QUESTION
Case: Highland Park Wood Company
Instructions
This is a team assignment which is worth 15 points as specified below. Each member of the team receives the same grade on the case. The cases are due at the beginning of the class in which they are discussed. In order to be graded, cases must be no longer than 2 pages and must use the case submission template available on Sakai. (Letter size,with appropriate header, 11pt font, and 1-inch margins on all sides.) Missed, late, or inappropriately formatted cases are worth 0 points. Do not waste space on rewriting the case statement. Make sure that the template header is completely filled out. The header must include the section and team numbers, the names and the NetIDs of all team members listed in alphabetical order by last name, and the locker number of one of the team members so that your graded assignment can be returned to that locker.
Assignment
Read the Highland Park Wood Case (HBS case 9-190-013) and answer the following questions. Your answers should provide clear and unambiguous recommendations. Please provide explanations for your answers and any outputs that you feel are needed to support your argument.
1. What is your best forecast of what the price of Southern Pine will be in March 1988, and what is your uncertainty about that forecast? (8 points)
2. Assuming Plainview accepts Highland Park’s quote, when should Highland Park purchase the necessary wood? What are the options and relevant considerations? (3 points)
3. What price should Highland Park quote to Plainview, and what are the issues that should be considered in choosing a price? In answering this question, do not inflate your quote for negotiating purposes. Assume that the quote is a take-it-or-leave-it offer. Also, for the sake of definiteness, assume that Simpson is prepared to reduce the price by at most $10 per thousand board feet in recognition of both the marketing value of this deal and of the size of the offer. (4 points)
Case: Highland Park Wood Company1
In early September 1987, George Simpson, sales manager of the Highland Park Wood Company, received an enquiry from Anne Butler, head buyer for the Plainview Homes, a major Dallas-area home builder. Plainview was proposing to buy one million board feet of framing lumber at a price to be fixed now, for deliver six months later, in March. Butler explained that Plainview was planning to begin the construction, in early March, of 100 homes in a subdivision northeast of Dallas. Plainview would be willing to purchase all of its framing requirements from Highland Park if Simpson could quote an acceptable, firm price now. Because of recent soaring prices of building materials, Plainview was very cost conscious and desired to fix in advance as large a portion of its construction costs as possible. Highland Park traditionally passed through to the customer its own cost of purchasing lumber thus eliminating the exposure both sides would face if the price were fixed at the time of the order. Butler, however, appeared to be asking Highland Park to assume this price risk by quoting in September for March delivery. She did indicate, though, that Plainview would be willing to pay more than the 5% margin which Highland Park usually commanded on its direct sales. At the same time, she hinted that Plainview expected a competitive price considering the size of the purchase. Costing a Normal Deal Highland Park was a wood retailer; it bought wood in bulk from a saw mill and carried it in inventory to satisfy customer needs. For a sufficiently large order Highland Park could arrange to have the wood shipped directly to the customer’s job site. The current mill price for wood Plainview was requesting (Southern Pine #2, 2×4) was $279 per thousand board feet. As a “favored” customer of the mill, Highland Park would receive a 4% wholesaler commission but would have to pay $24 per thousand board feet for delivery from the mill. The delivery charge would be the same whether it were delivered to Highland Park’s warehouse or directly to the customer’s job site. Thus Highland Park’s current delivered costs, before profit, was 0.96 x $279 + 24 = $291.84 per thousand board feet. For the usual retail order, Highland Park would add a markup of 20%, but for a direct shipment order the markup was only 5%. Had Plainview been asking for immediate delivery the company procedure would suggest a price of $291.84 x 1.05 or $306.43. Plainview could not accept current delivery since it did not have its own storage facilities which explained Plainview’s proposal to Highland Park.
