CASE STUDY: ALPHA MINERAL WATER LIMITED
Introduction
Alpha Mineral Water Limited is one of the many companies producing bagged and bottled mineral water. The company was established in 2010 and has grown rapidly. Mr. Kwasi Kwakye has served as the managing director since the inception of the company. He is an accomplished entrepreneur and has received many awards both at home and abroad.
The Industry
The competition in the bagged and bottled water industry revolves around pricing as each producer attempts to use penetration pricing strategy in order to capture maximum market share. Most of the materials used in the industry are imported.
A decade ago, the industry had few players. Currently, there are numerous companies with low exit rate. The industry for most part of its existence, has remained unregulated and does not require huge initial capital. Since the inception of production of bagged and bottled mineral water, the government has been battling rubber pollution in major urban centres. The drainage systems are often choked with used plastic materials, which are not biodegradable. To address this menace, government is considering a special tax to raise money to clear the waste. Again, a bill is before parliament which when passed into law would require all to use biodegradable materials for packaging their products.
Based on the concern expressed by the government over the years, a new body known as Plastic Waste Regulatory Authority was set up early 2015 to regulate the industry. The regulator is expected to enforce certain minimum standards to sanitise the industry and minimise the effect of its activities on the environment. This measure, according to the experts, will restrict new producers entering the sector.
The bagged and bottled mineral water produced is sold to corporate bodies in the form of water dispensers and bottled water. Also, they supply water to households and retailers through key distributors. The margins of the key distributors are very low and only make reasonable profit on huge volumes. As a result, the key distributors tend to resist any price hikes by the producers. The past experience shows that anytime price increases, demand slows down as alternative sources of drinking water are sought by consumers. Again, some bulk distributors who perceive producers as raking in so much profit have ventured into production of bagged and bottled water in the past. Corporate clients are also cutting their expenditure on water. There are some companies that have commenced importation of bottled mineral water for their own use.
Most of the companies in the industry depend on only two sources of water – Ghana Water Company (GWC) or bore hole. The industry water demand constitute 8% of GWC output. The producers have also not formed any association to deal with issues affecting them collectively. The water supply is increasingly becoming erratic, unreliable and very expensive with the withdrawal of government subsidies, further squeezing the margins of the sector. The working conditions of most of the workers in the sector is nothing to write home about and it has been difficult negotiating for better conditions, since they did not belong to any labour union. However, with the passage of the new labour law, it has become easier for the workers to join existing labour unions. As a result, most of the workers now belong to Industrial Workers Union.
The producers within the sector have a fair share of the market and no single company dominates the market. The market survey conducted indicates that the highest market share of the leading companies is 10%.
Expansion Plans
Alpha Mineral Water Ltd currently has presence only in Accra and its surrounding settlements. The company is proposing to expand its operations to four regional capitals in the country. The details of the proposed investment is presented as follows:
The company has estimated investment outlays of GH¢200,000 fixed capital items. This outlay includes GH¢25,000 to be expended to acquire the land for the factory. The rest of the amount will be incurred on water processing and packaging plant that will be depreciated on straight-line basis over five years with scrap value. At the end of fifth year, the company will sell off the assets for GH¢60,000. Additional initial investment is expected to be made in receivables and inventory of GH¢50,000 and the short-term payables of GH¢20,000 will be generated by the project. No further investment would be made in working capital during the project life and the initial investment would be recouped at the end of the fifth year.
The Board of Directors have tasked the Finance Director to advise the Board on whether to lease or buy the plant using a bank loan.
The company could purchase the plant for cash using a bank loan on which the current rate of interest is 20% before tax. The trade-in value is GH¢20,000. If the plant is purchased, the company can claim tax depreciation allowance of 25%, on a reducing balance basis over the plant’s five year life.
The company could lease the plant under an agreement which would entail payment of GH¢52,000 at the end of each year for the next five years. The tax authorities allow lease payment for tax purposes.
