASES HARVARD BUSINESS PUBLISHINGPurchased for use on the MSc Business Valuation, at Imperial College London. Taught by James Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. Usage permitted only within these parameters otherwise contact infothecasecentre.orgEducational material supplied by The Case CentreCopyright encoded A76HM-JUJ9K-PJMN9IOrder reference F211857Operating projections for a given project were used to develop cash flow forecasts that would underpin calculations of net present value (NPV), internal rates of return (IRR), leaveback period, and other investment metrics. Cash flow forecasts were intended to beget the incremental effect of a proposed project on the firms cash flow for each year within the forecast period. That is, each projects cash flow forecasts excluded non-cash items, such as depreciation charges, and nonincremental items such as sunk costs (i.e., costs that would be incurred regardless of whether a given project was undertaken or not). The cash flow forecasts were computed on an after-corporate- levy basis, but excluded all financing charges. Some elements of the cash flow forecasts were prepared with assistance from treasury analysts, but most of the necessary adjustments were well understood by division staff.New Heritage Doll Company Capita l Budgeting 4212To exploit the current popularity of the original Match My Doll Clothing line, especially given the fickle nature of childrens fashion trends, McAdams believed the opportunity had to be exploited without delay. Her investment proposal contained comparatively large outlays for R&D, market research, and marketing to maximize the fortune of quick acceptance and longer-term success for the follow-on line. Upfront investment expenditures are summarized in Table 2. Table 2 Match My Doll Clothing Extension OutlaysThe R&D and marketing expenditures would be deductible for tax purposes at New Heritages 40% corporate tax rate. The property, plant and equipment was expected to set out a useful life of 10 years the associated depreciation charges, shown in Exhibit 1, were based on the modified accelerated cost recovery system (MACRS) allowed by the IRS. Working capital requirements, shown in Table 2 for 2010 and in Exhibit 1 for subsequent years were based largely on recent h istorical experience with the original Match My Doll Clothing line. Finally, given the proven success of Match My Doll Clothing, Harris believed the project entailed moderate riskthat is, about the same degree of risk as the production divisions existing business as a whole.Design Your Own DollThis initiative targeted existing New Heritage customers, many of whom owned several of the companys heirloom dolls. The companys research showed that, when asked what features (e.g., appearance, ethnicity, life story, etc.) New Heritage should give to future dolls, loyal customers responses had a high correlativity with their own personal data. That is, girls wanted dolls like themselves. Further research suggested that many loyal customers would purchase barely another doll if they could customize the dolls features to create a one-of-a-kind addition to a girls or familys existing collection of dolls. It also promised to increase the girls fleece in and identification with the doll, both because of their shared features and because of the girls participation in creating the doll. This in turn further cemented customer loyalty.The customization process would begin with a new section of New Heritages website, where proprietary design software enabled the customer to select physical attributes of the doll such as hair color, hair length & style, skin color, eye shape, eye color, and other facial features. The software could combine selected features and produce a photo-realistic image showing the finished doll with user-selected accessories. The customer could zoom in or out on the image and rotate it to see different aspects. The softwaremade it easy to try out different combinations of features and accessories before making a purchase.Elizabeth Holtz, brand manager for heirloom dolls, was very excited about the project. She observed, A girls relationship with her favorite doll is often partly mommy and partly big sister. Either way, having your doll look more like y ou is really powerful. And theres excitement in the experience exploring the website, naming the doll-to-be, selecting her first outfiteven the anticipation of waiting for the new doll to arrive. I really think this is big. Holtz also believed that the dolls could command a premium price. Customers will naturally expect to pay more for a HARVARD BUSINESS PUBLISHING BRIEFCASESPurchased for use on the MSc Business Valuation, at Imperial College London. Taught by James Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. Usage permitted only within these parameters otherwise contact infothecasecentre.orgInitial Expenditures ($ thousands)4212 New Heritage Doll Company Capital Budgetingcustom doll, she said. Market research with focus groups revealed significant enthusiasm for the product concept and supported the notion of premium prices.The web-based software tools and order compliance system required New Heritage to make significant modifications to its existing technology i nfrastructure, expand its webhosting capacity, and turn the terms of its third-party service agreements to ensure a higher level of service quality. The majority of the R&D expenditures shown below were related to software development, hardware upgrades, and web design. The development time involved, including product testing, was expected to be approximately 12 months. Initialoutlays, some of which occurred in 2010 and some in 2011As with Match My Doll Clothing, the required R&D and marketing costs would be tax deductible. Manufacturing equipment had to be ordered by the end of 2010 to be ready for production at the beginning of 2012. While New Heritage had the natural selection to pay for custom equipment in quarterly installments, the firmcould get a substantial discount by paying for the equipment up front, in 2010. Figures in Table 3 and Exhibit 2 reflect the discounted cost of the equipment. To support the forecasted level of sales, substantial investment in working capital (primarily work in process inventory of partially manufactured dolls) would be required beginning in 2011. And windlessness more equipment would sire to be purchased and installed no later than 2014. In years 2015 and following, investments in working capital and equipment would revert to patterns known from the production divisions traditional lines of dolls.To complete development work, Holtz planned to use some of the companys existing IT staff. The majority of the work would take place during calendar 2011. The number of people and their in full loaded costs are shown Table 4. These costs were not included by Holtz in the initial outlays shown in Table 3 or in the forecasts presented in Exhibit 2. The development personnel Holtz take were considered corporate resources and were almost certainly available to work on the project.Table 4 Design Your Own Doll Development Personnel, ($ 000s) Application Development Personnel CostsWeb Application DevelopersDatabase ManagerSystems desegregation SpecialistTotal CostBRIEFCASES HARVARD BUSINESS PUBLISHINGPurchased for use on the MSc Business Valuation, at Imperial College London. Taught by James Sefton, from 21-Aug-2013 to 31-Dec-2013. Order ref F211857. Usage permitted only within these parameters otherwise contact infothecasecentre.orgHowever, even a limited degree of customization increased manufacturing complexity and expense. Further, because of the low production runs and volume, fixed costs on a per unit basis were expected to be relatively high. Consequently, the breakeven volume for the project was also expected to be high.New Heritage Doll Company Capital Budgeting 4212Finally, Holtz needed to give Harris her assessment of the projects riskiness. On the one hand, Design Your Own Doll had a relatively long payback period, introduced some untested elements into the manufacturing process, and depended on near-flawless operation of new customer-facing software and user interfaces. If the project stumbl ed for some reason, New Heritage risked damaging relationships with its best customers. On the other hand, the project had a relatively modest fixed cost ratio, and it played to the companys key strengthcreating a unique experience for its consumers.Educational material supplied by The Case CentreCopyright encoded A76HM-JUJ9K-PJMN9IOrder reference F211857Emily Harris still needed to complete her review and financial analysis of the two proposals. McAdams and Holtz were in frequent touch with Harris and both had offered to respond to any questions she might have about the proposals the business case, the financial projections, the operating details, or anything else. Harris expected that she would indeed have some follow-up questions as she worked through her financial analyses.She also knew that her final tribute might disappoint some executives within the division, who would scrutinize it closely. It had to be well-supported.