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Commoditisation: Choice or destiny? Exploring the strategic options of an entrepreneurial
South African cheese manufacturer.
A Research Report
presented to
The Graduate School of Business
University of Cape Town
In partial fulfilment
of the requirements for the
Masters of Business Administration Degree
by
Hendrik Jacob du Plessis
December 2011
Supervised by: Dr Eric Wood
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PLAGIARISM DECLARATION
I know that plagiarism is wrong. Plagiarism is to use another’s work and pretend that it is
one’s own.
I have used a recognised convention for citation and referencing. Each significant
contribution and quotation from the works of other people has been attributed, cited and
referenced.
I certify that this submission is my own work.
I have not allowed and will not allow anyone to copy this essay with the intention of passing
it off as his or her own work
Hendrik du Plessis
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ABSTRACT
The research report takes the form of a teaching case that revolves around the difficulties
faced by an entrepreneurial cheese manufacturer in the Western Cape of South Africa. The
business finds itself in a serious cash flow crisis at the end of 2010 and the case explores the
causes of the company’s difficulties and the options available to it.
The commoditised bulk cheese-trading environment forms the background of the case,
underpinned by the theory of commoditisation and strategies to deal with the phenomenon.
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Table of Contents
Table of figures ............................................................................................................. 6
GLOSSARY OF TERMS ............................................................................................ 7
ACKNOWLEDGEMENT ........................................................................................... 8
1. Introduction ........................................................................................................... 9
1.1 Case theme & background ........................................................................................ 9
1.2 Significance ................................................................................................................ 9
1.3 Learning objectives .................................................................................................. 10
2. Literature review ................................................................................................ 11
2.1 Commoditisation ..................................................................................................... 11
2.1.1 Definition .......................................................................................................... 11 2.1.2 Commoditisation process/ causes of commoditisation ..................................... 11 2.1.3 Characteristics ................................................................................................... 14
2.2 Strategic options in a commoditised environment ............................................... 17
2.2.1 Cost leadership .................................................................................................. 19 2.2.2 Differentiation ................................................................................................... 21 2.2.3 Delivering superior customer value .................................................................. 23
2.3 Conclusion ................................................................................................................ 28
3. Research methodology ........................................................................................ 29
3.1 Type of research and research design ................................................................... 29
3.2 Data and information requirements ...................................................................... 30
3.3 Data collection and analysis ................................................................................... 31
3.4 Limitations & constraints ....................................................................................... 32
3.5 Ethics ........................................................................................................................ 33
3.6 Research process ..................................................................................................... 34
4. The Case Study ....................................................................................................... 36
MVS: An accident of history ............................................................................................ 37
MVS’ product mix ............................................................................................................. 38
MVS’ customers ................................................................................................................. 41
The MVS business case ..................................................................................................... 42
The decade preceding the crisis: “Feast or famine” ....................................................... 42
Crunch time ....................................................................................................................... 44
Exhibits ............................................................................................................................... 45
5. Teaching notes ........................................................................................................ 50
5.1 Case summary .............................................................................................................. 50
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5.2 Pedagogical objectives ................................................................................................. 50
5.3 Assignment questions .................................................................................................. 51
5.4 Pedagogical overview and suggested discussion question ........................................ 51
5.5 Concluding the session ................................................................................................ 60
5.6 What did Hendrik do and where did that leave MVS .............................................. 61
4. Bibliography ........................................................................................................... 63
Appendix A: Consent to conduct research .............................................................. 68
Appendix B: Consent to release research ................................................................ 69
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Table of figures Figure 1: The commoditisation pull ......................................................................................... 12
Figure 2: Commoditisation - drivers and effects ..................................................................... 13
Figure 3: Commoditisation level as a multi-dimensional construct ........................................ 14
Figure 4: A typology of customer perceptions and switching costs ........................................ 16
Figure 5: Value map................................................................................................................. 25
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GLOSSARY OF TERMS
Cheddar A semi-hard cheese of English origin, named after the town
Cheddar in England.
FMCG Fast Moving Consumer Goods
Gouda A semi-hard cheese of Dutch origin, named after the town of
Gouda in the Netherlands.
MPO Milk Producers Organisation: An organisation representing
the interests of dairy farmers in South Africa.
MVS Mooivallei Suiwel (Pty) Ltd: A private company producing
cheese from Bonnievale in the Western Cape, South Africa.
The subject of the case study.
SAMPRO South African Milk Processors Organisation: An industry
body representing the secondary dairy industry in South
Africa
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ACKNOWLEDGEMENT
I would like to thank Dr Eric Wood for his invaluable advice, dedication, composure and
good humour when my tight time lines coincided with life’s other crises.
I would like to thank my father and business mentor for his guidance and friendship and my
mother for her unfailing love and support.
Lastly, I would like to thank my wife, Monique, and children, Lia, Louis and Willie-Pieter.
Without their love, support and encouragement I would never have been able to accomplish
what I set out to do.
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1. Introduction
1.1 Case theme & background
The research report will take the form of a teaching case featuring the strategic options of a
medium sized cheese factory, Mooivallei Suiwel (MVS). MVS operates in the commoditised
South African bulk Cheddar and Gouda market from their base in Bonnievale, Western Cape.
The case is meant to serve as a real life example of the challenges faced by a firm operating
in a commoditised market place, characterised by product homogeneity, low margins and
almost non-existent switching costs (Reimann, Schilke, & Thomas, 2010b).
MVS was founded in 2000 by Mr Louis du Plessis (ex-CEO of a major national dairy
concern) and a group of local farmers and it sells its products in the undifferentiated bulk
cheese (Cheddar & Gouda) market in the Western Cape, Gauteng and, most recently, Kwa-
Zulu Natal. All the evidence points to the bulk cheese market being highly commoditised
with high levels of price sensitivity, low margins and very erratic market conditions.
To date MVS has not attempted to differentiate its products in any meaningful way and very
little brand awareness exists at the end consumer level. MVS tries to keep costs low and to
maintain a simple business model in order to stay competitive in a highly contested market
place. MVS therefore presents a fitting case subject to explore the challenges and
opportunities faced by a company in a commoditised market.
1.2 Significance
Commoditisation is seen as one of the most pressing challenges facing business today
(Wright & Snell, 2004). If the dynamics in the market are not understood, innovation might
only reap very short-term rewards for the innovator and companies that used to be cutting-
edge can suddenly find themselves caught in the “commodity trap” (Robinson, Clarke-Hill,
& Clarkson, 2002). Studying the process of commoditisation and its results as well as the
strategies to deal with it, is therefore imperative to students wishing to enter the managerial
arena.
In 1998, Harling & Misser lamented the lack of teaching cases dealing with the challenges
faced by food companies (Harling & Misser, 1998). From the research for this case, including
several electronic databases, such as EBSCO, Science Direct and Emerald, as well as Google
Scholar, it appears as if little has changed in this regard.
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When one turns to commoditisation itself, the literature seems to be focussed either on the
traditional commodities such as steel (Schorsch, 1994) and copper (Hax, 2002) or, when
dealing with the proliferation of commoditisation, the focus tends to be on more technology-
driven sectors, such as information and telecommunications technology (ITC) (Turner, 2009)
and consumer electronics (Olson & Sharma, 2008). Very little mention is made of the
commoditisation process with regards to the FMCG sector in general or agro-processing
specifically. These matters have seemingly not been explored in any depth in the South
African scenario and it is therefore submitted that there is an urgent need for research in this
area.
1.3 Learning objectives
This case will be targeted at business management students or other interested groups at a
level advanced enough to grasp the issues associated with commoditization and deal with the
complexities and challenges involved (e.g. MBA candidates).
The main learning objectives for readers/ students are:
To understand the nature and effects of the commoditisation process,
To be able to juxtapose and critically evaluate the different schools of thought and
conflicting attitudes regarding commoditisation,
To be able to identify the different strategic options for companies within a
commoditised environment and
To offer an opportunity to students to grapple with the challenging task of evaluating
the implications of those options and identifying, planning and implementing an
appropriate and effective response.
The research questions as posed to the students will relate to the facts of the case, but will be
centred on the following, more generic question themes:
When can a product market be typified as a commodity market?
What are the underlying causes of commoditisation?
What are the strategic options in a commoditised environment?
What is meant by customer value?
How can customer value be maximised in a commoditised environment?
How does focussing on customer value aid a company in formulating a coherent
strategic response to the challenges of commoditisation?
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How can relationships be fostered to maximise the value in the chain, make the value
offering more compelling and create a sustainable competitive advantage?
2. Literature review 2.1 Commoditisation
2.1.1 Definition
Commoditisation “denote(s) a competitive environment in which product differentiation is
difficult, customer loyalty and brand values are low, and sustainable advantage comes
primarily from cost (and often quality) leadership” (Weil & Stoughton, 1998, p. 3). Reimann
et al. (2010b) consider “commoditisation as occurring when competitors in comparatively
stable industries offer increasingly homogenous products to price-sensitive consumers who
incur relatively low costs in changing suppliers” (p. 188).
Commoditisation is a serious challenge facing business today and is a common feature across
wide-ranging industries (Turner, 2009, Weil & Stoughton, 1998, Olson & Sharma, 2008). In
these industries, companies find it more and more demanding to capture the hearts and minds
of consumers through traditional product driven marketing approaches (Sena & Petromilli,
2005).
2.1.2 Commoditisation process/ causes of commoditisation
In the long run, everything is a toaster.
Bruce Greenwald as quoted by Schrage (Schrage, 2007, p. 10)
The product life cycle and other theories of strategy seem to suggest that commoditisation is
an unavoidable fact of the competitive landscape that no industry will manage to escape.
Superior profit leads to increased competition in a more contested marketplace, resulting in
lower prices and eventual decline (Turner, 2009).
One of the causes mentioned for the perceived acceleration in the pace of commoditisation of
an increasing array of industries, is the degree to which customers are becoming more and
more knowledgeable. In the information age, markets have become highly transparent and
customers are aware of all available alternatives, which increase the probability of customers
switching to alternative suppliers (Reimann, Schilke, & Thomas, 2010b).
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Davenport (2005) points to the introduction of industry standards as another factor that can
cause or accelerate the commoditisation process. Industry standards can make the recipe for
success more transparent, leading to increased competition as well as homogeneity.
In their much-cited article, Beating the Commodity Magnet, Rangan & Bowman (1992) argue
that it is not merely a product related characteristic that leads to commoditisation, but the way
in which the market powers interact with the specific product class. They suggest that
products and their markets can be arranged along what they call the “axis of equity” – a line
or zone representing what can be seen as a reasonable pay-off for extra services and/ or
features offered as part of the value proposition to the consumer.
Figure 1: The commoditisation pull
(Rangan & Bowman, 1992, p. 218)
When a product market becomes commoditised, increased competition and large-scale
copying of innovative product features make the market for the product homogenous in the
mind of the consumer who is unwilling to pay for extra features and/ or services, driving
down price levels and margins. The effect is depicted in Figure 1: The commoditisation pull
above, which illustrates how the process of commoditisation forces a product market to the
lower right of the chart, representing a position where increased service and/ or innovative
product features are not fairly compensated for along the so-called “axis of equity.”
A firm situated to the upper left area the equity axis is in the enviable position of producing a
speciality product and earning excess returns due to its unique product market position. Such
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a position is not usually seen as sustainable in the medium to longer term, as these margins
will attract competition that will drag such a firm down to the commodity position described
above.
It is important to note that the process of commoditisation does not necessarily follow a linear
path. Matthyssens & Vandenbempt (2008) depicts the circular nature of commoditisation as
follows:
Figure2:Commoditisation‐driversandeffects
(Matthyssens&Vandenbempt,2008,p.317)
While a company might have a superior market position due to being meaningfully
differentiated from other companies in whatever way, a variety of market forces will tend to
undermine this competitive advantage, diminishing returns and necessitating a new bout of
customer value creation in order to once again become the market leader - and then the cycle
starts again.
