LAER PRODUCTS

In 1991 as Jacques Boudreau was driving home for Christmas break from university he wondered whether he should join his father's firm, Laer Products of Arichat, Nova Scotia, after graduation in May. He had told his father he would decide within the next two weeks.

Jacques had been balancing an active role in the development of Laer while completing his Bachelor of Commerce degree with majors in marketing and management at Saint Mary's University in Halifax. He had found it exciting to be involved with the Federal Business Development Bank (FBDB) and the Atlantic Canada Opportunities Agency (ACOA) in developing a financial proposal for Laer. He had also enjoyed marketing Laer's pet food supplements at trade shows, making deliveries and selling their products at various sales outlets. He was convinced there was a large market waiting for Laer and that they had a superior product. He was not sure, however, about committing his future to Laer in its rural setting. He thought he might be better off starting his first full time job with a large national or international firm with a developed training program.

Jacques had already run small ventures successfully. He had operated a student painting franchise the previous summer in Halifax and had achieved the highest above-target figures in the organisation. He had also operated his own landscaping and painting firm in Arichat for eight summers.

The questions that kept surfacing for Jacques were: "Is Laer a viable operation? How can I assess its potential and its long-term viability?" He knew there was a possibility that the financing would not come through for the proposed marketing manager position but both he and his father were assured that this was very unlikely.


This case was prepared by Patricia A. Fitzgerald of Saint Mary's University and Nicola M. Young of Mount Saint Vincent University for the Atlantic Entrepreneurial Institute as a basis for classroom discussion, and is not meant to illustrate either effective or ineffective management.

Copyright 1992, the Atlantic Entrepreneurial Institute. Reproduction of this case is allowed without permission for educational purposes, but all such reproduction must acknowledge the copyright. This permission does not include publication.


Background

In 1982, Andre and Sylvia Boudreau of Arichat, a small rural community in Cape Breton, Nova Scotia, were advised to try fish oil as a treatment for their horse which had developed a skin disorder. The halibut oil capsules purchased from the local drug store were very expensive. This prompted the Boudreaus to find an alternate source. They did not have far to go as the shores of Cape Breton and the rest of Nova Scotia are dotted with fish plants, so the oil by-product was cheaply and abundantly available.

The results of administering the oil supplement to the horse were so impressive that Andre began to investigate the idea of producing and selling a fish oil based supplement to the pet food market.

Andre approached the Cape Breton Development Corporation (Devco) for help in assessing market demand for such a product. This organisation, later renamed Enterprise Cape Breton, was a Canadian federal government agency whose responsibilities included industrial development in Cape Breton, an area with a history of high unemployment. One of Devco's mandates was to assist ventures capable of creating employment, particularly those using the natural resource base of Cape Breton Island. To this end, it commissioned a study by the Nova Scotia Research Foundation to assess the potential for the Boudreau's product in Nova Scotia. The final report indicated that the product would be commercially viable if the problems of odour and limited shelf life could be overcome. The Research Foundation's study was the first of many contributions by government sponsored research facilities financed by federal, provincial and local government agencies.

The Canadian Institute of Fisheries Technology (CIFT) at the Technical University of Nova Scotia in Halifax, through the research interests and expertise of Dr Robert G Ackman, researched a distillation process to deodorise the fish oil and remove a number of trace elements. In April 1987, Andre Boudreau's company, then named VitaShine Limited, installed a full scale production facility in nearby Louisdale using this process and began to market the fish oil pet food supplement under the trade name of "VitaShine". The company's association with Dr Ackman and CIFT continued, with the Institute continuing to research and find solutions to problems encountered in processing and bottling the fish oil product.

Between 1987 and 1991, the company had limited success. While VitaShine and a second similar product, Bio-Glow, were well received, marketing efforts did not really get off the ground. In April of 1990, in an attempt at wider distribution and access to the larger Canadian market, VitaShine Limited appointed a Quebec pet-care products company as its exclusive Canadian distributor. This relationship was ended a year later as the company failed to promote and sell VitaShine's products as it promised.

Although the financial position at March 3l, 1991 was precarious, with the current year loss of $44,000 pushing the deficit to $155,000, 1991 brought a number of opportunities and the Boudreaus were optimistic that business might improve. Research indicated significant market potential for pet food supplements using fish oil products: a large private-label sale was negotiated with a major United States pet food company to provide the fish oil product in an encapsulated form; studies indicated a strong potential in the much larger North American market for VitaShine and Bio-Glow; Jacques Boudreau, Andre and Sylvia's son, was becoming more involved in the company; and it appeared that the Atlantic Canada Opportunities Agency (ACOA) and the Federal Business Development Bank (FBDB) might be interested in financing a major marketing effort.