The corporate rate of tax is 25% and tax is payable one year in arrears. The company’s required rate of return is 15%.
Required:
b) Analyse the nature of competition faced by Alpha Mineral Water Ltd. (12 marks)
View Solution
Nature of competition in the industry refers to five forces analysis and in this particular case each of the forces will be examined.
Threat of new entrants
The competition in an industry get intense when the barriers to entry are weak hence many businesses are able to enter the industry. In the case there are number of factors that show that industry is easily entered.
- Capital requirements – given the fact that the industry has grown from one to over two hundred producers and the assertion that the capital requirements are generally low makes the industry highly competitive.
- Product differentiation/standardised product – the case suggest that basis of competition is price which implies that producers in the industry do not differentiate their products or in other words the product of the industry is standardised which will make competition very keen.
- Switching cost – it appears that consumers face very low switching costs since water is not any technical and sophisticated product. Hence consumers can easily switched from one producer to another without any major cost. This makes competition much more severe.
- Knowledge requirements – no special skill or knowledge is required to operate in this industry hence competition will be more intense.
Bargaining power of buyers
The group of buyer can be power or less power depending on a number of factors. In this particular the industry faces two buyer group – thus corporate buyers and bulk distributers. A number of factors in the case make the buyer groups power.
- Low switching costs – it will not cost buyers corporate and bulk distributors buyer groups to switch from one producer to another. This makes buyer group very powerful relative to the industry.
- Buyers face standardised/undifferentiated product – “all water be water”. This simply means that sachet water or bottle water from one producer is not much different from the next producer hence consumers are really indifferent as to which producer produces what. This makes buyer group very power.
- Threat of backward integration – from the case some bulk distributors are actually venturing into production by bypassing already existing producers and this makes the buyer group very powerful.
- Low profit margins – in the case bulk distributors clearly face low profit margins and so are very sensitive to price increases by producers of Pure Water.
Bargaining power of suppliers
The supplier group provide the inputs into the production process of the industry. There supplier group include the labour, providers of water and electricity. These supplier groups will be more powerful and hence intensify competition with the following conditions.
- Few or dominant supplier group – currently apart from the few producers who have their own water supply, most industry players depend on Alpha Mineral Water Ltd Water Company which is the sole supplier aside drilled bore hole. This makes powerful as it can afford to hike prices without much input from the industry.
- Limited alternative sources of supply – Currently bore hole drilling is the only available alternative for the industry. But since majority of the producers depend on TWC it may suggest that there could be challenges with owning one’s bore hole which may include locating favourable site and cost of drilling minimum required number of bore holes to supply sufficient water.
- Suppliers’ product is an important input to buyer’s business – without supply of raw water sachet and bottle water will not be produced. It is an indispensable input into the industry.
- Unionisation of labour – will make wage negotiation tougher and makes the labour supply input powerful.
Rivalry among existing firms
This force deals with how the exist firms in an industry contend for the market share. The case points a number of situation that give rise to intense competition among rivals.
- Declining/negative growth – since the industry is declining it will make the fight for remaining market share much intense.
- Equally balanced competitors – from the case it appears that there no one particular firm that dominates the market and since they all have fair share of the market each firm can respond to any price cut by the competitor.
- Many producers – there are over 200 producers in the industry and this makes them weak especially when they have not form any cartel or association to regulate the price.
- Low switching cost – the industry products have no or very low switching costs. This makes the competition keen since each producer would have to make effort to retain the existing customers so they are not taking over by other competitors.
Threat of substitute products
These talks about alternatives to the industry products. In the case it is clear that there are substitutes from imported sources, TWC and other water bodies.
- Availability of substitutes – there are readily available substitute sources to the industry. Some corporate clients are importing sachet and bottle water, TWC is available as well as other water bodies.
- Low switching cost – There is low switch cost in moving from the industry source to other sources available.