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ACCT 6260

Gary Colbert

Cliff Jumper Bicycle Case


This case looks at a private label opportunity for a small mid-market
bicycle manufacturer. Analysis of the problem requires a blending of
financial, marketing and strategic considerations.
In March 2009, Suzanne Leister, marketing vice president of Cliff Jumper
Bicycle Company, was mulling over the discussion she had the previous
day with Karl Knott, a buyer from Hi-Valu Inc., a retail mass
merchandiser with stores in the Northwest. Hi-Valu's sales volume had
grown to the extent that it was beginning to add "house-brand" (also
called "private-label") merchandise to the product lines of several of its
departments. Mr. Knott, Hi-Valu's buyer for sporting goods, has
approached Ms. Leister about the possibility of Cliff Jumper producing
bicycles for Hi-Valu. The bicycles would bear the name "Challenger,"
which Hi-Valu planned to use for all of its house-brand sporting goods.
Cliff Jumper had been making bicycles for over 10 years. In 2009, the
company's line included 12 models, ranging from a child's beginners
model to a high-end adult's mountain bike targeted at amateur
weekend competitors. Sales were currently at an annual rate of about
$10 million. The company's 2008 financial statements appear in
Exhibit 1. Most of Cliff Jumper's sales were through independently
owned retailers, primarily bike shops but to a lesser extent toy stores,
hardware stores and sporting goods stores. Cliff Jumper had never
before distributed its products through store chains of any type. Ms.
Leister felt that Cliff Jumper bicycles had the image of being above
average in quality and price, but not exclusively a "top of the line"
product.
Hi-Valu's proposal to Cliff Jumper had features that made it quite
different from Cliff Jumper's normal way of doing business. First, it was
very important to Hi-Valu to have ready access to a large inventory of
bicycles, because Hi-Valu had had great difficulty in predicting bicycle
sales, both by store and by month. Hi-Valu wanted to carry these
inventories in its regional warehouses, but it did not want title on a
bicycle to pass from Cliff Jumper to Hi-Valu until the bicycle was shipped
from one of its regional warehouses to a specific Hi-Valu store. At that
point, Hi-Valu would regard the bicycle as having been purchased from
Cliff Jumper, and would pay for it within 30 days. However, Hi-Valu
would agree to take title to any bicycle that had been in one of its
warehouses for four months, again paying for it within 30 days. Mr.
Knott estimated that on average, a bike would remain in a Hi-Valu
regional warehouse for two months.

ACCT 6260
Gary Colbert

Second, Hi-Valu wanted to sell its Challenger bicycles at lower prices


than the name-brand bicycles it carried, and yet still earn
approximately the same gross margin percentage on each bicycle sold - the rationale being that Challenger bike sales would erode somewhat
the sales of the name-brand bikes. Hi-Valu expected that given the
lower price there would be increased total volume that would more than
offset the volume loss. Nevertheless, Hi-Valu needed to purchase bikes
from Cliff Jumper at lower prices than the wholesale prices of
comparable bikes sold through the more typical market channels.
Finally, Hi-Valu wanted the Challenger bike to be somewhat different in
appearance from Cliff Jumper's other bikes. While frame and
mechanical components could be the same as used on one of Cliff
Jumper's current models, the seats, handlebars and shifters would need
to be somewhat different, and the tires would have to have the name
"Challenger" molded into their sidewalls. Also, the bicycles would have
to be packed in boxes printed with the Hi-Valu and Challenger names.
These requirements were expected by Ms. Leister to increase Cliff
Jumper's purchasing, inventorying, and production costs over and
above the added costs that would be incurred for a comparable
increase in volume for Cliff Jumper's regular products.
Ms. Leister was acutely aware that the "bicycle boom" had flattened
out, and this plus a poor economy had caused Cliff Jumper's sales
volume to also flatten out the past two years. As a result, Cliff Jumper
currently was operating its plant at about 80 percent of its two-shift
capacity. Thus, the added volume from Hi-Valu's purchases could
possibly be very attractive. If agreement could be reached on prices,
Hi-Valu would sign a contract guaranteeing to Cliff Jumper that Hi-Valu
would buy its house-brand bicycles only from Cliff Jumper for a threeyear period. The contract would then be automatically extended on a
year-to-year basis, unless one party gave the other at least threemonths' notice that it did not wish to extend the contract.
1

Suzanne Leister realized she needed to do some preliminary financial


analysis of this proposal before having any further discussions with Karl
Knott. She had written on a pad the information she had gathered to
use in her initial analysis; this information is shown in Exhibit 2.