In August of 1991, in anticipation of larger markets and potential new products, the company changed its name to Laer Products Incorporated.

The People

The Boudreaus were a close knit Cape Breton family of Acadian descent who disliked being indebted to anything but the land and the sea.

Andre Boudreau, the president and general manager of Laer Products Incorporated, had been employed since 1961 with a major forestry company, and, in 1991, was the manager of its newsprint division. Over the years, Andre had acquired various properties in Cape Breton, many of them with ocean frontage, some of which he had sold as the need arose. He was the sole shareholder of Laer and had invested a significant portion of his savings in the company in order to finance accumulated losses.

Sylvia Boudreau, Andre's wife, had worked as a registered nurse until they had their family. Sylvia was now the company secretary and managed Laer Products on a full time basis. Neither she nor her husband took a salary from the company, although the company did cover the cost of their automobile.

Jacques Boudreau was Andre and Sylvia's 22-year-old son who was in his final year of studies in the business school at Saint Mary's University where he was majoring in marketing and management. He had become increasingly involved in Laer in the marketing area, and was the primary candidate for the position of marketing manager, should ACOA and FBDB approve Laer's application for funding of an ambitious marketing plan. To date, Jacques had not drawn a salary from the company.

Pat Jobe, Laer's only full time paid employee, was the product development and production manager. Pat graduated from the University College of Cape Breton in 1989 with a diploma in Chemical Engineering Technology, and was responsible for the company's production process and for product research and development. Twenty-five percent of Pat's $20,400 salary was covered by a National Research Council of Canada grant for work he was doing on another project. Production help was provided by five to six workers who were hired part-time as needed, primarily for the packaging operation.

Dr Ackman, while not an employee of the company, had been instrumental in developing the product and the distillation process, and continued to advise the company on technical matters. He was a widely published and recognised authority on fish oils who worked with the Canadian Institute of Fisheries Technology at the Technical University of Nova Scotia in Halifax. Dr Ackman's research relating to Laer's product and process had received funding from a number of government agencies such as the Industrial Research Assistance Program, the National Research Council of Canada, and the Nova Scotia Department of Industry, Trade, and Technology.

Current Product

Laer produced pet food supplements for cats, dogs and horses under two brand name products, VitaShine and Bio-Glow, and had agreed to produce a private brand for a large American firm. Each product was essentially the same but had a different distribution channel; VitaShine, the original product, was distributed through veterinarians while Bio-Glow was sold in pet stores. When veterinarians indicated they did not want the same product sold in pet stores, Bio-Glow was introduced. VitaShine was somewhat different from Bio-Glow because it has menhaden oil and additional vitamins. It often sold at a higher price to the ultimate customer as it was accompanied by a veterinarian's expert advice. Laer entered the private label market in late 1991 after being approached by an American company who negotiated a product formula.

All Laer products were produced from fish oil and contained vitamins A, D and E. The major difference between Laer's products and other pet food supplements was the presence of a higher concentration of Omega-3 polyunsaturated fatty acids (EPA and DHA) because of its fishoil base. Competitive products used wheat germ or vegetable oils as a base and these oils contained Omega-6 fatty acids but little Omega-3. Scientific studies confirmed that Omega-3 fatty acids produced healthier skins and coats in animals. Evidence of reduced cholesterol, arteriosclerosis, and cancer in animals given Omega-3 fatty acids as part of their regular diet had also been found.

Laer produced its product in liquid form. The private-label customer preferred his product in an encapsulated form for ease of administration and ensuring the proper dosage was received. Laer agreed to this innovation and subcontracted the encapsulation process to a pharmaceutical firm in Ontario.

VitaShine and Bio-Glow were sold in three sizes: 225 ml, 450 ml and 4 litre containers. The two products were differentiated in packaging, promotion and channel distribution. There was also different packaging of the products for cats, dogs and horses but the major difference in use was in dosage, with the larger animals having larger daily requirements. Packaging complied with government regulations as stipulated by the Department of Consumer and Corporate Affairs in Canada and by the US Government.