Getting back to the opening quotation, Schrage (2007) disputes the inevitability of
commoditisation by referring to real life examples (including the toaster!). He points to firms
like Starbucks and Evian that have turned products that seem to epitomise commodities
(coffee and water) into innovative, differentiated value propositions targeted at specific
customer segments. He does not see the road to commoditisation as one that is only driven by
Superior Market Position
Commoditisation through:
1. Standardization
2. Customer experience
3. Competitive immitation
Profit squeeze
Need to create additional customer value and/ or to redefine customer value
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ubiquitous economic forces, but also as a state that results from “an arid absence of unique
innovation” (Schrage, 2007, p. 14). The pre-eminence of price need not be a fait accompli
and can be a temporary state if innovatively addressed.
While industries might be on the slippery slope to commoditisation, individual firms can
create value and earn superior returns regardless of the industry commodity cycle (Rangan &
Bowman, 1992). The challenge is for management not to acquire a commodity mindset that
shuts out various possible avenues of value creation and innovation. Indeed,
“commoditization can be a self-fulfilling prophecy, in which lower price, profits, service, and
customer loyalty interlock in a cycle of decline” (Rangan & Bowman, 1992, p. 216).
2.1.3 Characteristics
When determining whether an industry is already commoditised or susceptible to a process of
commoditisation, it is important to keep in mind that “commoditization is a process
characterized by multiple contributing factors that… may change over time, and as they do,
the commoditization level of an industry can evolve” (Reimann, Schilke, & Thomas, 2010b,
p. 193). Commoditisation is therefore a highly dynamic, multi-dimensional construct.
The common features of commoditisation identified by Reimann, Schilke & Thomas (2010),
are homogenous products, sensitivity to price, low costs of switching between suppliers and
an industry environment that is relatively stable (see figure 3 below).
Figure 3: Commoditisation level as a multi-dimensional construct
(Reimann, Schilke, & Thomas, 2010b, p. 190)
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Homogeneity
As far as product homogeneity is concerned, the offerings of different suppliers are seen as so
similar that they are readily substitutable (Narver & Slater, 1990). While traditionally this is
used to refer to products that are intuitively commodities in nature such as wool, timber and
raw metals, product homogeneity is becoming an increasing phenomenon in a wide range of
industries, including consumer electronics (Olson & Sharma, 2008) and telecommunications
(Turner, 2009). The increasing “sameness” of product offerings can be put down to a more
transparent market place (Reimann, Schilke, & Thomas, 2010b) and a resultant increase in
imitation of innovation amongst competitors, leading to what D’Aveni (2010) refers to as
“the differentiation proliferation trap” (p 44) in his discussion of the hotel industry. This will
be discussed in further detail in the section on differentiation.
Price sensitivity
On the premise that all products are essentially similar with regards to all important features,
including functionality and quality, price remains as the determining factor influencing
buying decisions (Reimann, Schilke, & Thomas, 2010b). Consequently, competition in
commoditised markets is typified by an increased focus on price, often leading to price wars
(Davenport, 2005) and leading to ever narrowing margins (Rangan & Bowman, 1992).
In a typical commodity market demand growth is depressed, real price levels are on the
decline and importers and large brand owners are powerful. Other producers become price
takers, who must accept the price the market determines. This trend has been exacerbated by
globalisation (Olson & Sharma, 2008), liberalisation of trade and improved communication
and transport options (Dumlupinar, 2006).
It is interesting to note that the significant focus on price does not result in price stability, but
that commoditised industries are rather known for meaningful price variability (Reimann,
Schilke, & Thomas, 2010b). Commoditised business sectors do experience upswings, and
what Weil & Stoughton (1998, p. 40) call an “increasingly severe ‘feast or famine’
marketplace”. Both macro-economic and industry-specific factors drive the cyclicality, with
fluctuating levels of excess capacity and price competition (Alajoutsijarvi, Klint, &
Tikkanen, 2001). During down-cycles, market prices disassociate from the product’s
underlying cost base and, even in the face of aggressive cost savings, price levels drop further
and at a faster rate than cost structures can adapt (Weil & Stoughton, 1998).
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The “feast or famine” (Weil & Stoughton, 1998, p. 40) nature of mature industries mentioned
above, makes it very difficult for companies to plan capital expenditure in such a way that it
coincides with a period of upswing. During depressed phases, maintaining existing capacity
is a challenge and the result is that firms become very conservative and less-and-less
proactive. This exacerbates the commoditisation process in the form of a negative self-
reinforcing cycle. As such, the lack of innovation and meaningful investment are “both
causes and effects” (Weil & Stoughton, 1998, p. 41) of commoditisation.
Switching costs
Burnham, Frels and Mahajan (2003) define switching costs as “the onetime costs that
customers associate with the process of switching from one provider to another” (p. 110).
They point out that these costs encompass a wide range of different actual and perceived
costs, far beyond the obvious, apparent financial costs that are directly incurred when
changing suppliers. A distinction is drawn between procedural switching costs (those
activities requiring time and effort), financial switching costs (explicit financial losses) and
relational switching costs (perceived losses due to ended relationships or lost brand
association).
Procedural switching costs
Financial switching costs Relational switching costs
Economic risks costs: Possibility of negative outcome.
Benefit loss costs: Loss of benefits due for continued
support of current supplier.
Personal relationship loss costs: Loss of inter-personal affection.
Evaluation costs: Time and effort to make the
switching decision.
Monetary loss costs: Onetime costs to start transacting with new
supplier (e.g. deposits).
Brand relationship loss costs: Loss of identity
based on association with supplier’s brand.
Learning costs: Time and effort to learn to use new
product/ service optimally.
Setup costs: Time and effort to build new supplier-customer
relationship and optimise product/ system.
Figure4:Atypologyofcustomerperceptionsandswitchingcosts
(AdaptedfromBurnham,Frels,&Mahajan,2003,p.112)
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The importance of the analysis of switching costs is that building close, value-enhancing
relationship with customers, innovative loyalty reward structures and a strong brand affinity
can increase customer retention by increasing firm-specific switching costs in a
commoditised environment where natural switching costs are low. Indeed, it has been shown
that switching costs can play a bigger role in customer retention than customer satisfaction,
although customer satisfaction remains significant (Burnham, Frels, & Mahajan, 2003).
Industry stability
In commoditised industries the customer base and the competitive environment remains fairly
stable, as does aggregate demand (Reimann, Schilke, & Thomas, 2010b). Whereas strong
industry growth and performance invites competition, which seeks to share in the spoils,
competition eventually destroys margins and “as profits fall across the board, struggling
companies fail or are bought up. The resulting consolidation leaves the power in the hands of
a small number of firms, which ultimately leads to higher entry barriers (and) weaker
competition” (Slywotzky & Hoban, 2007, p. 55). According to Slywotsky & Hoban (2007)
this can result in less innovation, although it is not always the case. At worst “destructive
competition pushes out constructive competition, and everyone suffers” (Slywotzky &
Hoban, 2007, p. 55). Any form of meaningful differentiation is difficult in industries that are
stable with low innovation capabilities (Reimann, Schilke, & Thomas, 2010a).
The very nature of commoditised industries explains why commoditisation normally results
in fairly stable, although unprofitable, markets. By stable markets the literature refers to
markets where the set of competitors and the competitive forces in action are not very
dynamic so that the competitive landscape remains stable for extended periods of time. Real
life examples are easy to identify where oligopolies that should earn good returns due to
consolidated market power, earn lacklustre returns in the commodities they trade in, e.g.
paper.
2.2 Strategic options in a commoditised environment
Commodities only exist in the mind of the inept.
(Hax, 2002, p. 14)
According to Weil & Stoughton (1998), a firm’s performance in a mature industry, facing
commoditisation, will be determined by the stage and speed of the commoditisation process
and the strategic response of management to these dynamics.
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There are two widely recognised generic models to attain competitive advantage: Cost
leadership and differentiation (Porter, 1985, 1980). Porter believes that one of these options
should be exercised to the exclusion of the other while others believe that a combination of
these two strategies can be effective in the creation of value (Hill C, 1988). It has been argued
that the context in which the firm operates is decisive as to the effectiveness of cost-,
differentiation- or dual strategies (Li & Li, 2008). Specifically, domesticity and size seem to
play a role in the effectiveness of either cost or differentiation strategies as further elaborated
on in the discussions below.
Li & Li (2008) confirm the findings by other researchers (Reimann, Schilke, & Thomas,
2010b, amongst others) that “positive roles of both pure and dual generic strategies” (Li & Li,
2008, p. 15) exist. However, dual strategies require sufficient organisational resources to
manage and balance contrasting management objectives, which are often only at the disposal
of larger firms. A dual goal is difficult to accomplish, especially in a market that is not highly
concentrated (Li & Li, 2008).
According to Rangan & Bowman (1992) the challenge facing organisations in a
commoditised environment is to attain a stable position somewhere in the area that represents
fair return for services offered. They suggest 4 possible strategies to move from a position
below the “axis of equity” to one on the axis:
1. Value-added strategy: moving to the diagonal by increasing price as well as
augmented services.
2. Price compression/ innovation strategy: moving to the diagonal by essentially
decreasing price (through cost reductions which exceed price reductions).
3. Market focus strategy: moving to the diagonal by focusing on customers who
would pay the additional price for augmented services because they value them.
4. Service compression/ innovation strategy: moving to the diagonal by decreasing
some prices, but stripping away several service features.
(Rangan & Bowman, 1992, pp. 219 -220)
Rangan & Bowman (1992) refer to service levels throughout, but we contend that
differentiated product features would have the same effect as additional services and
therefore include that in their definition of “services”. As such, strategy 1 is for all intents and
purposes a pure differentiation strategy.
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Strategies 2 and 4 are different ways of executing a low cost strategy. With a “price
compression/ innovation strategy”, Rangan & Bowman (1992) refer to the ability to “design
the next generation product at considerably lower cost” (p. 221), while maintaining or
enhancing product features. The firm therefore becomes a cost leader through technological
or operational excellence. A typical example would be the PC industry, which is constantly
offering more ‘bang for your buck’ due to improved technological efficiency. Strategy 4
enables a firm to be a cost leader by minimising any extras so as to offer the cheapest
possible product to the most price sensitive consumers.
Strategy 3 focuses on delivering superior customer value. This third strategic focus area to
overcome the “commodity trap” (Robinson, Clarke-Hill, & Clarckson, 2002) relies on so-
called “customer intimacy” (Treacy & Wiersema, 1993), which revolves around getting an
in-depth understanding of what customers’ needs are and addressing those needs in an
optimal manner (Reimann, Schilke, & Thomas, 2010b). These three strategic responses to
commoditisation will now be discussed in greater detail.
2.2.1 Cost leadership
By keeping their cost base as low as possible, companies strive to out-price competitors while
maintaining profitability. However, as companies operating in commoditised mature
industries all start following cost leader strategies they end up with “flattening cost curves
and virtually identical product quality” (Fischer, Frankemolle, Pape, & Schween, 1997, p.
81).
The view is therefore widely held that, as a response to commoditization, focussing on
creating value in ways other than price is preferable. Having said that, sometimes price wars
cannot be avoided in the short- and medium term. One option would be to tailor price
structures in such a way that reduced prices do not affect all sales (Dumlupinar, 2006).
Some observers, however, believe that low cost models should not be frowned upon.
Karchaner et al. (2011) point out that low cost business models do not necessarily produce
inferior goods at unprofitable price points, but can be highly effective if all activities are
strategically aligned to offering a compelling and unique value proposition.
An increased focus on tapping into the market at the “Bottom of the Pyramid” – those
earning less than $1,500 per annum, comprising almost 70% of the world’s population – has
also emerged. It necessitates innovative, low cost business models (Wiliams Jr, Omar, &
Ensor, 2011). These consumers have been shown to be highly brand loyal and aspirational
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and therefore an enterprise with first entry advantage might have a long lasting competitive
edge.
The target market segment should be clearly defined and their evolving needs understood.
