operational cost management

7/21/2019 operational cost management

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S. K. Packaging: Offest Printing Opportunity

School Of Business Management, NMIMS, Mumbai 26 July, 2014

Aditya Marphatia (A057)

Andrew Simoes (E050)

Deboprasad Das (E013)

Divyanshi Pandey (E038)

Neha Anna John (A006)

It was a bright cold December morning in 2012 and Ravindra Kedar stood looking out of the

window in his Juhu apartment, watching the waves. They broke easily against the sand

hardening and strengthening the surface. Ravindra knew that this was the strongest point of S

K Packaging, his printing and packaging business: the solid foundation. However, he found

himself musing yet again on the fact that there were greater profits to be made in a more

advanced form of packaging: one that used offset printing on the boxes instead of theprinting. This form would lead to production of boxes that commanded higher margins. He

wanted to take the plunge while he was still young, but had some reservations and knew that

he needed to make a proper quantitative and qualitative evaluation before getting into it. He

had a meeting with the purchase manager of a large pharmaceutical company the next day.

The meeting was about the companys annual requirement for corrugated boxes with good

quality printing on the outer side for ten years commencing November 2013. He looked

forward to the meeting, for it was an old client and he had an excellent relationship with the

purchasing manager. However, he couldnt help but feel that he would need to make an

important business decision before getting into the details of the order.

Industry overview: Containers and Packaging Industry

The $3 billion corrugated packaging industry in India constitutes approximately 5% of the

global turnover in packaging. The industry had seen a healthy annual growth rate of 12% to

14% for the past 3 years and was scheduled to touch $15 billion by 20251[See Exhibit 1 for

growth drivers in the packaging industry]. The packaging industry was highly fragmented

with over 22,000 players, an estimated 85% of which were MSMEs2. The industry may be

further divided into two sub-industries: Metal and Glass Containers and Paper Packaging.

Paper packaging accounted for about 22% of the turnover of the industry3. The industry was

characterized by intense rivalry to get orders as the players had little to offer in terms of

differentiation. In the face of this competition, relationship management played a crucial role

to generate orders. Being a commodity business, the companies try to achieve returns with

larger orders, thereby driving down per unit costs.

1Source: Corrupack Website, http://www.corrupack.com

2MSMEs is an abbreviation for Micro, Small & Medium Enterprises.3Source: Central Warehousing Coporation Annual Report, 2013-2014


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Business Foundation: The history of S K Packaging

S. K. Packaging had been setup 25 years ago by Ravindra. He wanted to provide a complete

packaging solution to companies across multiple industries. A majority of the companys

clients were pharmaceutical companies and pesticide manufacturers, while the rest included

fruit & vegetable wholesalers and automobile spare part manufacturers.

The company had product lines that could provide their clients the flexibility to handle

different types of products. Heavier materials were used for automobile gears compared to

the packaging of lighter products such as switches. The company manufactured boxes of type

2 ply, 3 ply, 5 ply, 7ply and 9 ply quality; 2 ply indicated that two sheets of paper were

corrugated to form the packaging material.

The printing on the boxes was mostly simple printing, a form of planographic printing

capable of printing only shades of blue and black on the boxes. Over 90 per cent of the orders

were serviced through simple printing, a facility available in-house. The remainingpercentage was serviced via offset printing, accomplished through outsourcing as the

necessary equipment and labour requirement was not available in-house.

In the last 5 years, Ravindra had shut down two out of his three factories in order to gain

more control over the quality, centralise all the operations at the Vashi unit and to cope with

labour problems. His revenue for the year ending 31stMarch 2012 was INR 55 million4. Over

the years, Ravindra had created a reputation for S K packaging of quality products, timely

delivery and flexible credit periods. He has maintained strong relations with local buyers and

hence was able to consistently generate orders over the years. However, he felt that growth in

his business had stagnated and that he relied to heavily on select clients.

Manufacturing Process: Corrugated boxes

The manufacturing of printed, corrugated boxes involves a number of steps. The steps are

automated but require workers to operate, sort and carry work in progress items from one

workstation to another. The end to end process flow takes 10 to 15 minutes for the

manufacture of one box. The boxes are first put through the forming process [see Exhibit 2]

after which simple printing is done. Alternately, in case offset printing is used, the printing is

first done on the paper after which the box is formed by the above process.

To achieve maximum utilization of labour and other resources, processing is done in large

batch sizes. The bottle neck in the process is the punching machine which requires a die

change in case of a different product line. All product lines follow the same process and

hence their overhead allocation is done on a per unit basis. The difference in the costs of the

products is mainly because of the quality and quantity of raw material used. Raw material

sourcing is done primarily from Vapi, Gujarat on a full truckload basis5. On an average, raw

4Source: Mr. Ravindra Kedar, Promoter, S. K. Packaging5A truckload is approximately 9.5 metric tonnes of paper


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materials are procured twice a week. Wastage constitutes 10% of the raw materials, which is

resold at one-third of its purchase price.

Labour

Three kinds of workers are employed at the factory: skilled, semi-skilled and unskilled. Theworkers are gradually promoted from being an unskilled labourer to a skilled labourer as they

gain experience.

Offset Printing

Offset printing is the most common form of printing for non-packaging printing (books,

newspapers, magazines etc) approximately 40% of all print jobs use it. It uses three

cylinders to transfer the image onto the final layer. Because of the complexity involved in

handling the machine, it requires the employment of skilled labour. Hence, it calls for large

amount of investment in equipment and set up.