1 Harvard Business School case 9-190-013. This case was prepared by Professor David E. Bell and retyped and reformatted for The Fuqua School of Business. Copyright © 1989 by the President and Fellows of Harvard College
Buy and Hold One viable possibility was for Highland Park to buy the wood now and store it until the spring. Apart from the nuisance of taking delivery there was the holding cost to be considered and the additional trucking cost from Highland Park to Plainview’s job site in March. The additional trucking cost Simpson estimated as $6 per thousand board feet, but the other costs were less clear. Highland Park usually figured storage costs at an annual rate equal to the prime interest rate plus 6%. This was broken down as Highland Park’s cost of short-term capital (prime plus 2%), together with factors to cover taxes (1%), insurance (1%) and depreciation (2%). With the prime currently at 11% this implied a holding cost for six months of 8.5% or about $26 per thousand board feet. Simpson was reluctant to go with the alternative partly because an order of this size threatened to strain Highland Park’s storage capabilities but also because he believed Plainview would balk at the price associated with this strategy.
Wait and Buy The storage problem could be avoided if Highland Park simply waited until March to order the wood from the mill. However this would entail Highland Park bearing a substantial price risk if prices rose between September and March. A review of past prices confirmed Simpson’s fears. (See Exhibit 1, columns 2 and 3.) Had Highland Park undertaken such a strategy in 1975, for example, they would have had to pay a price 35% higher in March (1976) than had prevailed in September (1975). On the other hand, in many years the price was substantially lower in the spring than it had been in the fall, which would have allowed Highland Park a substantial profit.
Hedging Simpson had ruled out the possibility of trying to pass along the price risk in this deal to a third party such as a bank or a mill. In particular he had ruled out the possibility of hedging in the futures market Indeed, if it had been possible to hedge away the risk by forward buying, Plainview could have done this directly themselves.
Forecasting There was an active forward market in Hem-Fir, a wood grown almost entirely in the western part of
North America and not completely substitutable for Southern Pine. Hem-Fir prices and Southern Pine prices were often quite different and did not always fall and rise together. However, Simpson watched the forward prices for Hem-Fir quite closely in the belief that they offered some insight into the likely trends in the market conditions for wood in general. Perhaps significantly the forward price for March delivery of Hem-Fir was now considerably lower than the spot price (see Exhibit 1, columns 4 & 5). Simpson had asked his assistant to see if there was a useful way to use available information to get a better feel for the likely price of Southern Pine in March. The assistant had compiled the data shown in Exhibit 1 but had not been able to interpret their usefulness. The Decision Simpson was perplexed by the historical pricing details his assistant had collected. He was intrigued by the Plainview proposition and regarded the advance purchase with fixed price guarantee as marketingexperiment and potential source of competitive advantage. At the same time realized that his company’s competitive position had not slipped sufficiently to warrant substantial risk taking.
Explanation:
Spot. The price of Southern Pine at the beginning of September 1971 was $135 per thousand board feet. The price of Southern Pine at the beginning of the following March was $147. Similarly, the price of HemFir at the beginning of the September 1971 was $108 per thousand board feet. The following March the price had climbed to $118. Forward. In early September 1971 the current price of Hem-Fir if delivered in March 1972, was $101 per thousand board feet. (For the purpose of this case, it suffices to think of these figures as market forecasts, as of September of the given year, for Hem-Fir prices the following March.)
Exhibit 1
| Spot and Forward Prices for Southern Pine | ||||||
| and Hem-Fir ($ per thousand board feet) | ||||||
| Southern Pine | Hem-Fir | |||||
| Spot Prices | March | Spot Prices | ||||
| Year | Sept | March | Forward | Sept | March | |
| 1971 | 135 | 147 | 101 | 108 | 118 | |
| 1972 | 153 | 175 | 131 | 147 | 183 | |
| 1973 | 201 | 158 | 121 | 163 | 168 | |
| 1974 | 112 | 119 | 128 | 126 | 125 | |
| 1975 | 127 | 171 | 146 | 140 | 165 | |
| 1976 | 187 | 183 | 173 | 180 | 195 | |
| 1977 | 264 | 226 | 193 | 218 | 235 | |
| 1978 | 225 | 237 | 196 | 246 | 238 | |
| 1979 | 303 | 210 | 235 | 293 | 210 | |
| 1980 | 197 | 214 | 191 | 194 | 195 | |
| 1981 | 170 | 203 | 176 | 178 | 173 | |
| 1982 | 191 | 280 | 159 | 163 | 222 | |
| 1983 | 222 | 258 | 195 | 189 | 227 | |
| 1984 | 202 | 212 | 146 | 177 | 178 | |
| 1985 | 212 | 244 | 145 | 188 | 220 | |
| 1986 | 215 | 242 | 172 | 232 | 238 | |
| 1987 | 277 | 182 | 240 | |||
ANSWER
Price Forecast
To be able to find the price first thing that is b required to be done is to see which variable is most suited to calculate the price of Southern Pine. We have many options to calculate the march price as it can be calculated from September price or from the prices of Hem Fir.