Products and pricing should be directed at meeting specific consumer needs at unambiguous,
affordable prices. Value chain efficiency focussing on core competencies is crucial in
keeping costs down. Costs should be minimised throughout the value chain, with definite
targets set by leaders who operate within “an entrepreneurial, aligned, and visionary culture”
(Kachaner, Lindgardt, & Michael, 2011, p. 44).
Rangan & Bowman, (1992) suggest two ways of achieving cost leadership. Price levels can
either be reduced through innovative ways of reducing production costs or by eliminating
unnecessary product features. We agree with their contention that the second option (a “no-
frills” type offering) requires a unique understanding of a specific customer segment in order
to identify what services and/ or product features are surplus to their requirements. It is
therefore aligned with the customer value focus approach discussed below.
To achieve a low cost position, it is essential for any company to model all the different cost
drivers involved in their business and achieve an understanding of how these costs interact to
achieve the goals of the company and deliver profits. Once costs are understood in minute
detail, focus areas can be determined and costs further analysed and benchmarked (Ryan &
Holmes, 2009).
Li & Li (2008) assessed the effectiveness of different business strategies (low cost,
differentiation or both) in the Chinese markets, comparing local and multi-national firms.
They found that foreign-controlled firms were more successful in following low cost
strategies than local firms. They expected the contrary to be true, due to lower labour costs
exploited by local firms and intimate local knowledge driving production efficiencies.
The fact that the (bigger) foreign firms are more successful possibly points to the importance
of economies of scale, access to technology and bulk buying power to pursue a successful
low cost strategy. This is an important consideration for smaller firms operating in a
commoditised environment in competition with larger and possibly multi-national firms. The
study suggests that a pure cost leadership strategy might not be the best strategy for these
firms to follow.
The subject of the current case study is a small-medium cheese factory in competition with
much larger firms, with its largest competitor in the cheese market, Parmalat (SA), part of the
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multi-national Lactalis group. Li & Li’s (2008) findings are therefore highly relevant to the
current case study. MVS’ management disputes the positive effect of economies of scale in
the cheese market as illustrated in the case study. What is beyond dispute is that operational
effectiveness is a prerequisite (no matter what strategic focus a company embraces) that
allows them to compete in what is a highly contested market place (Reimann, Schilke, &
Thomas, 2010b).
2.2.2 Differentiation
Thereisnosuchthingasacommodity.Allgoodsandservicesaredifferentiable. (Levitt, 1980, p. 83)
The key to differentiation lies in creating a different perception of the product and/ or brand
in the consumer’s mind vis-à-vis those of competitors and is often built on intangible
attributes (Forsyth, Gupta, Haldar, & Marn, 2000). Therefore, in addition to physical
qualities, service, convenience and brand are also possible distinguishing features of a
company’s value proposition (Dumlupinar, 2006).
Levitt (1980) draws a distinction between two different kinds of products – “the offered
product is differentiated, though the generic product is identical” (p. 83). He points out that
“a product is a complex cluster of value satisfactions” (p.84) with tangible attributes and
various intangibles combining to meet customers’ specific needs.
The actual value proposition can differ from the generic product class by meeting customers’
expectations in a specific manner (“the expected product”) or exceeding their expectations
(“the augmented product”) by meeting the customers’ hidden needs - those things they never
considered, but nevertheless find valuable. Levitt (1980) points out that, ironically, as
customers become more knowledgeable in a mature market place, it increases the need for
augmented products even as the pressure on cost increases. Hill (1990) responds to Levitt
(1980) by pointing out that the “augmented product” can become the “expected product” as
added benefits become the norm.
Sharp & Dawes (2001) challenge the conventional distinction that is drawn between
differentiation- and low cost strategies, based on the work of Porter (1980, 1985). They assert
that setting unique price points is just one way of differentiating and usually involves very
strategic decisions around target segments and which add-ons to forego to meet only the
needs of the targeted segment and keep costs at a minimum. They point out that lowering
consumers’ direct cost is seen as price competition, whereas the indirect lowering of their
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costs (e.g. providing home delivery) is seen as differentiation. They see the distinction as
artificial and embrace a definition of differentiation that sees anything (product quality,
service, brand, price or any other) that makes a consumer choose a product or service as the
point of differentiation.
If one accepts their rejection of the distinction between a price-driven strategy and
differentiation, it becomes clear why they assert that differentiation is not optional, but
imperative – without some form of competitive advantage (no matter how apparently menial),
customers will not chose the product or service. While appreciating the need to move away
from an over-simplified silo mindset that has dominated ever since Porter originally
formulated his theory on competitive advantage, there does seem to be strategic value in
distinguishing conceptually between cost or price reduction strategies on the one hand and
differentiation (as normally understood) on the other. The rest of the discussion will therefore
return to differentiation as a construct that is in essence not related to low cost and price
competition.
As mentioned earlier, a big danger facing companies embarking on a differentiation strategy
is the possibility of being copied and the competitive advantage therefore disappearing. This
leaves companies with the prospect of having to choose between relentless innovation to stay
ahead of the pack, adopting a narrow focus and being the best player in a niche market space
or trying to expand its range of offerings to the point of being able to offer a solution to
almost any customer (Turner, 2009).
One solution to the conundrum of copycat behaviour when it comes to differentiation is for
companies that have traditionally been product oriented to focus more of their attention on
adding value through providing services. “Services, by being less visible and more labor
dependent, are much more difficult to imitate, thus becoming a sustainable source of
competitive advantage” (Oliva & Kallenberg, 2003, p. 160). Companies that are product
centred, however, often falter in trying to implement service strategies, since they are not
structurally optimised to for service delivery (Auguste, Harmon, & Pandit, 2006).
(Rothenberg (2007) provides a useful discussion of the main challenges and opportunities
surrounding “servicizing.”) Whatever the course of differentiation is that a company choose
to follow, it is safe to say that in the transparent market of today, combating commoditisation
through differentiation is definitely not getting any easier (Turner, 2009).
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There are some contradictions in the literature when it comes to the desirability for smaller
firms to pursue competitive edge through differentiation, with some pointing to the brand
power of multi-national firms as a hindrance to smaller firms trying to establish a strong
identity based on some differentiated aspect (Dumlupinar, 2006). Others have found, though,
that smaller, local firms are more successful in following differentiation strategies, possibly
due to local expertise with regards to customer preferences (Li & Li, 2008). In addition, there
appears to be an inverse relationship between the concentration of an industry and the
effectiveness of differentiation strategies. The lower the concentration and the higher the
competition, the more effective a differentiation strategy appears to be (Li & Li, 2008).
What is clear is that a successful differentiation strategy must focus on the needs of the
customer and “requires strategic re-examination of the market, developing a better
understanding of the segments that drive it, and redefining and re-branding offerings and
customer experiences based on customer needs and behaviors” (Sena & Petromilli, 2005, p.
73). The next section will focus on the challenge of understanding customers in such a way
that a distinct and compelling value proposition can be offered to the relevant segments.
2.2.3 Delivering superior customer value
Defining customer value
Before we examine ways of delivering superior customer value in the context of overcoming
commoditisation, we have to examine what is meant by value creation in relation to
customers and how that concept has evolved and is still evolving over time (Galbreath,
2002b). Indeed, “the value concept is considered as a fundamental constituent of relationship
marketing” (Ulaga & Chacour, 2001, p. 526).
In the past few decades, management has focused increasingly on customer satisfaction.
However, it has been shown that customer satisfaction and customer retention are not
significantly correlated. It has also been shown that customer retention is a vital part of
trading profitably, given the costs associated with replacing customers (five to seven times
more than retention costs) and the significant time lag before a new customer becomes a
profitable prospect. Therefore a construct of customer value beyond mere customer
satisfaction is required (Galbreath, 2002b).
In his review of marketing literature in relation to customer value, Ulaga has identified the
following themes:
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Customer value is a subjective concept
It constitutes a trade-off between benefits and sacrifices
Benefits and sacrifices can be multifaceted
Value perceptions are relative to competition
(Ulaga, 2003, p. 678)
Most studies concentrate on transactional value, i.e. what the customer receives in exchange
for the money he/ she parts with, as opposed to relational value – the perceived value that a
customer derives from the relationship with the supplier (Ulaga, 2003). Moller & Torronen
(2003) attributes customer-supplier relationship value to the efficiency with which resources
are consumed, the supplier’s ability to find effective solutions exceeding current solutions
offered to the customer and the possibility of enlarging the network to also include other
players to create additional value.
Anderson & Narus (1998) encourage firms to produce monetary models of the value created
for its customers. Importantly, though, they view value as “the technical, economic, service,
and social benefits a customer company receives in exchange for the price it pays for a
market offering” (Anderson & Narus, 1998, p. 54). The definition therefore includes aspects
beyond the mere product attributes and encompasses the relational elements of value.
Similarly, price should be interpreted in a way that represents more than the monetary
consideration a customer has to forego.
They present their model as an equation as follows:
(ValueS – PriceS) > (ValueA – PriceA), with:
ValueS = Value of supplier’s offering,
PriceS = Price of the supplier’s offering
ValueA = Value of next best alternative
Price A = Price of next best alternative
In line with Anderson & Narus’s (1998) model, Schorch (1994) confirms the assertion that
customer value is the difference between perceived benefit (or value) in a multi-dimensional
sense and the perceived price. They represent it graphically as follows:
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Figure5:Valuemap
(Schorsch,1994,p.118)
Value maps such as these are valuable in identifying a company’s strategic advantages and -
disadvantages vis-à-vis its competitors and aids the firm in improving its competitiveness
(Ulaga & Chacour, 2001). It identifies opportunities for price increases and exposes
vulnerabilities where competitors’ value propositions offer more than the company’s offering
(Schorsch, 1994). Value tables/ maps can be either multi-dimensional with a consolidated
measure such as “value” or “benefit” as a variable or the different value parameters that have
been identified can be plotted in order to identify the company’s relative strengths and
weaknesses.
Delivering the value
Companies which differentiate themselves successfully in a commoditised environment are
those which “identify customer requirements, select customer groups for which they can
develop a competitive edge, and design and produce the right product or service package”
(Schorsch, 1994, p. 111). This requires a profound understanding of customers on a
segmented basis and the alignment of all business processes to meet customer expectations.
To attain this profound understanding of customers requires a break with the traditional way
that customers are grouped and served.
Traditional segmentation does not serve the purpose of extracting maximal value, since the
added value attributes that customers are willing to pay for are not necessarily defined by
geographical location, size, industry and the like. What is needed is segmentation that is
based on customers’ particular needs – “a needs-based segmentation” (Forsyth, Gupta,
Haldar, & Marn, 2000, p. 80). A firm needs to identify the crucial elements in the final
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customer’s decision process, apart from price and quality (Fischer, Frankemolle, Pape, &
Schween, 1997).
By focussing on the customer, a firm can differentiate its value proposition and create a
competitive advantage by providing customers with an offering that fulfils the customers’
unique needs. This requires “customer intimacy and value creating network relationships”
(Turner, 2009, p. 439). Furthermore, if common characteristics of customers with similar
needs can be identified, these can be extrapolated to refine offerings to new customers
(Forsyth, Gupta, Haldar, & Marn, 2000).
Customers need to be assessed with regards to their qualitative and quantitative
characteristics, rather than merely basing segmentation on demographics in isolation (Sena &
Petromilli, 2005). Specifically, customer attitudes and the relative value they attach to such
non-tangibles as service, lead times, relational elements and brand value should be assessed
and segments with regards to these attributes identified (Forsyth, Gupta, Haldar, & Marn,
2000). This will enable the company to provide each customer segment with a product and
service combination that meets their specific needs (without providing excess, unwanted
services) (Schorsch, 1994) by developing “segment-specific value propositions” (Sena &
Petromilli, 2005, p. 75). It is also important to note that proper segmentation will often
require extensive empirical research to uncover those needs that might not be apparent to the
supplier or even the customer (Forsyth, Gupta, Haldar, & Marn, 2000).