The American bicycle industry been volatile in recent years. In the


early 1970s sales peaked at 15 million units a year. Volume has been
more or less flat for a couple of decades. In 2008 volume had risen to
13 million units but was expected to fall back closer to 10 million units
in 2009.
1

ACCT 6260
Gary Colbert

Exhibit 1
CLIFF JUMPER BICYCLE COMPANY
Balance Sheet, As of December 31, 2008
(thousand of dollars)
Assets
Cash

Liabilities and Owners Equity


$ 340

Accounts payable

$ 520
Accounts receivable
1,360
Accrued expenses
340
Inventories
1,760
Short-term bank loan
2,640
Plant and equipment (net)
4,640
Long-term Notes
payable
2,000
Total liabilities
5,500
Owner's equity
2,600
$8,100
$8,100
CLIFF JUMPER BICYCLE COMPANY
Income Statement, For the Year Ended December 31, 2008
Sales revenues
$10,900
Cost of Goods Sold
8,500
Gross margin
2,400
Selling, General and Administrative (including interest) costs
1,900
Income before taxes
500
Income taxes
200
Net income
$

Exhibit 2
DATA PERTINENT TO HI-VALU PROPOSAL
(Notes taken by Suzanne Leister)

300

ACCT 6260
Gary Colbert

1. Estimated first-year costs of producing Challenger bicycles (average


unit costs, assuming a constant mix of models):
Components and Materials
$40.00
Assembly Labor
20.00
Allocated Overhead
variable manufacturing overhead
10.00
fixed manufacturing overhead
15.00
$85.00

Components and materials includes items specific to models for Hi-Valu,


not used in our standard models. Variable manufacturing overhead
costs includes an estimate of the incremental costs of handling
materials, shipments out, etc. Fixed manufacturing overhead includes
depreciation on the building, management salaries, etc., is allocated
over total projected production volume.
2. One-time added costs of preparing designs and tooling, arranging
sources for seats, handlebars, shifters, tires, and shipping boxes that
differ from those used in our standard models: approximately $100,000.
3. Unit price and annual volume: Hi-Valu estimates it will need 24,000
bikes a year and proposes to pay us an average of $95.00 per bike for
the first year. The contract contains an inflation escalation clause. The
price will increase in proportion to inflation-caused increases in costs
shown in item 1, above. Thus, the $95.00 and $85.00 figures are, in
effect, "constant-dollar" amounts. Knott intimated that there was very
little, if any, negotiating leeway in the $95.00 proposed price.
4. Working capital financing costs (annual variable financing costs, as
percent of dollar value of working capital) are:
Pre-tax cost of funds (to finance receivables and inventories not
carried by vendors) is 12.0%.
5. Other assumptions for Challenger-related added inventories (average
over the year):
Materials: two month's supply.
Work in process: 1,000 bikes, half completed (but all materials for
them issued).
Finished goods: 500 bikes (awaiting the next truckload lot shipment
to a
Hi-Valu warehouse).

ACCT 6260
Gary Colbert

6. Impact on our regular sales: Some retail consumers comparison


shop for bikes, and many of them are likely to conclude that a
Challenger bike as a good value when compared with a similar bike
(either ours or a competitor's) at a higher price in a non-chain store.
Also, our direct customers (local shop owners, etc.) are likely to
recognize these bikes as Cliff Jumper products or to otherwise learn of
this private brand deal. In 2008, we sold 99,000 bikes. My best guess is
that our sales over the next three years will be about 100,000 bikes a
year if we forego the Hi-Valu deal. If we accept it, I think we'll lose
about 4,000 units of our regular sales volume a year, since our retail
distribution is quite strong in Hi-Valu's market region.

ACCT 6260
Gary Colbert

CASE QUESTIONS
These are to get your thought processes started. If you are going to
submit this as a case write-up, dont just answer the questions, rather
use an organized case write-up approach.
1. What is the issue facing Leister?
2. What are the pertinent aspects of Cliff Jumper situation?
How would you describe Cliff Jumper's financial situation at the end
of 2008?
How would you describe Cliff Jumper's operating performance for
2008?
How would you describe Cliff Jumper's strategic position at the end
of 2008?
Is the Challenger deal a good strategic fit for Cliff Jumper?
3. Perform a relevant cost analysis of the Challenger deal. Calculate
the annual net profit (revenue less all relevant costs).
What is the "relevant" manufacturing cost for one Challenger bike?
What is the relevant total annual gross profit (relevant revenue less
relevant manufacturing costs) on the deal?
What is the "relevant" annual cost of the working capital
requirement involved
in the Challenger deal? (Note: this is asking for the annual cost of
working
capital financing, not the amount of working capital. We do this to
take account of the
cost to financing these resource requirements over time (i.e., time
value of money)
Should the Challenger deal be charged for the lost sales of bikes
through the
regular distribution channel ("erosion" or "cannibalization" cost)? If
so, what is
the "relevant" erosion charge?
4. What do your recommend Cliff Jumper do? (Relate this to your
overall your
relevant cost analysis).

ACCT 6260
Gary Colbert

Are there other important issues the relevant cost analysis does not
address?
Are there changes to the proposal you would recommend?
How does this deal fit relative to Cliff Jumpers existing business?
Are there other problems or issues at Cliff Jumper that this deal
solves or
accentuates?