For the corrugated boxes, the outer side often requires to be printed for branding and to

specify certain information. Moreover, offset-printed packaging requires the printing to be

done before the forming process.

As of now, S. K. Packaging outsources offset printing while doing simple printing in-house.

Unlike simple printing, offset printing can also be used for colour and fine printing. An

additional benefit of offset printing is that it allows the packaging business to cater to big

industry houses such as the pharmaceutical sector, automobile spare parts and export oriented

businesses. These clients typically require a more detailed description on these boxes forregulatory purposes. Compared to corrugated printing, costing in offset printing is opaque

and it is possible to achieve a higher margin on the sale of offset printed boxes.

The Business Opportunity

The purchase manager of the pharmaceutical company informed Ravindra that he would get

annual orders worth INR 5 million from his company. It was crucial for a pharmaceutical

company to have a trustworthy source to print on the boxes as piracy was a problem.

Ravindra believed that this was just the trigger to enable offset printing in-house. He

projected that in-house offset printing would gain him additional revenues (over and above

the pharmaceuticals contract) of INR 1 million and savings of INR 200,000 per year. The

additional costs would include new equipment worth INR 5 million, a month of working

capital to meet orders on short notice and extra space to store the increased inventory. As the

job required skilled workers, he would have to pay a monthly salary of INR 25,000 to the

operator and a rate of INR 200/day to the helper. The equipment would incur an annual

maintenance cost of INR 50,000 a year. All the other costs will increase proportionately on

the basis of sales.


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Ravindra felt that he faced an excellent opportunity to enter the high margin business with

assured sales of approximately INR 6 million6. With a booming pharmaceutical and pesticide

industry in India, he felt that local players like him would be the key to meet the extra

demand arising out of these industries. However, he was unsure of how to finance the heavy

investment in equipment and working capital requirement. The offset printing business facedrapid changes in terms of technology, hence obsolescence of machinery was a critical issue.

In addition, he needed to be assured of sustaining the number of orders should the

pharmaceutical contract not work out as positively as anticipated, something that would incur

sales expenses and perhaps the hiring of additional sales personnel. This made him slightly

uncomfortable as he was used to complete personal client acquisition thus far. Also, plunging

into an entirely new business line simply on the trigger of an order did not seem the most

strategic option. As he looked out of his window, he began to weigh the two options in front

of him and project the financial outcomes of both in his mind.

6Mr. Ravindra Kedar, Promoter, S. K. Packaging estimated the value at the time.


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Exhibit 1 Growth Drivers In The Packaging Industry

Source: Paper, Film & Foil Converters Organisation, USA

Exhibit 2 Manufacturing Process At S. K. Packaging

Source: Case-writer & Mr. Ravindra Kedar, Promoter, S. K. Packaging

Corrugation Cung Pasng Scoring Slong Sching Punching


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Exhibit 3 A Corrugating Machine At The S. K. Packaging Factory

Source: Case-writer

Exhibit 4 A Stitching Gun At The S. K. Packaging Factory

Source: Case-writer


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Exhibit 5 Balance Sheet As On 31 December, 2012

Assets

Equipment

Corrugation Machine 48,00,000.00

Cutting machine 2,88,000.00

Pasting machine 7,20,000.00

Rotary machine 2,40,000.00

Slotting machine 2,40,000.00

Stitching machine 1,92,000.00

Punching machine 19,20,000.00

Total equipment 84,00,000.00

Land 50,00,000.00

Building 20,00,000.00

Total assets 1,54,00,000.00

Liabilities

Equity 1,19,00,000.00

Long term loan (at interest rate of 10% for 10 years) 35,00,000.00

Total Liabilities 1,54,00,000.00

Machines have a life of 25 years and the current machines were bought 10 years ago.



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Exhibit 6 Income Statement For Year Ending 31 December, 2012

Revenue

Revenue From Finished Goods 5,40,00,000.00

Resale Revenue (10% Wastage, Sold At Rs. 10/Kg) 13,35,600.00

Total Revenue 5,53,35,600.00

Expenses

Raw Material 3,78,00,000.00

Other Raw Materials 27,00,000.00

Transportation Expense 1,44,000.00

Labour Expense 13,50,000.00

General & Administrative Expense 8,40,000.00

Depriciation Of Machinery

8,40,000.00Depriciation Of Building 2,00,000.00

Interest Expenses 3,50,000.00

Selling Expenses 5,40,000.00

Total Expenses 4,47,64,000.00

PBT 1,05,71,600.00

PAT (Tax Rate = 33%) 70,82,972.00


Exhibit 7 Costing Parameters

Monthly Sales 100.00 tonnes

Average Sale Price 45.00 per kg

Average Paper Cost 70% of sale price

Other RM Costs 5% of sale priceTransportation Costs 1,000.00 per truck load

Average Labour Expense 2.5% of sales

General & Administrative Expense

1.5% of sales, additionally 30,000.00 is needed for equipment

maintenance

Depreciation Machinery

Existing machinery has been considered for 25 years, it has been in

use for 10 years

Depreciation Building After 10 years the building needs renovation

Current Interest Rates 10% p.a.

Selling Expense Transportation of finished goods at 1% of sales


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