Laer was proud that its products, which produced almost immediate improvement in the health and comfort of animals, had been well received by pet owners, veterinarians, researchers in fish oil and by distributors. The production process removed environmental contaminants and fish odour from the fishoil, and produced a product with a long shelf life.

Laer had begun to develop other fish oil based products, but was constrained by the limited resources available for research and development. The Boudreaus saw possibilities in new hoof-treatment creams for horses, and in skin-care products and food supplements for humans. The company had hesitated in entering the latter markets because of the long time frame involved in securing the governmental approvals required to offer these products for humans.

Industry/Competition

In 1988, Advertising Age estimated that the pet food industry in North America had reached US $6.3 billion and that it was expected to continue to experience fast growth. Pet food supplements were estimated to make up three percent of this market or US $189 million. The 1991 comparable figures were US $7.9 billion and US $237 million respectively. The super premium, or high end, segment of the pet food market was expected to experience the fastest growth. Literature in this area speculated that the health craze experienced by humans would be transmitted to their pets as they were considered an integral part of the family, and that pet owners who felt guilty about leaving their pets alone during the day would buy them special treats.

Laer had many competitors, including large well-financed international firms, with products which claimed to cure skin and coat problems. Exhibit 1 outlines Laer's major competition.

Exhibit 1

LAER PRODUCTS INC.

MAJOR COMPETITORS IN HEALTH PRODUCT SUB MARKET

Products

Manufacturer

Linatone
Miracoat
Dermcaps
Dog Shedless
Efa-z-Plus
Dia-Glow
Effavet
Dermacare
Nutri-Sol

Lambert-Kay
Borden Chemical
DVM
Four Paws
Allerderm Inc.
Sintex
Vet-Kem
Rolf C. Hagen Corp.
Beecham Laboratories

 

VitaShine and Bio-Glow faced direct competition from multi-vitamins and vegetable oil products. A real threat came from super premium pet foods as many pet owners believed that this expensive product would meet all the dietary needs of their pets. It would be necessary to educate pet owners about the need for Omega-3 in a complete diet. Laer had a head start in pet food supplements containing Omega-3 fatty acids as it was the first company to offer Omega-3 in a natural product. Laer's products also contained the vitamins and Omega-6 fatty acids offered by other products and were priced competitively at or below the market prices of products without Omega-3 fatty acids. Most of the competitors in this market, however, had much greater financial resources than Laer, and could, if necessary, refine their products to include the Omega-3 fatty acids.

Manufacturing

The process:

Laer processed products through distillation. While the application of this process was unique in Canada, it was based on commonly used technology and therefore was not patentable.

Unrefined fish oil was transported in Laer's tanker truck from the supplier's fish plant to Laer's facility in a Louisdale industrial park, where it was held in stainless steel tanks until it was distilled. The fish oil was refined by distilling it in two stages through a six inch (15.24 centimeter) diameter still which was the largest of its kind in Canada and custom designed for Laer by Pope Scientific Inc of Wisconsin.

The first stage removed volatile gases and preheated the oil. Stage two pulled the higher volatile components (such as aldehydes, free fatty acids, vitamins, cholesterol and PCBs) from the oil, leaving a purified oil product which was virtually odour free.

The purified oil was collected in an intermediate tank and then transferred to a cooling tank, where the saturates were solidified and left behind when the oil was removed. Vitamins, pulled from the oil in the second distillation phase, were added back in amounts specified by the Canadian Veterinarian Medical Association. The final step involved bubbling nitrogen through the liquid to form a blanket over the oil, preventing it from oxidising with the air.

When the oil cooled, it was packaged in an automatic process which filled, capped and labelled the bottles. The production manager oversaw the entire process so that any quality control problems that arose could be corrected before shipment. Laer's products used all natural ingredients and their product claims were approved by Health and Welfare Canada.

In 1991, a contract was signed for encapsulated product with a major US veterinary pharmaceutical company based in United States. As the Louisdale production facility did not have an encapsulation capability, Laer subcontracted this part of the process to a company in Windsor, Ontario. Jacques wondered about the feasibility of expanding into encapsulation, both for the production of the private-label supplements and for their own VitaShine and Bio-Glow products. He estimated that the supplier's price for the necessary equipment, which could be easily added to their present production process, would be about $115,000.

Materials and supplies:

The completed product had two major direct materials, fish oil and vitamins. The basic oil came from menhaden and redfish and was purchased by Laer from fish plants in Nova Scotia and New Brunswick. The supply was abundant and inexpensive as these species were underused and the oil was a by-product of the fish plants. The vitamins were purchased from a Canadian pharmaceutical company.

