Rawhide Brewery Case

After several prosperous years, sales of Rawhide are currently growing more slowly, which is leading the business to function below capacity. Due to a 10-year bank loan that had been used to finance the growth plan, the CEO is in a difficult situation. The fixed cost of marinating the fixed cost of underutilized facilities is another issue that worries the management. According to sales forecasts, Rawhide won't reach full output anytime soon. Due to its substantial debt, Rawhide has few options for financing. On the other hand, Tabby Cat Beer (Rawhide's rival) has experienced a consistent increase in sales and is having trouble with its production processes. Tabby is currently using leased premises whose lease is almost coming to an end. With the increasing sales, Tabby is planning to move its production to a larger premise. Although Tabby can secure a debt financing to finance its expansion, the conservative management is hesitant to give up leverage. The following is an analysis of the two proposals and counter proposals to help the two companies deal with their current situation

Proposal Analysis

Rawhide CEO, Upson has forwarded two proposals to Tabby’s CEO, McAlphine. In the first proposal, Upson seeks to convince McAphine to outsource production operations from Rawhide under-utilized capacity for a fee. The fee is to be based on the number of cases produced, but it is 20% higher than the current Tabby’s production cost. In the second proposal, Upson seeks to secure a joint venture with Tabby to start a new company (Newco). Rawhide and Tabby would produce from the same premise and the proposed cost would be 15% less than in proposal 1. After evaluating the two proposals, McAphine decided to offer a counter offer. McAphine proposes a joint venture in which the two firms will have 60% (Tabby) and 40% sharing on shares. McAphine share was based on the fact that although combining the two firms would give them cost saving opportunities and improved production capacity, Tabby will have to loss control of making certain strategic decisions. Outsourcing as proposed in offer 1 would imply that, not will Tabby lose control over quality, but also incur most cost per case.

For Rawhide, it has to reduce the debt ratio either by paying the debt (which is not possible with the current low sales), source a financing partner, or boost its sale (sale forecasts are negative). While the counter propose would offer Rawhide the much needed cash flow to offset its long-term debt, the company has to give a huge part of its company (40 of common share). By surrendering 40% of the new company, Rawhide will also be surrendering a significant amount of its future profits. However, the capital buy-in provided by Tabby will help it reduce the debt ratio. There is the only solution to pay off the debt or lower it to acceptable levels. It can be achieved by increasing sales and lower cost. It’s the same like to turn the company around and become profitable again.

The counter proposal will be fair for both companies. It has the potential to help Rawhide solve its debt problem and help Tabby to meet her expansion plan. As a relatively new firm, Tabby can learn from Rawhide’s experience in the brewery industry while Rawhide can learn strategies Tabby is using to attain and sustain sales.

Decision Model

Probability

Net Cost

Value

Proposal 1

15%

$ 1 M

0.15

Proposal 2

30%

$ 1.55 M

0.465

Counter proposal

55%

$ 1 M

0.55

The probability of the first proposal and second proposal being accepted is very low. The firs proposal will increase Tabby’s cost of operation, which would consequently affect its pricing strategy or profitability. The effect of increased operation costs would be manifested in Tabby’s competitiveness. In the second proposal, Tabby is also the greatest loser. The company will lose critical control of its quality. Rawhide will have the ultimate decision on various production elements which implies that Rawhide can influence Tabby’s competitiveness. It may also have indirect effects on Tabby’s customer base (Gold, 2016). It is also unprecedented the effects of the joint venture on brand image and value.

The counter-proposal has a high probability of acceptance. It represents a compromise between the two firms. Tabby receives the brewing capacity the need to sustain its growth and retain control of critical production processes. Additionally, Tabby obtains value for its invest in the new company through 40% common share. Rawhide and Tabby will co-guarantee the long term loan, which implies that its long-term liabilities will decrease. In addition, Rawhide will receive $1 million for the common shares sell out. The counter proposal also gives Rawhide significant leverage regarding critical decisions. Rawhide will be responsible for human resource management, capital expenditure, relocation and expansion of the premises, additional borrowing, identification and selection of suppliers, outsourcing arrangements and managing delivery schedules. Tabby will retain power over the formula of its product, which will help it sustain quality and brand value. Although the counter-proposal is favourable to both firms, Rawhide has to consider the last clause of the proposal. While they will retain major decisions on production, Tabby will have veto powers to close or reduce the size of operation. This clause would antagonize Rawhide’s future decision to expand in case its sales recover. Therefore, Rawhide management would decide to negotiate the counter-offer to address some contentious issues. Uposon and CFO may negotiate the 40% common share offer because this would hamper Rawhide’s effort to boost its financial position. 40% common share implies that Tabby will be pocketing a significant amount of Newco’s profits in addition to receiving the production facilities. The counter proposal has not addressed issues such as trademarks and name use, which are critical in joint ventures. Bankruptcy positions are not also outlined. They also have to address the issues of non-compete and business opportunities, which are likely to occur because they will be sharing the same production facility (Zenichi, Munetaka & Masato, 2015). Therefore, the optimal is to the counter proposal, but the CFO has to negotiate some elements of the proposal.

Conclusion

Rawhide and Tabby case study demonstrates the various financing options and account issues during a joint venture. From the case study, it is clear that firms always seek the best deal, but end up with a suitable compromise. Decision making during such transactions is critical to ensure firms get value for their shareholders. Rawhide can benefit from the counter proposal, which offers the company a chance to reduce its debt ratio by selling equity in the new firm.

References

Gold, A. (2016). Integrated Perspectives. Blacklick, Ohio: McGraw-Hill.

Zenichi S., Munetaka F & Masato U (2015). Joint Venture Strategies: Design, Bargaining, and the Law. Edwaard Elgar Publishing.