Schorsch (1994) suggests basing customer segmentation on several different determinants of
the final buying decision, weighing these against each other and defining critical limits for
each of these factors for the different kinds of buyers. Hill (1990) refers to these as segments
defined by “different ways of choosing” (p. 279).
Various statistical methods to arrive at a meaningful combination of variables and weightings
are suggested in the literature. One of these is a “conjoint analysis” which weighs different
attributes of a product against each other and also provides critical limits (Forsyth, Gupta,
Haldar, & Marn, 2000). Another method is based on “the repertory grid” (with its roots in
personal construct psychology) – a tool that allows the customer to define his/ her own
variables (Marsden & Litler, 2000). A detailed analysis of these methods falls outside the
ambit of this research.
Reimann, Schilke & Thomas (2010b) have shown empirically that operational effectiveness
(i.e. controlling costs and/ or quality) and strategies focussed on product differentiation are
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less effective in a commoditised environment vis-à-vis an environment that is not
characterised as prone to commoditisation. They have also shown that what they refer to as
“customer intimacy” – getting to know and understand what is required by customers to fulfil
their needs – becomes proportionally more and more important in a commoditised
environment. Indeed, where products are so similar and the options for differentiation are so
limited that the industry is referred to as a “stalemate industry”, the importance of
understanding the customer and how they make their purchasing decisions is the only true
and sustainable source of competitive advantage. Hill (1990) reaffirms “that the firm’s
competitive strategy should be based not upon what customers purchase but upon how they
choose between the offerings of competing firms” (p. 279).
The same researchers (Reimann, Schilke, & Thomas) have shown in a separate study that
“industry commoditization may significantly affect the extent to which CRM (customer
relationship management) enhances performance-improving strategies” (2010a, p. 338). They
have shown that customer relationship management improves performance by informing cost
leadership or differentiation strategies, rather than in a direct manner. They have found the
correlation between CRM and differentiation to be stronger in the case of commoditised
industries and the link to cost leadership to be equally valid regardless of the level of
commoditisation. This makes sense, since commoditised products are by nature more
homogenous and therefore more likely to be differentiated on intangible, relational qualities
that should be strengthened by CRM. We agree with Reiman, Schilke & Thomas’ findings
and support their logical link between relationship building and meaningful differentiation in
a commoditised environment, rather than seeing building customer relationships as a separate
strategy divorced from Porter’s (1980, 1985) original strategic options. No matter what the
strategic course is a firm embarks in, it should be informed by the needs of its customers.
The focus has now shifted from customer targeting to “customer integration” (Fischer,
Frankemolle, Pape, & Schween, 1997, p. 82), seeing suppliers and buyers in a holistic way in
order to minimise costs and maximise value. After a segment has been identified,
collaboration should take place to arrive at an offering that is superior to both parties and
offers a unique value proposition to the next buyer in the value chain (Hax, 2002). This
approach is coherent with Piercy’s (2010) concept of the strategic sales organisation, which
places its emphasis on the end users’ expectations and concepts of utility and value. An
integrated approach can cut costs through exploiting synergies and can lead to innovation
based on the quest to fulfil the final consumer’s demand (Fischer, Frankemolle, Pape, &
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Schween, 1997). Because the strategy is highly dependent on relationships and shared
resources, the competitive advantage is more sustainable and difficult to emulate.
One possible pay-off of improving customer relations and applying some form of network
integration, is the possibility of counter-acting the high degree of cyclicality that is so typical
of commodity businesses (Alajoutsijarvi, Klint, & Tikkanen, 2001). The dominant market
player approach that swings from a buyer dominated market in the event of difficult primary
market conditions to a seller dominated market during so-called boom periods, should be
replaced by “genuinely cooperative customer relationships” (Alajoutsijarvi, Klint, &
Tikkanen, 2001, p. 495)
Some of the suggested cooperative tactics that should act counter-cyclically are inventory
coordination, supply chain optimisation (e.g. Just in Time principles), introducing customer-
centred service solutions and adopting an end-user focus throughout the supply chain (Zokaei
& Hines, 2007; Alajoutsijarvi, Klint, & Tikkanen, 2001).
Taking the idea of relational value creation a step further, Galbreath (2002a) calls the modern
economy the “Relationship Age”, with success more and more dependent on the value
created through stakeholder relationships. This development can be seen as superseding the
Industrial Age, which led to mass-supply economies of scale, and the Information Age,
where decentralised, knowledge-driven firms concentrated on earnings multiples as the
benchmark of value (Galbreath, 2002a). “The goal of the Relationship Age firm is to
maximize its value through the productive utilization of its relationship network, comprising
the firm’s relationships with its customers, employees, suppliers and partners” (Galbreath,
2002a, p. 8).
2.3 Conclusion
While the traditional concepts of strategy remain valid and have been shown empirically to
be effective in delivering value (Li & Li, 2008), it is clear from the literature that in
commoditised environments the success of any strategic course of action will be determined
by the degree to which relationships with customers are leveraged in order to inform and
implement strategic imperatives (Reimann, Schilke, & Thomas, 2010a).
Only if a business understands the value drivers from the perspective of its customers and
tailors its value proposition in such a way that it meets customers’ specific needs, will it
attain a sustainable advantage in a commoditised environment. This understanding will only
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flow from an intimate relationship with customers and an organisational culture that places
the customer (and the end user if they differ) at the centre of the organisation at all times.
3. Research methodology
3.1 Type of research and research design
Commoditisation is a complex and contested concept with widely differing views on both the
reasons for commoditisation and the strategies available to companies in such a market place
(Schrage, 2007). This makes for a real life managerial situation with significant uncertainty
and no obvious solutions and it is in these situations that the teaching case method of tuition,
as pioneered and institutionalised by Harvard Business School (Barnes, Christensen, &
Hansen, 1994), is perceived as being most effective (Ballantine & Larres, 2004).
Bockler (1987) distinguishes between two kinds of teaching cases. The first is used in an
illustrative manner to show how theory was applied in reality by management. The learning
is therefore deductive in nature. By contrast, the problem case method “put(s) the burden of
analysis and decision making on the reader” (Bockler, 1987, p. 65) and it therefore amounts
to inductive or exploratory learning. This second kind of teaching case will be the format of
this qualitative research report.
The case will be designed and written along the guidelines proposed by Harling & Misser
(1998) as set out in the table below:
Table1:Teachingcasecharacteristicsandmanifestation
Characteristics (adapted from Harling & Misser, 1998, p.122 - 123)
Manifestation in the case
The case tells a story: A compelling narrative with sufficient dramatic tension.
The narrative of an entrepreneurial business with a strong culture and proud history facing challenges
due to a commoditised market place. The issues arouse interest. Company data and exhibits that appeal to the
readers’ fields of expertise will be included. The situation is accessible. Case material will flow logically and technical
information that is only applicable to the dairy industry will be kept to a minimum.
The case teaches a managerial skill.
The reader will have to get to grips with the challenges commoditisation creates and the options
available to managers. The case requires the
solution of a managerial problem.
The reader has to decide on the strategic course MVS has to embark on.
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The managerial problem has a history.
The history of MVS and the pattern of decision- making in the past will be highlighted and their
bearing on the current challenge explored. The case includes
quotations. Ample direct quotations will be used to bring the
personalities to life. The case permits empathy
with the protagonist. Enough personal and contextual information will be supplied to allow acquaintance and understanding
of the central characters. The case is set within the
past five years. The case is current.
The case is short and simple.
A good balance between length and substance will be adhered to.
The teaching case places the theory in the context of an actual managerial conundrum (MVS
at a crossroads due to commoditisation of its product market) and in this way brings the
theory to life. A good teaching case should provide a realistic simulation of reality, draw the
audience in and provoke lively discussion. This should stimulate critical and analytical
“higher-order thinking skills” (Harling & Misser, 1998, p. 119) and expose students to the
challenge of making actual management decisions with real consequences.
3.2 Data and information requirements There are different layers to the case, since the subject of the case will be a specific company
(MVS), but that company operates within a certain sector (bulk cheese) of an industry (dairy)
in South Africa. This implies that data and information for the case will have to come from
all three spheres – industry, sector and company.
As far as the industry and the sector is concerned, data is required to enable the reader to:
Assess the degree to which the bulk cheese market is a commoditised market.
Identify the drivers of commoditisation in dairy and cheese.
Explore the competitive landscape faced by MVS.
Identify strategic responses of other market players.
Investigate the medium term prospects of the industry and sector.
With regards to MVS, the following are of interest:
Financial history, including but not limited to net profit margins, gross profit margins
and efficiency measures.
Market information, such as types of customers and channels of distribution.
Human resource information, e.g. depth of management.
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Marketing plans (if applicable).
Operational challenges/ opportunities.
Management’s attitude towards the market and its degree of commoditisation.
The innovation culture within MVS.
The way decisions are made in MVS.
Any other pertinent organisational issues that may come to light during the
compilation of the report.
3.3 Data collection and analysis As far as the method of collecting data is concerned it seems sensible to once again
distinguish between industry/ sector information and company-specific information.
As far as the industry/ sector is concerned, there are a variety of secondary information
sources available that will be perused and studied for any information applicable to the
research topic at hand. Included in these publications are:
Industry statistics as frequently published and distributed by SAMPRO (South
African Milk Processors Organisation)
Published Annual Financial Statements of dairy firms in South Africa (Clover and
Parmalat)
Industry publications, such as the Dairy Mail
Previous reports on the structure of the South African dairy industry, e.g. a 2001
report by the National Agricultural Marketing Council on the effects of deregulation
on the dairy industry.
Press reports and website postings.
Any relevant books or academic articles.
In addition to these, a number of individuals have been identified for semi-structured
interviews that will serve as a source of primary research to ascertain to which degree the
market for bulk cheese is commoditised already, whether further commoditisation is taking
place and what the outlook of market participants in general is for the industry. Any relevant
competition legislation will serve as guideline for what topics can and cannot be raised
during these interviews. The author will interview the following individuals:
Alwyn Kraamwinkel (CEO: SAMPRO)
Bertus de Jongh (CEO: Milk Producers Organisation)
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Dr Koos Coetzee (Economist: Milk Producers Organisation)
Mr De Wet Jonker (Manager: SAMPRO)
Prof. Pierre Joubert (South African National Marketing Council, UNISA)
Mr Martin Swanepoel (Managing Director: Sonnendal Dairy)
When it comes to MVS itself, the author, as Managing Director, has full access to any
records required and will conduct semi-structured interviews with his colleagues round the
dilemmas faced by MVS and their view of the company’s future. The author was also a
member of a Company Analysis Project syndicate group that analysed MVS and its different
functional and operational parts as part of the requirements for attaining an MBA
qualification from the University of Cape Town Graduate School of Business. This report
will also serve as a source of company specific- as well as industry information (Du Plessis,
et al., 2011).
All interviews will be recorded and summarised in keeping with best practice (Saunders,
Lewis, & Thornbill, 2007). The nature of the interviews and the information gathered from
other sources will most likely be qualitative in nature and the aim is to establish general
trends experienced by industry players and identify any similarities and/ or differences. The
aim is to ensure the “trustworthiness, rigor and quality” (Golafshani, 2003, p. 604) of the
research and we concur with Golafshani (2003) that triangulation, whereby different research
sources are compared to identify recurrent themes can provide this validation. Multiple
sources will therefore be consulted before any conclusions are reached.
Any relevant quantitative data will also be assessed for reliability, or consistency, and
validity (Golafshani, 2003) using techniques that are relevant to the data that might come to
the fore during the research, be it statistical or financial in nature.
3.4 Limitations & constraints
Being a teaching case exposes the research and the learning it provides to the inherent
strengths and weaknesses of this pedagogical method. The universality of any specific case
can always be questioned and this is no exception. However, the drivers of commoditisation
have been shown to agree across industries and so have the strategic options (Reimann,
Schilke, & Thomas, 2010b).
