Oliver Wyman case: On the Right Track

Information that can be shared if inquired by the interviewee:

• The contract would cover 30 regional trains of a new generation that are planned to gradually replace the currently operated type over a period of 6 years (5 trains delivered per year)
• TrainCo’s bid for the contract would be for a sales price of CHF M 23.1 per train
• The management does not expect further business in Switzerland in the medium term as the current call for bids is the last in the customer’s rolling stock renewal program and there are no other big customers in the country
• TrainCo already has a production facility in Switzerland which the management would like to use for production and commissioning if they won the contract – they recently completed delivery of a new tram generation to three Swiss cities and the facility has been out of operation since. The real estate lease is expiring soon and a plan for dismantling the facility has been made
• Given pressure by shareholders to increase profitability, the management will only take on projects with a profit margin of at least 10%

At this point the interviewee should understand the situation and structure the problem solving strategy.

Assumptions

• Exchange rate of 1.1 CHF/€ – calculations should be made in €
• The main variable cost factors are materials and labor. All other variable costs can be neglected
• The engineering department has already made high-level assumptions on material costs per car as well the as the required manufacturing time for assembly:

• The client’s average labor cost for manufacturing workers is CHF 88 per hour
• The current real estate lease for the Switzerland facility could be extended for the next 6 years – however, the production setup would need to be adjusted to accommodate the new train type
  • Required initial investment for re-tooling is €M 16.0
  • Lease and other recurring cost are 20% of the initial investment per year
  • The current dismantling plan shows costs of €M 2.0 for disassembly of the facility (assume to be stable even if lease is extended by 6 years)
• No other fixed costs need to be considered

Analysis & calculations

Conclusion

The project does not fulfill the minimum margin requirement of 10% given the current assumptions. How can profitability be improved?

Assumptions

• Material costs (steel, electric components, etc.) largely depend on world market prices and the company has already run a global sourcing optimization program (= no further savings potential)
• The company has two other production facilities in Italy and Slovakia in which they currently work on existing projects (see Table 2)

• The Italian and Slovakian facilities have produced a similar train type in the past and would not require re-tooling investments or other additional cost
• The finished trains can traverse the European rail networks (assuming no cost)
• To ensure constant product quality and full realization of learning effects, the management does not want to split production between multiple sites
• Also, capacity extension of an existing or setup of an entirely new facility are not an option for TrainCo given the high investment needs and uncertainty in long-term business development

Analysis & calculations

• Annual production output is 30 cars (30 trains * 6 cars/train spread over 6 years)
• The Italian facility is able to accommodate the new project while the Slovakian facility does not have sufficient free capacity
• Labor cost in Italy is 50% of Switzerland: €M 58.6
• Fixed cost is 0
• New total profit is €M 115.4, new total profit margin is 18%

Conclusion

With production in Italy and transfer to Switzerland afterwards, the project meets the requirements on profitability

Assumptions

• In the discussion of your findings with the client’s management, the Head of Sales notes that the state-owned Swiss rail operator will require a share of local value creation (= share of work to be done in Switzerland) of at least 20% in the contract
• The following diagram shows the value creation steps for rolling stock production and the approximate share of manufacturing time (simplified)

• Explanation of value creation steps:
  • 1 Module production: Part production for each car (underframe, side walls, roof)
  • 2 Car body construction: Welding together the modules
  • 3 Undercarriage production: Wheel set incl. frame and drive
  • 4 Final assembly: Completion of operable car; connecting car body and undercarriage, installation of electrics, exterior lighting, etc.
  • 5 Interior fitting: Design of passenger cabin, e.g. seats, carpets, interior lighting
• Re-tooling the existing Switzerland facility for individual value creation steps requires varying investment costs:

• Transportation costs from components or complete trains between Italy and Switzerland can be neglected
• Assume the full lease and other recurring as well as dismantling cost for the Switzerland facility will accrue even if it is only partially used

Analysis & calculations

• Allocating interior fitting in Switzerland does not require any investment but implies higher labor cost of €M 14.6 (= 25% * €M 58.6) versus module production

The percentages shown in Diagram 1 refer to the labor share in hours (NOT the total cost share). In addition one can discuss whether it is reasonable to assume that total labor required is equal across all production sites. Sites may have a higher degree of automation and thus require less labor.

• All other value creation steps require a higher share of expensive labor cost in Switzerland and/or additional re-tooling investments
• Accordingly, it is advisable to allocate all value creation steps up to final assembly in Italy and then trail the cars to Switzerland for interior fitting
• Total manufacturing cost in this scenario is €M 73.2 (25% * €M 117.1 + 75% * €M 58.6)
• Fixed cost is €M 21.2 (lease + dismantling)
• New total profit is €M 79.6, new total profit margin is 13%

Conclusion

With production and final assembly in Italy and interior fitting in Switzerland, the project meets the customer’s specification on local value creation and the company’s minimum margin requirement

The interviewee should draw a conclusion from the analysis.

TrainCo should make a bid for the contract given its profitability under the following setup:

• Assemble trains in the Italian facility and
• move them to Switzerland for interior fitting