TENALPINA TOOLS:
THE ENTREPRENEUR’S DILEMMA

“You would not believe what just happened!” Giulia shouted whenher father answered the phone. “It may just be the opportunity of alifetime; I just need to work through the numbers to see what I’mgetting myself into.”

Background

It seemed that Giulia was fated to go into a business related torock-climbing. She loved challenging herself to ascents on sheerrock walls and liked to tell her friends that she was born to it.It might be more precise to say, however, that she was born nearit.

Giulia Ferrato was born in Pieve di Cadore, in the foothills ofItaly’s beautiful Dolomite Mountains. The region is famous for itsAlpine skiing resorts like Cortina, but she was more interested inthe mountains in the other seasons. The Dolomites are filled withsheer rock cliffs that are covered with ledges and caves. When shewas a young girl, Giulia was on a drive with her father and hepointed out some of the caves on a nearby mountain. “Those wereused by soldiers during the war as lookouts and gun emplacements,”he told her. She asked how the soldiers got there. “They climbedup, I suppose,” he replied. From that time on, Giulia wasfascinated with climbing those sheer rock walls.

As a teenager, Giulia spent two summers with her uncle and auntin London. Thus, by the time she left for university, she wasproficient in four languages: Italian, English, French, and German.After receiving a degree in engineering, Giulia returned to Italyand got a job as a manufacturing design engineer at Indesit, themultinational Italian appliance manufacturer.

She considered her time at Indesit as a stop along the way toher long-term goal. She longed to start her own business, just asher parents had done. With that goal in mind, she absorbed whateverrelevant knowledge she could in that job and scrupulously saved.After five years, Giulia left Indesit to get anentrepreneurship-focused MBA in the United States. At the time, herfather told her that he would provide her the “equivalent cost” ofthe MBA to start a business right then and get some “appliedknowledge” instead of the degree. Giulia demurred, saying she wouldrather spend her own money for the MBA first, seeking businessopportunities while pursuing her degree.

Between the first and second years of her MBA program, Giuliatook an internship at a well- established company that specializedin retailing mountaineering equipment, both online and in a largestore in Denver. She worked for a part of the business thatorganized and operated mountain-climbing tours. While there, shedeveloped the idea that led to her current business. A criticaltool for rock climbers is the piton, a device like a flat spikethat the climber hammers into crevices in the rock wall in order toattach support lines. These tools need to be strong enough to bedriven into rocks and removed numerous times. That strength comesat the expense of added weight, which is a significant issue forclimbers since they typically carry many pitons.

She shopped her employer’s store looking for lightweight,high-strength pitons, but could only find ones made of steelalloys. She asked the owner why none of the pitons were made oftitanium or a similar metal. He replied that there used to be atitanium product from Russia, but it was very expensive and notvery high quality. He told her that if he could reliably gettitanium pitons at the right price and quality, he would be happyto buy them.

When she returned from her internship at the end of the summer,she began to research the potential to produce high-quality pitonsfrom titanium. It turned out to be less complicated than she hadanticipated. She was able to design a piton that would takeadvantage of titanium's superior tensile strength while weighingsignificantly less than the standard steel alloy product. She alsofound a company that did drop forging, an integral part of theproduction process, within 30 miles of her school. She discoveredthat the company had excess capacity and could produce the productin volumes Giulia believed she could sell. Within weeks, TenAlpinaTools (consisting entirely of Giulia) was in business, purchasingtitanium alloy bars and having them delivered to the forge, wherethey were converted into the finished product and shipped toDenver.

Product and Process
Figure 1 illustrates typical pitons. Pitons have three criticalfeatures:

The blade is the portion that is driven into cracks and fissuresin the rock wall. It needs to be relatively thin and strong.

The head is the opposite end from the blade, where the piton isstruck by a “wall hammer” to drive it into the rock.

The eye is a round aperture beneath the head that serves as aconnection point for attaching climbing lines and for removing thepiton. For removal, a short cable is attached to the eye at one endand to a similar eye in the hammer at the other. Through a seriesof short swings of the hammer, the piton is then worked out of thewall. The connection to the cable keeps the freed piton from flyingoff into the air and down the mountain.

For a piton to be made from a single piece of metal, it must behammered into shape. This is not greatly different in concept fromthe old blacksmithing process, but uses complex and powerfulequipment. Figure 2 shows the typical drop-forge and rollingoperations. The forge used by Giulia’s supplier involved thefollowing steps:

The metal bars were cold rolled and flattened through ahigh-pressure extrusion process to flatten the blade end and leavea thicker end for the head and the eye ring. The resulting slug wascut off the bar.

The slug was placed in a furnace and heated to a temperaturewell in excess of 1,000 degrees Fahrenheit.

The hot slug was removed by a worker using long tongs and placedon the anvil (fixed table portion) of a drop-forge hammer. Theanvil held a mold (called the die) with a cavity the shape of thebottom half of the piton. The hammer, containing a matching die,was then fired to strike the slug several times rapidly with aforce of up to 20 tons.

The formed piton was removed using the tongs and dropped into avat of water to cool.

The cooled piton was then taken to a drilling station where theeye, which still had a membrane of titanium where the hole shouldbe, was bored out and smoothed.

The piton was then “de-burred” and buffed on a polishing wheelin order to remove any remaining metal “flash” at the seams wherethe upper and lower dies had met.