The aim of the research is to provide the reader with an understanding of the particular
managerial challenge and the various strategic options. Specific tools to enable the execution
of the chosen strategic option is therefore not the central focus of this research and where
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necessary the relevant literature should be consulted for this information (e.g. marketing
literature on needs-based segmentation techniques).
A unique peculiarity of this research that can be a source of criticism or a possible weakness
is the fact that the author is also the Managing Director of the company that is the subject of
the teaching case. While subjectivity will always be a part of research and is not peculiar to
the study of cases (Flyvbjerg, 2006), this does seem to be a particularly close affiliation that
might be deemed ‘too close for comfort.’
In this regard, the purpose of a teaching case should be kept in mind. The aim is to allow the
reader to get into the hearts and minds of those involved in the management decision so as to
emulate a real-life managerial situation. The author is in a unique position to expose the
unfiltered realities of the thought processes and emotions of the management concerned.
The author has chosen to present the research as a teaching case study, due to his close
proximity to the subject matter. The nature of a teaching case lends itself to being a
“combination of verifiable facts and opinions” that “give(s) readers the perspective of a
manager in a situation calling for a decision to be made” (Harling & Misser, 1998, p.120). In
this light, the author’s occupational position might aid, rather than detract, from the quality of
the research and the format it is presented in.
The organisation is facing a significant strategic challenge that does not present any
immediate answers. Its willingness to acknowledge this could be interpreted as an indication
that management is open to organisational learning through external scrutiny. This same
attitude was manifested in the Company Analysis report previously mentioned, where the
author assumed the role of external industry expert and editor and left the organisational
functions open to the other team members to investigate and to make recommendations as
they saw fit. As such, this report presents an objective point of departure for the current
project, since it represents the opinion of the group members, rather than that of the current
author.
Lastly, third party feedback and verification has been shown to be effective in controlling for
researcher subjectivity (Drapeau, 2002). In this regard, the author will rely on the research
supervisor and other third parties as and when necessary.
3.5 Ethics
MVS operates in a highly competitive market and is therefore understandably concerned with
the possibility of exposing sensitive information to competitors. Since the author is also the
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Managing Director of the company it can be safely assumed that the case will not unduly
prejudice the company and that all information will be treated with the necessary sensitivity.
It is acknowledged that the research will constitute a publicly accessible document in line
with the rules of the University and the company has given the assurance that it is
comfortable in that regard. The founder of MVS has repeatedly stated that he doesn’t care
about exposing the past, but is not willing to divulge future plans. The teaching case method
is, once again, ideal in this regard, since the whole point is for the reader to decide which
course of action management should take, given a past or present scenario.
The author would like to engage with other industry players to determine the degree to which
they see the cheese market as commoditised. These semi-structured interviews will have to
be undertaken in an open and honest environment and the purpose and expectations should be
explained and agreed upon. Since the author is involved in the management and ownership
structures of MVS, all discussions with competitors should be in keeping with the
Competition Act, No 89 of 1998 (as amended) of the Republic of South Africa.
3.6 Research process
In writing the case, the methodology of Harling & Misser (1998) will be followed, but in
keeping with their recommendations the process will be kept flexible enough so that neither
the analytical nor the creative process are stifled at any stage. At this stage, the so-called
“preliminaries” have been concluded in that a case subject has been found and the foundation
has been laid to begin the actual case writing process.
The following table illustrates the upcoming three phases of writing the teaching case:
Table2:Thecasewritingprocess(adaptedfromHarling&Misser,1998,p125)
Prewriting Writing Wrapping up Collect data Write case Obtain case release
Organize material Write teaching notes Test teaching case Revise case and notes
Before primary data is collected from the participants, as many secondary sources as possible
should be consulted to enable the researcher to identify the pertinent issues to be probed
during the interviews (Harling & Misser, 1998). During prewriting, the relevant publications
will be studied in detail to establish industry trends and possible evidence of
commoditisation. Only then will interviews with industry executives and company
management be conducted.
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Once the data has been settled on, the case will be written in line with the guidelines as set
out in section 3.1. Concurrently the teaching notes will be compiled, providing guidance to
instructors to facilitate learning and maximise the impact of the case. In the final stage, the
case will be signed for release by the company concerned, tested (either by teaching or by
expert review) and amended as necessary.
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4. The Case Study On the 10th of December 2010, almost exactly 10 years after it was founded, Mooivallei
Suiwel1 (MVS) was for the first time in financial crisis. The payment for November’s milk
was due2 and the company had run out of cash. Hendrik du Plessis, Managing Director,
recalls:
“As D-day approached, I could see that this time we were not going to make ends meet. By
the ninth of December, we had only R1.1 million available in our overdraft facility and I was
faced with having to pay almost R3.5 million for the 1.22 million litres of milk we received in
November. There was nowhere to hide. I had to phone some of the farmers and explain that
we would be late in the payment of their milk for November.
Earlier that year some of the shareholder-farmers had to wait a couple of days here or there,
but it was never anything serious. But in December, I would also have to contact some
independent farmers and was dreading it like nothing before in my seven years with the
company. As a small dairy, you can’t afford to have your farmers run for the door in a panic.
Losing your milk supply is the surest way out of the industry.”
On Christmas Eve, the last instalments for the November milk payments were still due, with
only 15 days to go until the December milk bill in excess of R3 million would be payable and
there were no solution to the cash flow problems in sight.
“I managed to pacify the farmers throughout December, keeping them updated on when they
could expect payment and assuring them that it was just a temporary setback. Now it seemed
as if it was all about to start again. Would I be able to keep everyone on board for a second
month in succession?
At the time, we really feared what the future had in store for us. We were already highly
geared and, in any case, the bank made it clear that they were not willing to extend our
facilities. The family’s money was tied up in property and there was no way to raise further
equity, unless we were willing to part with our controlling interest. That was the last resort.”
1Mooivallei Suiwel can be literally translated as Beautiful Valley Dairy and was named after the town of Bonnievale, home of the MVS cheese factory. 2It is customary in the South African dairy industry to pay milk suppliers 10 days after month’s end.
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MVS: An accident of history
On the 10th of December 2000 the MVS factory in Bonnievale3 produced its first batch of
Gouda cheese. The fact that it happened at all was the result of a sequence of events that was
set in motion about twelve months earlier.
When Hendrik’s father, Louis, retired from his position as CEO of Bonnita Ltd4 in 1996, he
thought that he had left the dairy industry behind for good. However, retirement was the
biggest failure of Louis’ career. Louis bought what was supposed to be a weekend farm on
the banks of the Breede River near Bonnievale, the same town where he spent the early years
of his corporate life with Bonnita. However, Louis’ son-in-law decided to farm and
eventually, at the end of 1999, he bought a prize Jersey5 herd. As the herd came into
production, the industry was experiencing surplus conditions and Parmalat (Bonnita’s new
owners) refused to allocate a quota to Louis’ herd. He therefore had to sell his milk at an
unsustainable so-called “B pool” price.6
Louis was not willing to wait until the market returned to shortage conditions and decided to
process his milk himself. Faced with the choice between a small factory for specialist, high
value cheeses using his own milk or a bigger plant capable of producing larger volumes for
the mass cheese market, he decided to stick to what he knew best and serve the majority of
South African cheese consumers. Eighty four percent7 of the South African cheese consumers
purchase Gouda and Cheddar cheese and this is the market he decided to target, specifically
the market for bulk Gouda Rounds (followed by bulk Cheddar and Gouda loaves at a later
stage).
Louis needed to supplement the 2,000 litres per day from his farm with another 8,000 litres
per day in order to cover the capital investment. Thanks to his years in the industry, he had
personal relations with an extensive network of dairy farmers and he identified four farmers
in the area to become his suppliers and business partners.
3Bonnievale is a small village in the rural Breede River Valley of the Western Cape, South Africa, approximately 200km from Cape Town. 4Bonnita Holdings Ltd, a former dairy cooperative, was listed on the Johannesburg Stock Exchange (JSE) in August 1994. In 1998, the international dairy group, Parmalat, acquired a majority stake in the company by buying out the shares of Premier Foods, bought out minorities and delisted the company. Parmalat was recently acquired by the French dairy group, Lactalis. 5A Jersey is a breed of dairy cow that produces milk that is known for high butter fat and protein content, making it the ideal milk for cheese production. 6Farmers are allocated production quotas. Production above this volume, called B Pool milk, is bought at a reduced price per litre in times of surplus. 7Cheese SA. (n.d.). South African cheese industry. Retrieved November 26, 2011, from South African Cheese: www.cheesesa.co.za
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To secure MVS’ milk supply he offered shares to the farmers at a very reasonable price8,
making sure he remained in control of the business, but only by a very slim margin. The goal
of the share issue to the farmers was to lock in milk supply, rather than to raise capital. Louis
had access to enough loan funding and intended to use it to the maximum.
MVS decided to match Parmalat’s milk price and pay the farmers a bonus payment equal to
whatever dividends are declared9 (up to a maximum of 15c/ litre). Louis’ generosity should
be seen in the light of the fact that he saw MVS as a retirement job and had limited growth
expectations of the business.
In March 2003 Hendrik joined the team at MVS for what was supposed to be a three-month
interlude between his Chartered Accountancy articles and his quest to pursue a career in
merchant banking. He decided to stay on and is now a dedicated dairyman. He was initially
primarily responsible for the marketing function as well as being very involved in the
operational side of the business. He was appointed to the position of Managing Director in
May 2010 and had therefore only been in the position for 8 months when he was faced with
the cash flow difficulties that arose later in the year.
He explained the constraints and advantages of their shareholding structure as follows:
“On the one hand, it is vital to ensure your milk supply as a small player in an industry
dominated by a few large, established firms10. On the other hand, it has left me with very
little room to manoeuvre as far as raising capital is concerned.”
MVS’ product mix
The cheese market in South Africa consists of 82 000 metric tons per year, of which 31% is
Cheddar and 20% Gouda11. Around 69 000 tons was sold through retail outlets12 by
December 2010, with the balance attributable to food service sales and the use of cheese as
an ingredient.
81,000 shares were issued at R1,000 each, with Louis taking up 518 shares. 9 MVS has a fixed policy of distributing a third of net profit after tax – half as a dividend and half as a bonus payment to milk producers.. 10Six dairy firms buy 70% of the country’s milk. Source: IFCN. (2010). Dairy report 2010. Kiel: International Farm Comparison Network.
11Cheese SA. (n.d.). South African cheese industry. Retrieved 2011, 26-November from South African Cheese: www.cheesesa.co.za12 Datamonitor. (2010). Dairy food in South Africa to 2014. Datamonitor.
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MVS started out by producing only Gouda Rounds13, since they believed it to be a less
crowded market, largely due to its labour intensive and quality sensitive production
processes.
South Africans eat Gouda at only three weeks old and it therefore can’t be replaced with
imports. The import of cheap Cheddar, on the other hand, is a perpetual problem, especially
during times of surplus conditions. Cheddar has the advantage that it can be stored for long
periods at low temperatures, although it is normally market ready at six weeks. It is therefore
a very good balancing product during times of surplus milk supply.
This also means that it is highly susceptible to the violent cyclicality of an industry where
“realistic expectations at a particular point in time can, due to new developments, quickly
become unrealistic.”14 Cheddar is one of the most traded dairy products on the international
markets and during times of surplus, cheap imports have a significant negative effect on local
cheese prices. This was the case towards the end of 2010.
Up until March 2008, MVS swapped Gouda for Cheddar with a company that produced
decent quality Cheddar, but no Gouda. This gave both companies access to both markets,
with customers preferring a single Gouda and Cheddar supplier. The Cheddar producer,
however, decided to start producing Gouda and MVS responded by producing their own
Cheddar. They soon ran out of capacity producing Gouda and Cheddar on the same
production line and decided to expand into a dedicated Cheddar line, doubling capacity in the
process. This plant came into production on the 19th of July 2009.
“Initially our Cheddar plant ran nicely, but then it started giving all kinds of problems.
