El-Tek Role of Sal Granger, President of Magnetic Advances By Max H. Bazerman & Jeanne M. Brett You are Sal Granger, President of Magnetic Advances, a Division of El-Tek, Inc. El-Tek, Inc. is an international organization engaged in the design, manufacture, sale and servicing of a wide variety of electrical products and components. Today, it is recognized as a leader in the electrical industry with sales over $30 billion. The firm employs over 100,000 people at locations throughout the world. El-Tek is a decentralized, product-centered organization. Divisions are responsible for particular product lines and are operated as profit centers. Division presidents have the responsibility for determining and implementing policies and practices related to the development of new products, discontinuation or expansion of product lines, production facilities, and the costing, pricing and selling of products. Division presidents are rewarded primarily on the basis of the bottom line profitability of their division. Divisions are chartered to sell and license their products to customers outside the company. Divisions that use another division's product as a component in their own products have the authority to either purchase the component from the other El-Tek division or to produce it themselves; buying the product outside of El-Tek is also an option, but only under special circumstances. Divisions selling products within the company are expected to make a "reasonable profit" of 10% on these internal sales. The division charters were intended to preclude competition among the divisions on the sale of general product lines to customers outside the company. They were not designed to diminish competition among the divisions in such areas as product development, production, and sales within the company. In choosing this organizational structure the CEO realized that there would be numerous problems to be resolved among the divisions. However, the CEO also realized that unless division presidents made as many decisions as possible on their own and among themselves, the small top corporate management team would be overwhelmed. In addition, the CEO believed that a decentralized structure would increase the entrepreneurial spirit in the company, and that this benefit outweighed any potential loss of coordination. A further consideration in adopting this structure was the belief that effective managers should be able to deal with the coordination issues that arise in a decentralized structure. For all these reasons the charters give division presidents broad authority to make decisions and to work out problems among themselves. The CEO also made it clear that a pattern of kicking decisions up to corporate would be disadvantageous to managers’ careers. Your division, Magnetic Advances, is primarily in the business of manufacturing and selling magnets and magnetic materials. It is the only El-Tek division with the charter to sell or license magnets externally. About 75% of its net sales of $1.6 billion are to customers outside the company. Bottom line profit is approximately $240 million. Of the $400 million in internal sales, $7 million is sold to Audio Components. Variable costs on the magnets that you manufacture are 60% of sales. Fixed costs on making magnets are typically 25% of sales. These costs are best estimates for the newest magnetic material that Audio Components engineers have just finished developing. The history of the new magnetic material is as follows. Three years ago, El-Tek's Advanced Development Laboratory (ADL, the basic research laboratory of El-Tek) developed a theoretical concept for a new magnetic material that would have properties that might permit the manufacture of highpowered, small, inexpensive magnets. In conformity with company policy, ADL approached your division © 1996-2014 Dispute Resolution Research Center (DRRC), Kellogg School of Management, Northwestern University. All rights reserved. Revised 2002. DRRC/KTAG teaching materials are protected by copyright law. DRRC requires a per person royalty for use of its exercises. Each purchase of an exercise authorizes copying or electronic distribution of that exercise equal to the quantity purchased. Access DRRC/KTAG materials at www.negotiationexercises.com Contact DRRC at drrc@kellogg.northwestern.edu as the logical group to do the developmental research on the new concept. Engineers in your division were dubious that ADL’s concept could be developed, let alone produced commercially, and passed on the opportunity to develop the new magnetic material. ADL then offered the concept to another El-Tek division, Audio Components. department's decision three years ago not to develop Z-25. If top management gets involved now in the decision about marketing Z-25 commercially, the folly of your previous decision will become salient again. You suspect that Audio Components does not want to transfer the Z-25 technology to Magnetic Advances for a number of reasons. First, if Magnetic Advances is selling Z-25 on the open market, Audio Components' direct competitors could buy it and Audio Components would lose the competitive advantage that Z-25 would contribute to its array of products. Second, Audio Components probably intends to recoup its development costs of about $12 million (in today's dollars) plus obtain a reasonable profit by producing Z-25 for sale to other divisions in El-Tek. Audio Components manufactures and sells a wide variety of miniaturized products and components related to sound amplification, such as: hearing aids, microphones and special-purpose amplifiers. Net sales are slightly under $2 billion. Magnets are an important component in three-quarters of the 200 different products manufactured by Audio Components. About half of these magnets are purchased from your division and the rest are manufactured in Audio Components' own foundry. Audio Components also sells about $10 million in specialty magnets and magnetic components to other divisions within the company. The reason that Audio Components makes some of its own magnets is that Audio Components often needs small lots of production that Magnetic Advances is not interested in producing and has no other customers for. Audio Components’ variable costs on manufacturing magnets are 65% of sales. Fixed costs of making magnets have been 25% of sales. To prepare for your meeting with Audio Components, you had your division's best financial analysts estimate the net profit to Magnetic Advances for producing and selling Z-25. The attached chart shows the future profitability to Magnetic Advances for various agreements that you might be able to reach with Audio Components. The numbers in the chart estimate the two-year lifetime expected incremental