The other major cost in production was for packaging materials: bottles, labels, caps, individual boxes and shipping cartons. Minor supplies needed in the processing included nitrogen gas and fuel.

Exhibit 2 sets out the estimated standard cost of a case of non-encapsulated product under efficient operating conditions.

Exhibit 2

LAER PRODUCTS INC.

STANDARD COST OF NON-ENCAPSULATED PRODUCT

Raw materials
Labour
Packaging

Bottles
Labels
Caps
Cartons
Case

Fuel


$ 4.89
.88
.88
3.42
.39

 

$1.06
5.18




10.46
.29
$16.99

 

Labour:

The production process was automated and could be handled by the production manager alone. When a production run was scheduled, five or six part time employees were hired to help with the packaging.

Plant capacity and utilisation:

The still had a flow capacity of 30 litres or 27.3 kilograms per hour, and output could be doubled by adding a second shift. Assuming an operating year equivalent to 48 weeks with the plant working five days per week, the annual production capacity for one eight hour shift per day of production was 57,600 litres or 52,416 kilograms. Two eight-hour shifts each day would double the annual capacity to 115,200 litres or 104,832 kilograms.

Marketing

While basic decisions about product lines and distribution channels had already been made, marketing was an area that needed management's attention.

Prior to production, Andre Boudreau had commissioned the Nova Scotia Research Foundation to assess the market potential for his pet food supplements in Nova Scotia. As they concluded that the Nova Scotia market alone might not be able to support the product, the Boudreaus have considered all of Canada and the United States as Laer's geographic market.

In 1990, Laer signed an exclusive distributorship agreement with a company which did not fulfil its minimum purchase commitments under the contract. In April of 1991 Laer terminated its agreement with this distributor and, as a result, the Boudreaus decided they would sign no further exclusive distributorship deals. They did, however, develop dealerships in both New England and Ontario and have been contacted by other parties who became interested either because of their success with Laer's products or from meeting the Boudreaus at trade shows. Laer had been effectively practising a geographic rollout of their products from east to west in both Canada and the United States. In 1991, the company projected its estimated market potential in the US $237 million market segment to be the following:

 

Exhibit 3

LAER PRODUCTS INC.

ESTIMATED TOTAL MARKET POTENTIAL (Cdn $)

 

Pet Supply

and Food

Retailers

Veteri-

narians

Total

Number of retailers and

vets:

Atlantic Provinces

Ontario

Quebec

New England

Total

 

 

43

443

211

450

1,147

 

 

124

783

406

800

2,113

 

 

167

1,226

617

1,250

3,260

Estimated average annual revenue per supplier--

10 cases each

$600

$600

$600

Laer's estimated annual

sales

$688,200

$1,267,800

$1,956,000

 

These figures represented sales for VitaShine and Bio-Glow alone with no allowance for private brand sales. Each case would be composed of either 24 bottles of 225 ml each, 12 bottles of 450 ml each, or 4 containers of 4 litres each, with the dealer price being $62.40 Cdn, $48 Cdn, and $64 Cdn respectively.

Much of Laer's success to date had been due to word-of-mouth promotion. People who had tried the supplements for their pets had been pleased with the results and had mentioned their animals' improved health to others. Promotions had been developed in the form of pamphlets and brochures and these had been distributed to veterinarians and pet supply stores and had been used for handouts at trade shows. The Boudreaus had decided to begin advertising in trade journals in order to target their potential customers more effectively. VitaShine and Bio-Glow had distinctive logos that tested well in informal reviews. The eye-catching designs stood out well on shelves of pet shops and veterinarians (See Appendix 1)

Pricing:

Laer had not changed its prices (see Exhibit 4) in eight years of operation.

Exhibit 4

LAER PRODUCTS INC.

Pricing Structure of VitaShine, Bio-Glow

 

 

 

225 ml

450 ml

4 lt.

Number of Containers Per

Case

24

12

4

Wholesale

 

 

$4

$8

$16

Retail

 

 

$8-$14

$16-$32

$32-$65

 

Laer's suggested retail price for the 225 ml container was $7.99 Cdn in Canada and $7.99 US in the United States. The US distributor suggested to retailers that they charge $9.99 US. The cost of the 225 ml product to distributors was $2.60 Cdn in Canada and $2.60 US in the United States. In both instances Laer paid the freight. It was obvious that many retailers were selling the product above suggested retail prices.