Throughout 2010 we were struggling with crumbly, mottled cheese and Cheddar machinery
that kept breaking down. We eventually found the root cause for the problem in November
2010 (a faulty vacuum valve), but there was still a lot of second grade cheese in the
storeroom by December.”
Despite the quality problems associated with the Cheddar, MVS had to produce a certain
quantity of Cheddar to meet customer demand and due to limited capacity to manufacture
Gouda. By December 2010, MVS was producing around 1.3 kg of Gouda for every 1 kg of
Cheddar produced (see production volumes October 2010 – December 2010 in exhibit 1).
13Gouda in the traditional round shape and with red wax covering it.
14SAMPRO. (2011). Key market signals for the dairy industry: November 2011. Pretoria: South African Milk Processors Organisation, p.4.
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Within the Gouda and Cheddar market, MVS decided to trade predominantly in the bulk
segment of the cheese market15. The market for bulk Cheddar and Gouda consisted of 10kg
blocks, 2.5 kg loaves and 4.5 kg Gouda Rounds. Delivery volumes are large and the cheese is
cut up into portions by the final buyer or processed further.
Hendrik reflects on this early choice to target the bulk market as follows:
“Our choice to concentrate on bulk cheese was really motivated by cost factors and the fact
that you are up against very strong brands in the pre-packed cheese market. The market for
bulk cheese is extremely volatile and customer loyalty is minimal, since products are virtually
identical. Once you have passed a certain ‘quality hurdle’, it is really up to price and to a
lesser extent service excellence to win and retain customers.
Price is determined by the market conditions, be it surplus or shortage. If a surplus is in full
swing, it is very tough. You have to fight for every sale and, with prices adjusting downwards
on a daily basis, it feels like the harder you work the less money you make. During times of
surplus, storerooms are overflowing and cash flow is tight. When the market turns, sales
happen almost by themselves, prices can rise rapidly and cash flow management is a
breeze.”
The bulk cheese market is defined to a large extent by a combination of inherent product
attributes and a long and defined history of regulations resulting in set standards for cheeses
like Gouda, Cheddar and Mozzarella.16 In legal terms, the possibility of differentiation by
means of product attributes was non-existent. Standards have remained in place and mass-
market cheese is still a fairly homogenous product, with customers able to switch between
suppliers with ease.
The alternative to bulk is to sell pre-packaged cheese, namely cheese portions that are pre-
packed in branded packaging material. Pre-packed cheese in the retail market enjoyed a
phenomenal growth rate of 17% for the quarter ended 31 December 2010, compared with the
same quarter in 2009. It did, however come at reduced price levels17 (see exhibit 2).
An identical batch of cheese can thus be traded as a full commodity or as a branded value-
added offering (pre-packed cheese). The value-added offering often coincides with a strong
national brand appearing on the packaging. This posed a challenge to MVS, since they had
1595.5% of MVS’ sales in December 2010 was bulk cheese.16Kraamwinkel, A., Jonker, D., & Joubert, J. (2011, November 16). The commoditisation of the bulk cheese market: Trends, analysis and strategic options. (H. Du Plessis, Interviewer) 17SAMPRO. (2010). Key market signals for the dairy industry: February 2010. Pretoria: South African Milk Processors Organisation.
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limited resources at their disposal to build a brand and they were up against the likes of
Clover, with a brand that was amongst the top ten brands in the country according to the
Markinor/ Sunday Times Brand survey 2009 and TGI SA 2010 SA Iconic Brand awards18.
MVS’ customers
MVS have actively avoided selling to national retail chains, since they believed that the
retailers stretch their terms and send their suppliers a lot of returns, mostly due to their own
bad handling of suppliers’ products.19 The retailers have also been found to exert severe
pressure on suppliers, driving prices down as far as possible.20 Hendrik explains:
“We purposefully avoided the national retailers and they are the big buyers of pre-packed
cheese. I have to admit that, except for actively avoiding large retailers, our customers were
not strategically targeted. We have been selling cheese to a variety of customers as and when
they needed our product.”
MVS does sell to independent Spar stores21 in a price range between 50c to R1 per kg below
the price the shops can buy at from Spar’s own distribution centre. If MVS were to list with
the Spar Group itself, they would have to pay a 4% royalty on sales value. MVS views Spar
stores as “higher end” retailers, serving more affluent consumers.
The rest of MVS’ customers as at December 2010 consisted of “lower end” retailers,
suppliers to the food service industry, cheese traders who sell the cheese on to a variety of
customers, industrial buyers who utilise the cheese as an ingredient in their final food product
and 70-odd small buyers (<150 kg/ month).
MVS experienced significant growth in the decade to December 2010 and established a name
for good quality and service, as confirmed by customer surveys.22
“We grew our market through aggressive pricing until late 2009. Our sales manager was
paid on turnover and it was much easier for him to earn his commission by making a few big
sales at lower prices, than trying to optimise price/ kg.
18Clover Industries Ltd. (2011). Annual Report 2011. Johannesburg: Clover Industries Ltd. 19 This belief was based on Louis’ earlier experiences when CEO of Bonnita. 20NAMC. (2001). Report on the investigation into the effects of deregulation on the dairy industry. Pretoria: National Agricultural
Marketing Council.21The Spar Group is one of the big three retailers in South Africa and conducts business on a franchise basis.
22Du Plessis, H., Malan, F., Moodley, M., Murray, X., Mutonho, J., Van Beuningen, M., et al. (2011). Company analysis project: Mooivallei Suiwel. Cape Town: UCT GSB.
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From the beginning of 2010, we focussed on providing excellent and flexible service to our
customers and I believe we had a loyal customer base. The frustrating thing was that we
hadn’t managed to convert our customer equity into an asset to counter the cycles we have to
endure. In the end, we remained price takers in a commodity market.”
The MVS business case
Despite the financial difficulties that he faced in late 2010, Hendrik believed that the
company’s fundamentals were sound and that there was a good business case to be made for
MVS’ survival in the competitive South African dairy arena.
“As a small factory in a dairy producing area, we had a very economical milk collection
regime which was all the more valuable competitively due to the soaring energy costs at the
time. Our furthest milk collection point was only 70 km from the factory. The big national
companies transported milk for hundreds of kilometres to ensure adequate throughput
through their large plants. Ladismith Cheese, one of our regional competitors, transported
most of its milk from Riversdale, 110 km away and on the other side of a steep mountain
pass. Lancewood sourced their milk locally in George, but needed to pay a premium for their
milk due to the strong competition between milk buyers in that area. All said and done, I
believed we were in a strong position for sourcing and collecting milk.
We also kept our cost base low in comparison with the larger players. This was partly thanks
to our flat management structure and the intimate operational involvement of top
management. In addition, we can make decisions quickly and can respond swiftly when it is
called for” (see Exhibit 3 for a comparison of expenses and revenue).
The decade preceding the crisis: “Feast or famine”
Since its inception, MVS’ turnover had grown by an average of over 6% compound annual
growth rate (CAGR)23. The same can’t be said of profits, although MVS managed to earn a
profit every year24 until the 2009 financial year, with fluctuations reflecting the typically
cyclical nature of the industry.
The dairy industry, like other agricultural businesses, went through cycles of product
shortage, followed by surpluses as the increased price levels incentivise production. In the
case of dairy, this was exacerbated by the highly perishable nature of the raw product, which
23Revenue gowth was 16.4% for 2008, 5% in 2009, 15.8% in 2010 and 5.9% for the 2011 Financial Year.
24MVS’ financial year runs to 28 February.
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makes the dairy industry more sensitive to conditions of market imbalance and therefore
more volatile. The production of milk was also “strongly influenced by climatic conditions
which are subject to unexpected changes.”25 Some variability in earnings was therefore to be
expected.
In 2007 the international dairy industry got turned upside down by unprecedented global
demand, which sent price levels soaring (see Exhibit 4). MVS shared in those good times
with excellent results for the year ended 28 February 2008. The company achieved a net
profit margin of 11.6% (see ratio comparison with industry heavyweight, Clover Industries
Ltd26 in Exhibit 3) and a return on equity of 64.1%.
“By the 28th of February 2008, everyone in the industry was upbeat. There was talk of a so-
called ‘new equilibrium’ at unprecedented price levels. We shared this optimism. We were
cash flush and decided to pay off all our hire purchase agreements, with a total value of R2
million, just as we went into the 2009 financial year. As of March 2008, we had built a
company with fixed assets worth R13.5 million and no debt in just over seven years. Little did
we now what lay in store for us!”
As meteoric as the rise in price levels was in 2007, so was the fall in 2008 on the back of
increased supplies and the worldwide economic slowdown, also known as The Great
Recession. In the year ended 28 February 2009, MVS made a loss for the first time. What
made their fate and that of other milk processors worse was the fact that the market price for
dairy products corrected more severely than the raw milk price, squeezing the margins of
milk processors even further (see Exhibit 5).
“After the disastrous 2009 financial year, we expected a recovery in the following year.
Although profits rose in the 2010-2011 financial year, our cash flows did not reflect that.27
We were desperate for a solid performance in 2010. It started out fine, with price levels
stable and fairly decent in March and April 2010, but then it went south all through the
winter, which is normally a time of increased prices28 (see Exhibit 6). We tried to hang on to
higher price levels, but that came at the expense of sales volumes.”
25SAMPRO. (2011). Key market signals for the dairy industry: November 2011. Pretoria: South African Milk Processors Organisation, p.4. 26Clover Industries Ltd is the largest dairy company in South Africa and currently the only dairy firm listed on the Johannesburg Stock Exchange. 27The R2.5 million from operations was wiped out by interest payments and taxation charges from 2008. The company also spent R900 000 out of cash flow on the building of a new Cheddar plant. 28Milk flow varies by around 30% between its highest point in October and the lowest point in June. This creates seasonal shortages in winter, which is therefore normally a time of rising prices.
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As the milk volumes decreased during the winter, inventory levels dropped and cash flow
improved. However, as summer approached and milk volumes increased, cheese prices began
to fall again and by December 2010, MVS had 396 tons of cheese in the storeroom. The
cheese was valued at R10.5 million at an accounting valuation of R26.50 per kilogram, taking
into account all costs directly attributable to the final product, but excluding any overhead
costs, e.g. administrative and selling expenses. Average debtors’ days were approaching 30
days, a far cry from the 18 days in 2008 (see exhibit 3).
Crunch time
As the preparations for Christmas Dinner got underway, Hendrik’s mind was far from the
festivities at hand. He was worried about the possibility of the immediate cash flow problem
turning into a full-blown crisis.
The fact that it was the holiday season did not make it any easier. Lacklustre sales volumes
typify the period between the 15th of December and the 15th of January and collecting
outstanding debtors during the summer holiday is always a challenge. Arranging any form of
bridging finance, such as debtor factoring, would also be very hard to get into place until
after New Year.
“At the time, my main concern was how to find sufficient cash quickly enough to stop the
cash flow difficulties bringing MVS down. As we sat down to enjoy Christmas Dinner, I had
no solution in sight.”