For this we use the correlation between the March Prices of Southern Pine and all the variables present. And the results are
|
Correlation of Spot Price March With |
|
| Year |
0.80 |
| Spot Price Sept Southern Pine |
0.61 |
| Spot Price Sept Hem-Fir |
0.56 |
| March Forward Hem-Fir |
0.58 |
As we can see the correlation of Spot Price March is highest with the year followed by spot price sept of southern pine. This gives us two options, either we can use the a linear regression mode taking year as an independent variable and spot price march as dependent variable. But the problem with this model is that the standard error is too high, therefore we have to use multiple regression taking southern pine September spot price and year as an independent variable and the spot price march as the dependent variable. The best price estimate for the month of March for Southern Pine that we could come to is $278.67 per thousand board.
The summary of the output is
|
Regression Statistics |
|||||
| Multiple R |
0.845462 |
||||
| R Square |
0.714806 |
||||
| Adjusted R Square |
0.67093 |
||||
| Standard Error |
24.98576 |
||||
| Observations |
16 |
||||
| ANOVA | |||||
|
|
df |
SS |
MS |
F |
Significance F |
| Regression |
2 |
20341.18843 |
10170.59421 |
16.29149984 |
0.000287351 |
| Residual |
13 |
8115.749074 |
624.2883903 |
||
| Total |
15 |
28456.9375 |
|||
|
|
Coefficients |
Standard Error |
t Stat |
P-value |
|
| Intercept |
-11722.5 |
2999.196343 |
-3.90856118 |
0.00179684 |
|
| Year |
6.001359 |
1.522437241 |
3.94194166 |
0.001687009 |
|
| Spot Prices Sept |
0.276208 |
0.147112856 |
1.87752616 |
0.08306327 |
|
| Price | |||||
| Forecast March |
278.6672 |
||||
We calculated the above Multiple Regression at 95% confidence level. As one can see the R square which is 71.48% which means that the above test covers 71.48% of the possible variation. Further this test gave the lowest standard error of 24.99 among all the test done.
To calculate the expected price we took the equation from the above test comes out to be
Spot Price March = -11722.5 + 6.001359 * Year + 0.276208 * Spot Price September
Substituting the value of year as 1987 and the value of spot price September as 277 in the above equation we come to a value of $ 278.67 per thousand board.
When to Buy
Now that Highland Park Wood Company has roughly estimated the price of Southern Pine, the biggest question is when the Highland Park Wood should actually buy the wood. They have two options either to buy the wood right now and store it or to buy it on the later date. This is because in 197-76 the prices were substantially lower in fall as compared to the spring. But over the years prices in spring were substantially lower as compared to the prices in fall.
If the company decides to buy the wood today, they have to go for all the hassle of storing the wood and in March delivering the wood to Plainview’s site. These two things are going to cost Highland Park. Calculating the price if the company decides to buy today,
Purchase Price $ 270 per thousand board feet
Storage Cost $ 26 per thousand board feet
Transportation Cost $ 6 per thousand board feet
The cost price to Highland Park would be $ 302 per thousand board feet which is way too high when compared to the calculated price of $ 276.67 in the month of March.
If the company will add its profit to this price it will be a way too high price and Plainview will definitely reject the offer. Also, the order is of huge size which will take up almost all of the storage capacity of the Highland Park Wood and thus impacting the existing business.
Therefore, the company should buy the wood in spring only.