Current Financial Situation

The comparative financial statements of the company for the year ended March 31, 1991 are attached as Appendix 2. Interim financial statements had not been prepared since then, but an update on some of the balance sheet items as of September 30, 1991 follows:

Accounts receivable: The balance was approximately $30,000 and the collectibility of $9,650 owed by the former distributor was doubtful.

Inventory: The cost of inventories of finished product, packaging material, fish oil, and vitamins was $41,240.

Fixed assets: There were no material additions to or disposals of fixed assets since year end.

Current liabilities: The total of accounts payable, mostly trade payables for the purchase of supplies and materials, was $22,900. All except $4,660 was current. The operating bank loan stood at $15,000, and the current portion of long-term debt amounted to approximately $24,000.

Long-term debt: After March 31, 1991, the company borrowed $54,362 from InRich BDC Ltd. using $41,000 to pay out its existing loan with InRich. Long-term debt at September 30, 1991 is outlined in Exhibit 5.

Exhibit 5

LAER PRODUCTS INC.

LONG-TERM DEBT, SEPTEMBER 30, 1991

 

 

 

Enterprise Cape Breton

InRich BDC Ltd.

Royal Bank

Royal Bank

------------------------------

TOTAL

Principal Outstanding

 

$ 36,619

54,362

21,118

8,000

------------------------------

$ 120,099

 

The InRich loan was taken out in May, 1991 for a 27 month term, maturing in July, 1993. This loan bore interest at prime plus 4%; repayment terms specified that interest only was payable for the first three months, then 23 months at $1,300 blended principal and interest, with the remaining principal balance due in the last month. At September 30, this loan was 5 months in arrears, and the Enterprise Cape Breton loan was in arrears to the extent of $10,466.

Advances from shareholders: Andre Boudreau made additional advances of about $10,000 since March 31, bringing the total to $152,000.

The proposal

In December, 1991, with product and production technology problems behind them, and with assistance from the Federal Business Development Bank (FBDB), the company approached the Atlantic Canada Opportunities Agency (ACOA) for financing under its Marketing Development Program. The application to ACOA was based on the fact that Laer's future depended on comprehensive marketing efforts, and that it lacked the financial resources to support such a marketing program. The proposal was designed to provide the company with financing for a three year marketing program as summarised in Appendix 3.

Earnings forecast

With help from Coopers and Lybrand and support from the FBDB, Andre Boudreau prepared projected income statements to support the ACOA proposal assuming approval of the marketing program financing. These projections and the assumptions underlying them are provided in Appendix 4.

Cash flow projections

Included with the proposal to ACOA were cash flow forecasts which are summarised in Appendix 5. In order to highlight the cash generated from operations, no provision had been made in these projections for debt servicing, that is, for payment of interest and repayment of principal on the company's long-term debt.

The cash required to service the company's long-term debt is outlined in Exhibit 6.

Exhibit 6

LAER PRODUCTS INC.

CASH REQUIRED TO SERVICE LONG TERM DEBT

March 31/92 March 31/93 March 31/94

Royal Bank $45,000

Royal Bank $10,000

ECB $61,000

InRich $54,362

Proposed term loan

$ 9,721

3,008

10,466

12,166

1,822

________

$ 37,183

$ 9,721

3,008

10,466

15,599

5,466

________

$ 44,260

$ 9,721

3,008

10,466

39,279

5,466

_________

$ 67,939

 

Jacque's Decision

Jacques was nearing home. He felt the drive had been useful for him to mull over the factors which would play a part in his decision about whether to join Laer in a full time capacity in May. He was ready to sit down and do some numerical and personal analyses. He expected to be able to give his father a decision within the next two weeks.

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APPENDIX 3

Laer Products Inc.
Program Cost and Financing Summary

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Source: FBDB, Business Financing Plan, Laer Products Inc, December, 1991

APPENDIX 4

Laer Products Incorporated
Projected Income Statements

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Tax losses from previous years would be available to offset profits generated over the next three years.

Source: Summarised by authors from FBDB, Business Financing Plan, Laer Products Inc, December, 1991

APPENDIX 5

Laer Products Incorporated
Cash Flow Projections
(excluding cash required for debt servicing)

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Source: Summarised by authors from FBDB, Business Financing Plan, Laer Products Inc, December, 1991