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Exhibits
Month 2010/ 2011
Production ‘000 kg
October 186 722 November 164 896 December 190 084
Exhibit1:ProductionvolumesOctober2010–December2010
Exhibit2:Pre‐packedcheeseaveragesalesvolumeperdayandaveragepricepermonth
(SAMPRO, 2010, p. 59)
75.00
77.00
79.00
81.00
83.00
85.00
87.00
89.00
91.00
93.00
20 000
21 000
22 000
23 000
24 000
25 000
26 000
Sep. 2008
Oct. 2008
Nov. 2008
Dec. 2008
Jan. 2009
Feb. 2009
Mar. 2009
Apr. 2009
May. 2009
Jun. 2009
Jul. 2009
Aug. 2009
Sep. 2009
Oct. 2009
Nov. 2009
Dec. 2009
Jan. 2010
Feb. 2010
Mar. 2010
Apr. 2010
May. 2010
Jun. 2010
Jul. 2010
Aug. 2010
Sep. 2010
Oct. 2010
Nov. 2010
Dec. 2010
R/kgKg per day
Pre‐packed Cheese average sales volume per day and Average price per month
Sales Volume per day Average price
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MVS Target
Mooivallei Clover29 PROFITABILITY: 2011 2010 2009 2008 2011 2010 2009 2008
Gross Margin 20% 17.10% 20.40% 10.30% 27.20% 26.60% 27.10% 23.00% 25.50%
Exp. vs. Rev. 10% 14.60% 13.20% 12.90% 10.70% 20.50% 20.50% 15.50% 19.30%
Operating Margin 10% 2.40% 7.30% -2.50% 16.50% 5.02% 5.21% 0.89% 6.03%
Net Margin 6% 0.40% 4.10% -2.80% 11.60% 2.93% 3.04% -1.52% 2.57%
Return on Assets 30% 5.30% 17.10% -6.70% 48.80% 5.41% 6.40% -2.32% 3.83%
MVS
Target
Mooivallei Clover 2011 2010 2009 2008 2011 2010 2009 2008
EFFICIENCY:
TA Turnover 2.5 2.15 2.36 2.63 2.96 1.85 2.1 1.52 1.49
Operating Cycle 52.9 50.7 42.4 30.7 -0.3 -0.3 13.4 8.5
Debtors Days 29.9 28.2 21.8 18.5 54.5 54.5 57.9 52.5
Inventory Days 64.4 64.5 57.8 51.7 39.3 39.3 47.9 54.4
Creditors Days 41.1 42 37.2 39.4 94.1 94.1 92.3 98.4
LIQUIDITY:
Current 1.5 0.96 0.96 0.88 1 1.43 1.43 1.29 1.16
DU PONT MVS
Target Mooivallei Clover
2011 2010 2009 2008 2010 2010 2009 2008
ROE: 40% 2.58% 26.12% -18.19% 64.07% 11.01% 17.89% -5.78% 13.79%
Efficiency 2.5 2.15 2.36 2.63 2.96 1.85 2.10 1.53 1.49
Profitability 6% 0.37% 3.53% -2.78% 9.11% 2.93% 3.04% -1.52% 2.57%
Leverage 2.7 3.25 3.14 2.48 2.38 2.03 2.80 2.49 3.59
Exhibit3:KeyfinancialratiosofMVSandCloverLtd
29Clover ratios are based on profit from ordinady activities adjusted for exceptional items as it appears in the 6 year financial overview section of their 2011 Annual Report.
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Exhibit4:Worlddairyprices1990–2011
(SAMPRO,2010,p.10)
Exhibit5:PPIofrawmilkvs.dairyproducts2003–2011
(SAMPRO,2010,p.45)
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MVS: Sales Price YE 28 Feb 2011
MONTH SALES PRICE
Mar-10 37.80 Apr-10 37.90
May-10 35.07 Jun-10 36.58 Jul-10 35.66
Aug-10 34.38 Sep-10 34.16 Oct-10 33.60
Nov-10 32.85 Dec-10 32.73 Jan-11 29.92 Feb-11 30.80
Exhibit6:MVScheesepricesMarch2010–February2011
Exhibit7:Turnovervs.NPAT2002‐2011
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Exhibit8:NetProfitAfterTaxvs.Cashflowfromoperatingactivities2002‐2011
Exhibit9:Operatingprofit%2002‐2011
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5. Teaching notes
5.1 Case summary
The case explores the challenges faced by Mooivallei Suiwel (Pty) Ltd (MVS), a cheese
producing company situated in Bonnievale in the rural Western Cape of South Africa. The
case is set in December 2010, with MVS’ Managing Director, Hendrik du Plessis, unable to
pay some of the company’s milk suppliers due to serious cash flow constraints.
The case takes place against the backdrop of the commoditised trading environment for bulk
Cheddar and Gouda cheese. MVS conducts the vast majority of its business in the bulk
cheese market, which is described as “a highly competitive environment conducive to low
margins, where all efforts should be made to eke out any points of differentiation or
competitive advantage possible”30.
In addition to the immediate cash flow concerns, the case also provides information relating
to MVS’ product and customer mix in order to enable the reader to critically consider the
desirability of MVS’ strategic market orientation.
5.2 Pedagogical objectives The case is particularly suited to teaching the subject of entrepreneurship, since it explores
the strategic positioning of- and difficulties faced by an entrepreneurial firm in a real life
scenario. In the process, the case also draws on the fields of marketing (strategic marketing
orientation and marketing mix), finance and accounting (capital structure, dividend policy,
key financial ratios and cash flow management) and human resources (organisational
structure).
The key learning outcomes are:
To appreciate the importance of working capital management and how it
impactsonacompany’scashposition;
To understand the causes and effects of industry commoditisation and the difficulties
faced by individual companies operating in such an environment;
To be able to identify the different strategic options for companies within a
commoditised environment;
30 Du Plessis, H., Malan, F., Moodley, M., Murray, X., Mutonho, J., Van Beuningen, M., et al. (2011). Company analysis project: Mooivallei Suiwel. Cape Town: UCT GSB, p.86.
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To offer an opportunity to students to grapple with the challenging task of evaluating
the implications of the different options and identifying, planning and implementing
an appropriate and effective response and
To appreciate the constraints and opportunities arising from being a small to medium
entrepreneurial venture.
5.3 Assignment questions
1. What gave rise to the cash flow difficulties faced by MVS in December 2010?
2. Describe the trading environment MVS operates in.
3. If you were Hendrik, what actions would you take to steer MVS through this crisis?
5.4 Pedagogical overview and suggested discussion question
It is assumed that the case will be discussed during a single class session. The teaching case
study and the assignment questions should be made available to students a reasonable time
before the class, to enable them to study the case and critically answer the assignment
questions.
The instructor should facilitate a discussion that focuses on the immediate crisis, while also
sketching a picture of the state of the industry MVS operates in and the consequences it holds
for the company. Throughout the discussion, the context of a family-controlled, small to
medium sized entrepreneurial firm should be kept in mind.
In the guiding answers to the questions below some points for further discussion will be
suggested. These are interesting, open discussion topics arising from the main questions for
discussion. The instructor can decide to what degree he/ she wants to or can entertain these
discussions within the relevant time constraints.
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1. What was the most apparent reason for MVS’ cash flow crisis?
The decision to try to realise higher prices rather than keeping inventory levels under
control
“We tried to hang on to higher price levels, but that came at the expense of sales volumes.”
The most apparent reason for the difficulties faced by MVS in December 2010 is the
substantial build-up of inventory. The minimum inventory level and cash tied up in excessive
inventory can be calculated as follows:
Data from the case:
Actual inventory as at 31 December: 396 tons
Ratio of Gouda to Cheddar (in kg): 1.3:1
Optimal period31 of maturation for Cheddar: 6 weeks
Optimal period of maturation for Gouda: 3 weeks
Production figures given in exhibit 1
MVS CHEESE PRODUCTION IN KG: NOVEMBER & DECEMBER 2010
TOTAL PRODUCTION CHEDDAR PRODUCTION* GOUDA PRODUCTION#
November December November December November December 164 896 190 084 71 694 82 645 93 202 107 439
* TOTAL PRODUCTION x 1 / 2.3
# TOTAL PRODUCTION x 1.3 / 2.3
Minimum quantity of Gouda as at 31 December 2010:
21 days/ 31 days x Gouda production December 21/ 31 x 107 439 = 72 781 kg
Minimum quantity of Cheddar as at 31 December 2010:
December Cheddar production + (42 days – 31 days)/ 30 days x Cheddar production November 82 645 kg + 11/30 x 71 694 = 108 933 kg
TOTAL OPTIMAL INVENTORY LEVEL: 72 781 kg + 108 933 kg = 181 714 kg
EXCESS INVENTORY: 396 000 – 172 070 = 214 286 kg
31Optimal in the light of cash flow management.
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CASH TIED UP IN EXCESS INVENTORY KG PRICE/ KG RAND
214 286 32.73 ~7 013 581 214 286 29.92 ^6 411 437 214 286 29.00 6 214 294 214 286 28.00 6 000 008 214 286 26.50 §5 678 579
~ Average December sales price as per exhibit 6
^ Average January sales price as per exhibit 6 (indication of price stock was liquidated at)
§ Accounting valuation of inventory
It is clear that selling the excess inventory would have solved MVS’ cash flow problem, even
if it were sold at the price it was valued at (which appeared to be well below the market
price). Hendrik also states that a surplus situation is typified by “prices adjusting downwards
on a daily basis” – the strategy to hang onto inventory in the hope that price levels will
improve therefore seems irrational.
2. The worsening operating cycle and increased use of loan financing (see exhibit 3)
seem to suggest that, besides the immediate causes of the crisis in December 2010, some
medium to long term factors and decisions were eroding MVS’ liquidity. Indentify and
discuss.
A combination of factors and decisions contributed to MVS’ liquidity situation – some more
short term and some more long term in nature. The following are evident from the facts in the
case:
Management’s decision to pay off all the financing agreements after the very good year
ended 28 February 2008.
“We were cash flush and decided to pay off all our hire purchase agreements, with a total
value of R2 million.”
R2 million rand of cash was utilised to pay off debt that was long term in nature. While this
would have reduced interest charges in future (if the company maintained a net cash positive
position), it would have been more prudent to keep some cash in reserve, especially given
Hendrik’s comment that “the market for bulk cheese is extremely volatile.” Hendrik should
have foreseen a downturn after the excellent results for the 2008 financial year, but he seems
to have been caught up in the hype around the “new equilibrium” in the dairy industry.
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Was MVS growing at a sustainable rate?
The sustainability of MVS growth rate, given the fact that they were not able to alter their
capital structure (they could not raise further debt and were also constrained in raising equity)
must be investigated. The so-called Sustainable Growth Rate (SGR) can be used for this
purpose. It expresses the maximum sustainable growth rate given a fixed capital structure,
return on equity (ROE) and retention rate32 (b), and is calculated by the following formula:
SGR = ROE x b
Since the return on equity is highly variable from year to year, a range of SGR values is given
below, given the dividend policy of paying out 1/3 of net profit after tax.
ROE SGR 2008 64.0% 42.7% 2009 Neg. Neg. 2010 26.0% 17.3% 2011 2.6% 1.7% Avg. 9.8% * 6.5%
* ROE corresponding with compound annual growth rate for period 2008 - 2011
The company’s revenue grew by 5.9% in the 2011 financial year and 15.8% in 2010. While
the growth rate in 2010 was sustainable, the company’s growth rate for the year ended 28
February 2011 was not sustainable given a fixed capital structure, partly explaining the need
for refinancing in December 2010, unless funds were rolled over from 2010, which was not
the case, since the company experienced negative cash flow from operating activities during
that year (see foot note 27).
Is the average growth rate sustainable given the highly cyclical nature of
earnings?
HowshouldMVSplanitsgrowthwithinsuchanunpredictableenvironment?
Points for further discussion: Should a company like MVS that is clearly following a growth
strategy have a fixed dividend policy, especially in such a turbulent trading environment?
32The retention rate is the percentage of profits not declared as dividend. i.e. (1-dividend payout %).
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Second grade inventory probably contributed to the rise in inventory
“We were struggling with crumbly, mottled cheese and Cheddar machinery that kept
breaking down. There was a lot of second grade cheese in the storeroom.”
It might be difficult to sell second grade cheese in a surplus environment.
Worsening expense to revenue %
The expense to revenue ratio worsened throughout the period reported on, from 10.7% in
2008 to 14.6% in 2011 (see exhibit 3). This means that more money is spent on operating
expenses, negatively affecting cash flow.
Negative cash flow in 2010, despite profit made in that year.
“Although profits were up in 2010, our cash flows did not reflect that.”
Although the exact details are not known, interest and taxation charges absorbed the cash
flow from operations in the 2010 financial year (See foot note 27). The taxation charge
apparently stems from 2008, since the company made a loss in 2009. Delaying the payment
to 2010 means that the company probably incurred interest, further worsening the cash
position. The building of the Cheddar plant also absorbed cash.