Price Quote
The price quoted by highland should be as per the policy of Highland Park Wood Company. For the purpose of this calculation we are assuming that the company has decided to buy the wood in march and the price is quoted on the assumption of cost price calculated earlier i.e. $ 278.67 per thousand board. The quoted price should be
|
Per Thousand board feet |
|
| Cost Price |
278.67 |
| Less: Commission |
11.15 |
| Net Cost Price |
267.52 |
| Transportation Cost |
24 |
| Total Cost |
291.52 |
| Mark Up @ 10% |
29.15 |
| Quoted Price |
320.67 |
It is a direct sale to the Plainview therefore the mark up charged by Highland Park should be 5%, but given the circumstances of the case, Plainview is asking Highland to fix price in the month of September for the month of March and thus is willing to pay higher mark up as compared to other. Therefore, we have assumed a mark of 10%. Now Simpson is willing to give discount up to $ 10 per thousand board feet, thus price can range from $ 310.67 to $ 320.67 per thousand board feet.
Regression
| SUMMARY OUTPUT | |||||
| Regression Statistics | |||||
| Multiple R | 0.845461978102759 | ||||
| R Square | 0.71480595641743 | ||||
| Adjusted R Square | 0.670929949712419 | ||||
| Standard Error | 24.9857637521256 | ||||
| Observations | 16 | ||||
| ANOVA | |||||
| df | SS | MS | F | Significance F | |
| Regression | 2 | 20341.1884263985 | 10170.5942131993 | 16.2914998446246 | 0.000287351143905 |
| Residual | 13 | 8115.74907360146 | 624.288390277036 | ||
| Total | 15 | 28456.9375 | |||
| Coefficients | Standard Error | t Stat | P-value | ||
| Intercept | -11722.5424251683 | 2999.19634328522 | -3.90856118887094 | 0.001796840364267 | |
| Year | 6.00135879262662 | 1.52243724071388 | 3.94194166572839 | 0.001687008832106 | |
| Spot Prices Sept | 0.276208235976901 | 0.14711285597869 | 1.87752616275026 | 0.083063269748153 | |
| Price | |||||
| Forecast March | 278.667177146426 | ||||
Price
| Per Thousand board feet | |
| Cost Price | 278.67 |
| Less: Commission | 11.15 |
| Net Cost Price | 267.52 |
| Transportation Cost | 24 |
| Total Cost | 291.52 |
| Mark Up @ 10% | 29.15 |
| Quoted Price | 320.67 |
Exhibit
| and Hem-Fir ($ per thousand board feet) | ||||||
| Southern Pine | Hem-Fir | |||||
| Year | Spot Prices Sept | Spot Price March | March Forward | Spot Prices Sept | Spot Price March | |
| 1971 | 135 | 147 | 101 | 108 | 118 | |
| 1972 | 153 | 175 | 131 | 147 | 183 | |
| 1973 | 201 | 158 | 121 | 163 | 168 | |
| 1974 | 112 | 119 | 128 | 126 | 125 | |
| 1975 | 127 | 171 | 146 | 140 | 165 | |
| 1976 | 187 | 183 | 173 | 180 | 195 | |
| 1977 | 264 | 226 | 193 | 218 | 235 | |
| 1978 | 225 | 237 | 196 | 246 | 238 | |
| 1979 | 303 | 210 | 235 | 293 | 210 | |
| 1980 | 197 | 214 | 191 | 194 | 195 | |
| 1981 | 170 | 203 | 176 | 178 | 173 | |
| 1982 | 191 | 280 | 159 | 163 | 222 | |
| 1983 | 222 | 258 | 195 | 189 | 227 | |
| 1984 | 202 | 212 | 146 | 177 | 178 | |
| 1985 | 212 | 244 | 145 | 188 | 220 | |
| 1986 | 215 | 242 | 172 | 232 | 238 | |
| 1987 | 277 | 182 | 240 | |||
| 0.798418563322606 | 0.611484608363123 | 0.576150568823226 | 0.556664312379512 | |||
| Correlation of Spot Price March With | |
| Year | 0.80 |
| Spot Price Sept Southern Pine | 0.61 |
| Spot Price Sept Hem-Fir | 0.56 |
| March Forward Hem-Fir | 0.58 |
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