The finished piton was bagged and boxed for shipping.

The Growth Opportunity

Giulia’s original trial order was for 1,000 units, but soon shehad a reorder rate of 1,000 per month. The retailer paid Giulia$11.00 per unit for the pitons and absorbed the shipping costs. Theforge charged her $9,000 to make and pack an order of 1,000 pitons.After accounting for material waste and recovery, the cost of thetitanium alloy bars was $1.45 per piton. Clearly, she was notmaking much money on the business. In fact, a minimum wage jobwould have provided more income. However, what mattered to Giuliawas the proof of concept—she could successfully design and sell herown products. The start-up risk and capital requirements had beenlow and now she had her own business.

Giulia had been thinking about ways of increasing profits,including an idea for a new product line, when a quick series ofsurprise events changed the landscape. First, she received a callfrom her single customer. He told her that he had been impressedwith the quality and design of her product and proposed thefollowing offer: “If you give me an exclusive supplier arrangementfor two years, I will guarantee you a purchase volume of at least4,000 units per month at $10.50 per unit for the length of thetwo-year contract. I have to tell you, however, I think demandcould be about 10% higher, but I will not commit to that for thelength of the contract.”

Her elation at that offer quickly evaporated because the $10.50price would barely cover her current unit costs. She also knew thateven four times the current purchase quantity would not qualify herto move to the next level of volume discounts on material. Shewasn’t even sure that her contract manufacturer had the availablecapacity to quadruple production for her, nor whether he would giveher a price break for that extra volume.

The second surprise came when she contacted her contractmanufacturer to make those inquiries. Before she could even raisethe questions, he interrupted her to say that he had been meaningto call her. He had just decided to close down his business andretire. He asked if she wanted to buy the company. She felt her jawdrop open but quickly refocused and told him that she might beinterested. First, she said, she would need some operating datafrom him. He agreed to provide what he could and suggested that shecome to the factory to talk about it.

Giulia learned a few things even before getting to thequantitative data. First, the owner, Stanley Kowalchek, was 66years old and his wife wanted them to spend most of the year attheir second home in Clearwater, Florida. Both of his children weregrown and had no interest in the business. His business had thrivedin the 1990s while he was the exclusive forged parts supplier to acompany that made medical implants, mostly for hip and kneereplacements. However, that business had changed and his customershad begun to shift contract production to China. In fact, for thelast three months, Giulia had been his only customer.

Giulia also learned that Stanley had been operating with aminimum “skeleton” crew of six workers. They were all capable ofworking any of the equipment, and, because of the low demand, theywere required to move from work station to work station to fillGiulia’s orders. Even so, Stanley told her, her volume of 1,000units consumed only about one week of labor capacity per month. Shequickly realized that she would need all six, then, if her demandincreased to 4,000 units per month.

The laborers were paid wages that totaled $57,500 per year each,including benefits, holiday and vacation pay, and so forth. For sixworkers, that totaled $345,000. Given that it would take a month tomake 4,000 units and 12 months to make the full 48,000 units, laborcost per unit would be $7.19. Stanley told her that occupancy costs(lease costs for the building and maintenance and utilities costsother than electricity) totaled $33,000 for the last year. Theequipment takes a beating, so it needs to be replaced regularly,but Stanley assured Giulia that it was all in good working orderand in the middle of its useful life. Depreciation on the equipmentwas $14,355 last year.

Stanley appeared to be fairly cost conscious. For example, hekept track of the supplies used in the plant daily. He was able totell Giulia that the cost of supplies for the last order of 1,000pitons he made for her was $110.00. He was also very focused onenergy consumption and had metered all of the production equipment.He used this to monitor KwH usage. However, he still received onlya single electric bill. For last month, when the only productionwas 1,000 units for Giulia, the bill was $1,908. However, twomonths back he had made 1,300 units for her, since one order hadspanned the end of one month and the beginning of the next. Thebill that month was $1,962.

Some comments Stanley made led Giulia to believe that he nolonger considered the business a “going concern” and that he wassimply looking to sell the assets. He would be disposed to sellthem all to a single party, especially if the buyer would beinclined to keep his long-time workers employed. Based on somequick internet research, Giulia concluded that the purchase pricefor all the business assets would be under $100,000.

Giulia realized that this could be a once-in-a-lifetimeopportunity. She had guaranteed demand. No matter what she decided,she knew that she would not take a salary for at least the firstyear, but if she were operating the forge she would incur someadministrative costs that would average about $600 per monthrelated to the various duties associated with payroll, propertymanagement, and other issues. She needed to think about how herfledgling business would be affected if she absorbed the operationof the forge, both immediately and in the future. She decided tocall her father to talk it through with him after doing somepreliminary thinking about the situation.

My Question:

I need some help making sense of the case posted above and alsothe steps for the various calculations I need to do to analyze thebusiness alternatives in this case. The calculations, I think focusmainly on:

- Calculating breakeven, in units or dollars, for all 3 businessalternatives explained in the case (the current business situation,alternative 1 of buy forge, and alternative 2 of buy forge plus10%)

- Also, I think some cost estimation needs to be done here,preferably using the High-Low method of cost accounting. (I thinkthe entrepreneur's utilities is one of the things to use this costestimation method on)

- Finally, some recommendations for the decision theentrepreneur should take

(This is a case problem inManagerialAccounting)