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CASE ANALYSIS : Starfire’s dilemma

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Sughras Rizwan

on 13 June 2014

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Transcript of CASE ANALYSIS : Starfire’s dilemma

James fears: Adding extra capacity or outsourcing both have their own risks
James’s fears for adding these new routes:
Low Profit Margin + Economy Downturn + Increased Debt = Disaster
Independent Contractors Fears : Not easy to manage, service level might become poor

Other strategic issues :
If FHP restructures its supply chain, Starfire would hold dedicated assets for routes which does not exist
Might be able to service initial demand but will need to add tractor trailer rigs or outsource when additional routes are added in future

CASE ANALYSIS : Starfire’s dilemma
Capacity at What Cost?

Executive summary:
We recommended Starfire to serve FHP
by squeezing existing capacity
with 1 year contracts at a time
Background : Starfire receives a proposal from their key client FHP, but is unsure about it…
New demand: just 1.2% of perceived existing capacity… and well within over all utilization norm
Other alternatives: saying NO or squeezing capacity from existing fleet have downsides too
Financial analysis, rethinking capacity and strategic issues need to be factored in
Important existing client FHP has asked Starfire to serve 2 loads of 1500 miles round trip per week. It has offered $2.15 per mile inclusive of FSC, and is willing to offer $2.2 per mile for a 5 year contract.

Four options to Starfire include saying NO, squeezing existing capacity, adding new capacity, or outsourcing. All seem to have some issues.

Based on marginal cost-benefit, sensitivity analysis (to factor FSC), and strategic issues we find squeezing existing capacity dominates, and adds to the profitability insulating existing client from new competition.

Indeed rethinking capacity suggests that using slip seating and pick and drop method, Starfire can easily free up significantly more capacity from its existing fleet.

We suggest using 1 year contract to avoid added risk of fuel price
volatility. $2.2 five year contract price does not affect our choice.
(proved in Annexure)


James:
NO to FHP or squeeze capacity from existing fleet
Reason – His fears (mentioned in previous slide)

Roger Simmons an experienced Operations Manager (16 years with Starfire) :
taking debt if it’s not really risky given the profit potential of new route
hiring independent contract drivers
shifting trucks from another account
Reason - Saying NO to FHP would lead them away to competitors sooner or later

Financial Analysis of three Independent Scenarios :

Serving FHP with existing capacity

Serving FHP by buying one truck and one trailer. Increase of $50000 in fixed costs, annually.

FHP ready to pay $2.2 per mile(including FSC and miscellaneous fees) if 5 year contract is signed.

Serving FHP by outsourcing miles. Reliable independent contractor quoted $1.65 per mile. Increase of $20000 in fixed costs, annually.
FHP ready to pay $2.2 if 5 year contract is signed.

Capacity Analysis
How to view capacity? – defining and managing capacity?

Strategic Analysis
Strategic implications of decisions

Executive Summary
Summarize the financial, capacity and strategic analysis and provide recommendations

Alan James is founder of Starfire Trucking Company

Starfire has 90 trucks and 180 trailers.

FHP Technologies, Starfire’s largest customer, submitted a proposal to James

Proposal of FHP :
asks two dry-van loads per week;
each load -1,500 miles round trip.
quotes :
For 1 year contract $2.15 per mile, which includes the FSC and all miscellaneous fees
For 5 year contract $2.2 per mile, which includes the FSC and all miscellaneous fees

FHP is a stable, solvent company that presents no
question of collection, thus ensuring a reliable cash
flow

Current Capacity Utilization = 85% (Sourced from Case)
Current Miles Covered = 11250000 (Sourced from Case)
Total Perceived Existing Capacity = 11250000/0.85 = 13235294.1 (Calculated)

New Demand :
Per Load = 1500 miles
Total Weekly Load = 1500*2 = 3000 miles (Calculated)
Total Annual Load = 3000*52 = 156000 miles (Calculated)

New Demand as % of total perceived existing capacity = 156000/13235294.1 = 1.2% (Calculated)

Total Capacity Utilization if served with existing Capacity = = 85% + 1.2% = 86.2% (Calculated)

We extended marginal cost-benefit approach with sensitivity analysis…
Marginal Analysis
We undertake marginal cost-benefit analysis by considering the added revenue and deducting from it added costs(variable and fixed) for all the three scenarios and then compare the most beneficial one.


Sensitivity Analysis
Since FHP pay Starfire fixed revenue inclusive of FSC, Starfire has to pay the extra FSC in case it rises and doesnt get covered by the amount FHP pays. So we calculate10% increase in average FSC rate, average FSC rate , and 10% decrease in average FSC rate and ascertain its effect on Net Contribution.


Strategic Analysis
Strategic implications in terms of Pros and Cons of of all the three scenarios is analysed.

Rethinking Capacity
Is Capacity viewed appropriately by Starfire? What more can be done to add capacity?


Squeezing existing capacity appears to be most promising to serve additional demand
This comparison is based on $2.15 per mile for 1 year contract.
Five year contract price $2.2 will not change the relative ranking across alternatives
Based on sensitivity analysis, and strategic issues we recommend not signing 5 year contract.