value in today’s dollars to Magnetics as a result of manufacturing and selling Z-25. You are very confident of the accuracy of these estimates. Audio Components invested three years and $12 million (in today’s dollars) before the new magnetic concept, called Z-25, became a commercial reality. At the reception following the public announcement of Z-25, you went up to Chris Carlson, President of Audio Components, to offer congratulations on Audio Components' outstanding success in developing Z-25. You went on to say that Magnetic Advances was ready to exploit all of the commercial possibilities of the new product and begin manufacturing Z-25. You then made an appointment to get together with your team and Carlson’s team to discuss the transfer of the Z-25 technology. The outcomes include a dollar figure for Magnetic Advances’ profit depending on different competitive advantage scenarios and the transfer price (TP) that Magnetic Advances anticipates paying Audio Components for the technology. The competitive scenarios prohibit Magnetic Advances from selling the product to Audio Components’ direct competitors, and/or to the competitors of other ElTek divisions. The reason to consider the prohibition periods is that Audio Components may require some protection in order to prevent their direct competitors from gaining access to these magnets. In addition, a transfer payment to Audio Components may be necessary to get them to release the product to you. You are sure that Z-25 has enormous commercial possibilities. You expect that the product will have a lifetime of two years. Since Magnetics has the exclusive charter to sell magnets externally, only Magnetics can exploit the commercial opportunities associated with Z-25. However, Audio Components owns the rights to Z-25. You can only obtain these rights by reaching a mutually acceptable agreement with Audio Components or by a top management decision. You really do not want to see the decision concerning the future marketing of Z-25 made by top management. You are somewhat embarrassed by your The outcomes include a dollar figure for the net profit that you would earn from selling Z-25 and TP, a variable figure representing the money that you would have to pay Audio to release the technology to you. TP is equal to an amount that is negotiated between the two divisions to compensate Audio Components for the transfer of the magnet technology to Magnetic Advances. 2 El-Tek/President of Magnetic Advances Look at Outcome # 2. In this scenario you would get $140 million of bottom line profitability over the twoyear life of the product in today's dollars. This consists of $120 million in profits from external sales plus $20 million in profits from internal sales to other divisions of El-Tek, including Audio. Since you know that your division makes 15% profit on external sales, this means that your external sales volume is $800 million. Since you are only allowed a 10% profit on internal sales, you can figure that your internal sales will be $200 million. Audio may want you to supply Z-25 either at cost or for free. For every one hundred dollars of Z-25 you supply for free you can subtract one hundred dollars from your profits (i.e., you would be spending $90 on materials, and have to forgo $10 of profits). The Audio division meanwhile will be able to pocket these savings. Any cash transfer payment you make to Audio will erode your profitability, as will any market restrictions that you accept, for example, if you agree to restrict external sales either to Audio’s direct competitors and/or competitors of other El-Tek divisions. Your analysts have quantified this for you in the table. For example, the $140 million in Outcome 2 includes $20 million of internal profit and $120 million of external profit, while the $47 million in Outcome 10 includes $20 million of internal profit and $27 million of external profit, which has been severely eroded by restrictions. If you decide on an agreement that is between two options on the chart, you should interpolate linearly what your division’s profits would be. 3 El-Tek/President of Magnetic Advances Granger and the Magnetic Advances Negotiating Team Lifetime Profit -Net Profit to M.A. Lifetime Profit-Outcome 1) Audio produces Z-25 and the product is sold only internally $0 2) Magnetics produces Z-25 and no limitations are put on its distribution $140M – TP 3) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 6 months $130M – TP 4) Magnetics produces Z-25 and is prohibited from selling to competitors of any El-Tek divisions for 6 months (Audio’s direct competitors and competitors of other el-Tek divisions) $100M – TP 5) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 12 months $120M – TP 6) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 12 months and from selling to competitors of El-Tek divisions other than Audio for 6 months $90M – TP 7) Magnetics produces Z-25 and is prohibited from selling to competitors of any El-Tek divisions for 12 months (Audio’s direct competitors and competitors of other El-Tek divisions) $60M – TP 8) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 20 months $107M – TP 9) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 20 months and from selling to competitors of El-Tek divisions other than Audio for 6 months $77M – TP 10) Magnetics produces Z-25 and is prohibited from selling to Audio’s direct competitors for 20 months and from selling to competitors of El-Tek divisions other than Audio for 12 months $47M – TP 11) Magnetics produces Z-25 and is prohibited from selling to competitors of any El-Tek divisions for 20 months (Audio’s direct competitors and competitors of other divisions) $20M – TP M = Million 4 El-Tek/President of Magnetic Advances Rubric for Planning Document Criteria Ratings Pts Identify all the negotiation issues 2.0 pts Identify all the relevant issues 1.0 pts Identify key issues buy overlook some potential issues 0.0 pts No Marks 2.0 pts Understand the position and interest on each issue 2.0 pts Have clear understanding of your position and interest 1.0 pts Understand some of your position and interest 0.0 pts No Marks 2.0 pts Identify your BATNA 2.0 pts Correctly identify your BATNA 0.0 pts Fail to identify your BATNA 2.0 pts Identify your reservation point and target price 2.0 pts 1.0 pts Good understanding of your Good understanding but the reservation point and target price calculation is not quite right 0.0 pts No Marks 2.0 pts Understand your strength and weakness in the negotiation 1.0 pts Show good understanding of your own strength and weakness 0.0 pts No Marks 1.0 pts Plan your negotiation strategy 1.0 pts Full Marks 0.0 pts No Marks 1.0 pts Total Points: 10.0
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