Points for further discussion: Was it a good idea to spend the money on the Cheddar plant
after the bad performance in 2009? Should the company have explored other avenues after
their swop agreement with the Cheddar supplier ran out?
Volume growth without margin
This ties in with the SGR above. The graph in exhibit 7 clearly illustrates that the volume
growth was not matched by a growth in net profit after tax (NPAT). Growth in turnover
without earnings growth will put pressure on cash flow.
Points for discussion: Why did MVS embark on a growth strategy if margins were not
forthcoming? Is it a “low margin, high turnover” business plan? Is value being created by this
growth?
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Increasing use of financial leverage (see Du Pont analysis in exhibit 3)
The increased utilisation of loan funding is both a cause (due to interest charges) and a
consequence of cash flow strain.
Points for discussion: Is there merit in the opinion that being highly leveraged is the only way
to earn attractive ROE and create value in a low margin environment?
Quality of earnings
The quality of earnings as far as the degree to which NPAT is matched by positive cash flows
was particularly poor in 2008, 2009 and 2010 (see exhibit 8). Although all details are not
known, this seems to indicate that operations are not resulting in cash flowing into the
business. There was a correction in 2011 with cash flow outstripping NPAT, but this
probably stems from action taken in the months after the conclusion of the case – i.e. January
and February 2011.
3. Having identified the low margin, highly cyclical nature of MVS’ business as a source
of financial vulnerability (in answering question 2), consider Hendrik’s comment below.
Do you agree with Hendrik’s assertion that MVS is stuck in a commodity market? Or is
the problem that Hendrik is stuck in a commodity mindset?
“In the end, we remain price takers in a commodity market.”33
Most students should agree that the market for cheese is one that is highly commoditised.
There are a number of typical characteristics of commoditised markets mentioned in the case.
Some are explicitly stated and should be immediately identified by students, while others are
hinted at.
Cyclicality: Hendrik contrasts the business environment during times of surplus and
shortage, echoing the description of commoditised industries as an “increasingly
severe ‘feast or famine’ marketplace”34
Product homogeneity: Bulk cheese is per se a homogenous product class. Once the
product passes a certain minimum quality standard demanded by the buyer, it is
basically identical to other market offerings and readily substitutable.
33 Case study: p.42 34Weil, H., & Stoughton, M. (1998, p.40). Commoditization of technology-based products and services: The base case scenarios for three industries. Cambridge, MA: Sloan School of Management, M.I.T.
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Low switching costs: Suppliers can easily switch from one supplier to another, since
offerings are similar and the customer is not tied in to buy from any specific supplier.
Difficulty to plan capital expenditure: MVS’ capital expenditure on the Cheddar plant
coincided with a downturn in profitability.
Price sensitivity: “…it is really up to price and to a lesser extent service excellence to
win and retain customers.”35
Low margins: In keeping with prices that are under pressure and “flattening cost
curves and virtually identical product quality”36, the margins in commoditised
industries are characteristically low. This is evidenced in MVS’ operating margins
and the PPI of dairy products vs. raw milk as depicted in exhibits 9 and 5
respectively.
Power of imports and large brand owners, reducing others to the position of price
takers.
Universal standards: The introduction of product standards led to product
homogeneity.
Some students might challenge the notion of bulk cheese as a particularly commoditised
market. What makes it any different from cellular telephone services, PC laptop computers or
bottled water? The aim should be to illustrate the universality of the challenges faced by
MVS and broaden the discussion to follow, so that students can draw on a wide range of
industries and companies when they start to think of ways to overcome the commodity trap37.
The instructor should emphasize the fact that commoditisation is not categorically present or
absent in any industry, but should rather be thought of as a continuum. An example of a bulk
cheese market that is far more commoditised than the South African market is the market for
bulk Cheddar in the United States of America (USA). Cheddar cheese has reached the status
of a true commodity in the USA, with it trading on the Chicago Cheese Board, just like corn,
maize or any other agricultural commodity.
Emphasis should also be placed on commoditisation as a multi-dimensional construct. The
characteristics described above and others associated with commoditised industries should 35 Case study: p.40 36Fischer, M., Frankemolle, H., Pape, L., & Schween, K. (1997, p.81). Serving your customer's customer: A strategy for mature industries. The McKinsey Quarterly , 81 - 89. 37Robinson, T., Clarke-Hill, C., & Clarckson, R. (2002). Differentiation through service: A perspective from the commodity chemicals sector. The Service Industries Journal , 149 - 166.
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not be treated as a checklist to determine whether a product or service is a commodity. The
process of commoditisation is dynamic and can evolve for better or worse over time.
Or is the problem that Hendrik is stuck in a commodity mindset?
“We tried to hang on to higher price levels, but that came at the expense of sales volumes.”38
“We grew our market through aggressive pricing.”39
“Our choice to concentrate on bulk cheese was really motivated by cost factors and the fact
that you are up against very strong brands in the pre-packed cheese market.”40
Do these comments reflect an almost passive acceptance by Hendrik of MVS’ fate as
a commodity player?
How much blame for the company’s difficulties rests with management’s inability to
think innovatively about their industry, rather than accepting the status quo?
Students should be encouraged to provide alternative ways of thinking about the
company and its markets, within the constraints of the actual situation, rather than
merely criticising from the sideline.
Students who feel that the industry structure is the main culprit and that Hendrik’s attitude
had nothing to do with the difficulties the company was facing, should be pointed to firms
such as Starbucks and Evian, who were able to formulate innovative, segment specific value
propositions while their underlying products (coffee and water) seem to define what
commodities are41.
4. Should Hendrik alter the strategy of MVS or stay predominantly in the bulk cheese
market? Consider the costs, benefits and risks involved.
The instructor can conduct a quick poll to determine who feels that MVS should change their
strategy and who believes they should stay the course. There are no right and wrong answers
to the proposed question and students should feel free to express their opinions on the matter,
including those who are in the minority.
38 Case study: p.43 39 Case study: p.41 40 Case study: p.40 41Schrage, M. (2007). The myth of commoditization. MIT Sloan Management Review , 10 - 14.
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Yes, MVS should change course
Students who believe that MVS should change their strategy will most likely point to the low
margin, ultra-competitive, cyclical and unstable market for bulk cheese as elaborated on in
question 3. The question might arise: “Who wants to trade in such a market, anyway?”
When those who propose a change in strategy are asked how, they should be encouraged to
be as specific as possible with the information at their disposal. If they suggest that MVS
should differentiate, they should say how. Students should be encouraged to be creative in
finding unique solutions that can be applied to MVS.
If students propose vigorously pursuing the market for pre-packed cheese (the obvious
alternative to selling in bulk) in the light of the volume growth in that market, the instructor
should ask the class to identify facts from the case that suggest that this is not the optimal
solution to MVS’ challenges. These include:
There has been deflation in the market for pre-packed cheese despite substantial
growth in volumes. This suggests that this is also a heavily contested market.
There are strong national brands in this space and MVS might struggle to establish
brand loyalty in competition with these well-established brands with big advertising
budgets.
Pursuing the pre-packed cheese market en masse will entail selling to powerful
national retail chains. MVS appears unwilling to do this.
Manufacturing and distribution of pre-packed cheese will drive up costs. Will the
extra margin follow?
MVS runs the risk of being a “me too” product and getting caught in “the
differentiation proliferation trap”42, whereby a differentiated offering is copied and
quickly becomes the norm and the next commodity.
The possibility of differentiation by means other than product attributes or packaging should
be considered, e.g. through service excellence or innovative brand building. It is stated in the
case that MVS’ customer service is seen in a very positive light. Any suggestions should
42D'Aveni, R. (2010, p.44). How to escaoe the differentiation proliferation trap. Strategy & Leadership , 44 – 49.
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keep the reality of the case in mind. MVS already produces large volumes of cheese and a
niche market that is too small is therefore not a viable option.
No, MVS should remain in the bulk Gouda and Cheddar market
Students who feel that MVS should stay the course and remain in the bulk Gouda and
Cheddar market, might support their recommendation with some of the following points that
is evident from the case:
MVS has a transport cost advantage and low organisational overheads.
Management is experienced in dealing with the difficulties presented by the bulk
cheese market.
The market for bulk cheese is large and MVS is already manufacturing 180 tons a
month.
Differentiating through the production of pre-packed cheese might be costly and
might erode the cost advantages MVS enjoys relative to its competition.
These students should be challenged on the basis that apparently playing it safe might prove
disastrous in the long run. The intense competition in the bulk cheese market shows no sign
of abating and would probably increase in severity. Can MVS afford to just ride it out? What
if conditions worsen and MVS has done nothing to create alternative marketing
opportunities?
It is of course possible for MVS to deal in both undifferentiated bulk and a differentiated
product line. How will a dual structure influence their cost base? Will it erode the
organisation’s focus?
Points for further discussion: What about MVS’ customers? Do they know who they are? Do
they know what their needs are? How can they find out and how can they capitalise on this?
5.5 Concluding the session
The instructor should ensure that the students understand the severity of the crisis facing
MVS and the importance of cash flow management in general. He/ she should drive the point
home that it is not a lack of profits that results in companies going under, but a lack of cash to
settle their debts. The instructor should recap how Hendrik and MVS got themselves into the
difficulties they were facing.
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As a conclusion, students should be asked what their answer to assignment question 3 was:
If you were Hendrik, what actions would you take to steer MVS through this
crisis?
5.6 What did Hendrik do and where did that leave MVS
Hendrik realised that the support of the farmers was more crucial to MVS than keeping other
creditors satisfied. He therefore instructed the accounting office to put all payments to non-
farmers on hold until the farmers were paid in full in January for their December milk. In
conjunction with this, debtors were vigorously pursued to collect as much outstanding
amounts as possible.
These actions enabled MVS to pay all but three (out of sixteen) farmers in full on the 10th of
January; with all milk bills settled a week later. The immediate crisis relating to the security
of milk supply was averted, but the company was still cash-strapped and far from secure.
Hendrik knew that the root cause lay in the unprecedented inventory levels absorbing cash
flow. He also realised that selling the inventory to clients with lengthy payment terms would
only transfer the problem to another part of working capital, namely debtors. Together with
his sales team, he therefore immediately targeted those clients they knew could be convinced
to agree to short payment terms in exchange for very competitive pricing. In particular, MVS
sold around 100 tons of cheese to a large fruit and vegetable retailer.
As soon as the inventory levels came down to normal and clients started settling their debts
for those sales, the liquidity issues disappeared. In conjunction with this, the cheese market
went into a shortage situation as winter approached and prices started improving from around
April with MVS facing excess demand for their product.
A year later, in December 2011 (the date of this report), prices had still not started to come
down and the company is in the position to pay their farmers twice over, with a five million
Rand turnaround in their cash position. This was largely due to the fact that the industry is
now in a boom phase. Hendrik comments on their good fortunes as follows:
“It is a huge relief. We are making record profits, matched by cash flow. What I do know is
that this, too, shall not last. This time around we will not settle any long-term debt and we
will make sure that our storerooms remain empty.
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We have launched a new brand of pre-packed Cheddar cheese, called Rigg’s, and our sales
of pre-packed cheese have doubled. There are also a number of initiatives in the pipeline to
build partnerships with our clients to meet the unmet needs of the final consumer, their
customers.”
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Appendix A: Consent to conduct research
MOOIVALLEI SUIWEL (EDMS.) BPK POSBIS 426, BONNIEVALE, 6730; TEL 023 616 3912; FAKS 023 616 3915
To Whom It May Concern:
Consent to participate in research by Hendrik du Plessis in partial fulfilment of the
requirements for the Masters of Business Administration Degree
We hereby confirm our willingness to participate in the above-mentioned research. We
understand that the research will take the form of a teaching case, that the report will be not
be confidential and that it may be used freely by the Graduate School of Business.
We will endeavour to give our full cooperation in the process and look forward to the
outcome.
Kind Regards,
Mr L.S. du Plessis
DIRECTOR
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Appendix B: Consent to release research