Sensitivity analysis suggests that squeezing existing capacity dominates in all three scenarios
This comparison is based on $2.15 per mile for 1 year contract.
Based on the case, average FSC is assumed to be $0.44 per mile

Various strategic issues suggest that squeezing capacity is a better alternative
? : Shows doubtfulness, the bigger the “?” , more the doubtfulness

: Shows mild affect

Perceived capacity is much less than the potential capacity of existing fleet
Laws require a driver to take a 10-hour break after 11 hours of driving. Furthermore, a driver can’t work more than 70 hours in an eight-day period without taking a 34-hour break.
Number of trucks = 90

Assuming  average speed of 40 miles per hour , which is still lower than the standard speed of 55 miles per hour allowed for trucks in U.S

If taken into consideration the current setting of one driver per truck.
The 90 trucks can cover up to 13593643 miles in an year (ANNEXURE 11)

But, Starfire claims that their current capacity is 11250000 miles, which shows how they are under-estimating their capacity and consequently under-utilizing their capacity


How to Add MORE to capacity..
We can further increase the utilization of available hours ,by placing a new driver for 10 hours every time the current driver goes for his break(10 hours), for this they can:
- hire more drivers if necessary and/or
- implement slip shifts and pool teams.
And thereon leave the truck for maintenance during the 34 hour break period in every 8 days.

As a result miles coverage will increase by 12357857.1 miles.(ANNEXURE 12)

Yet again, Starfire can increase the utilization of the available hours and be restricted with the availability of the trailers.
As and when need arises, trailer should be available.

So rather than leaving the trailer idle while customer loads trailer:
- Starfire can adopt “drop and hook” system and/or
- Use the spare trailers which are reserved for emergency situations and/or
- Buy new trailers as they are far less expensive to purchase and
operate than tractors.

Last Recommendation to Starfire..
The vehicles are the profit centers in a trucking business. The trucks are the main means, generally speaking, of revenue creation.

Therefore, all Income Statement items of Starfire’s profit should be determined on a per vehicle basis rather than per mile basis.

Certain vehicles will run more efficiently than others.

This comparative efficiency, which translates to different costs of service calculations, needs to be monitored, reviewed, and addressed.

Annexure 1 :
Marginal analysis when Starfire serves from existing capacity
Annexure 2:
Sensitivity Analysis
COMMENT - Assuming that there is no extra fixed cost due to higher capacity utilization (such as maintenance cost etc.).

However question may arise about the increase in depreciation, but the needed 156000 miles (1.2% of sourced total capacity) doesn’t really pressurize existing trucks and trailers(proved from capacity analysis and recommendations),

thereby there wont be any significant "increase in depreciation" and which means the results are not going to be affected significantly, hence not considered.

Since FHP pay Starfire fixed revenue inclusive of FSC, Starfire has to pay the extra FSC in case it rises and doesnt get covered by the amount FHP pays.

Annexure 3:
Marginal analysis when starfire serves by investing in 1 truck & 1 Trailer
(When Starfire signs 1 year contract)
COMMENT - Its safe to take debt for financing this as the current debt ratio is not too high to be considered risky – 12.33% (Calculated) => Total liabilities /Total assets => 2115000/17150000 (sourced from case)

Annexure 4:
Sensitivity Analysis – 1 year contract
Since FHP pay Starfire fixed revenue inclusive of FSC, Starfire has to pay the extra FSC in case it rises and doesnt get covered by the amount FHP pays

Annexure 5:
Marginal analysis when starfire serves by outsourcing (When Starfire signs 1 year contract
Referring to Page 57 of the Case, all the variable costs are incurred by the contractors except for Trailer pool expense, so Starfire still incurs this cost.

Annexure 6:
Sensitivity Analysis – 1 year contract
Even though the fuel charges are incurred by the Contractors we believe that no contractor would be ready to lock himself in to absorb fuel cost rise for a long time. They will either ask for renegotiation or simply become unreliable. Hence we presume that effectively Starfire will have to bear the FSC charges.  

Annexure 7:
Marginal analysis when starfire serves by investing in 1 truck & 1 Trailer
(When Starfire signs 5 year contract)
Annexure 8:
Sensitivity Analysis – 5 year contract
Since FHP pay Starfire fixed revenue inclusive of FSC, Starfire has to pay the extra FSC in case it rises and doesn’t get covered by the amount FHP pays


Annexure 9:
Marginal analysis when starfire serves by outsourcing
(When Starfire signs 5 year contract)
Referring to Page 57 of the Case, all the variable costs are incurred by the contractors except for Trailer pool expense, so Starfire still incurs this cost.

COMMENT - Its safe to take debt for financing this as the current debt ratio is not too high to be considered risky – 12.33% (Calculated) => Total liabilities /Total assets => 2115000/17150000(sourced from case)


Even though the fuel charges are incurred by the Contractors we believe that no contractor would be ready to lock himself in to absorb fuel cost rise for a long time. They will either ask for renegotiation or simply become unreliable. Hence we presume that effectively Starfire will have to bear the FSC charges.  

Annexure 10:
Sensitivity Analysis – 5 year contract
Annexure 11:

For this analysis we assume 40 miles per hour as average speed, which is still lower than the standard speed of 55 miles per hour allowed for trucks on U.S roads.

Annexure 12:

For this analysis we assume 40 miles per hour as average speed, which is still lower than the standard speed of 55 miles per hour allowed for trucks on U.S roads.
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