Chapter 17: Questions & Answers
1 The nature of strategic business analysis
Question 1 David Gould
David Gould set up his accounting firm, providing accountingservices to small businesses, in 20X6. Within three years his fee incomewas in excess of Â£100K a year and he had nearly 100 clients most ofwhom had been gained through word of mouth. David recognised that thesesmall or micro businesses, typically employing ten or fewer people, werereceiving less than satisfactory service from their currentaccountants. These accounting firms typically had between five and tenpartners and operated regionally and not nationally. Evidence of poorservice included limited access to their particular accountant, poorresponse time to clients' enquiries and failure to identifyopportunities to save clients money. In addition bad advice, lack ofinterest in business development opportunities for the client and poorinternal communication between the partners and their staff contributedto client dissatisfaction. David has deliberately kept the costs of thebusiness down by employing three part-time accountants and relying onhis wife to run the office.
David had recently met Ian King who ran a similar sized accountingfirm. The personal chemistry between the two and complementary skillsled to a partnership being proposed. Gould and King Associates, subjectto securing the necessary funding, is to be launched in September 20Y0.David is to focus on the business development side of the partnershipand Ian on the core services provided. Indicative of their creativethinking is David's conviction that accounting services are promotedvery inadequately with little attempt to communicate with clients usingthe Internet.
He is also convinced that there are real opportunities for thepartnership to move into new areas such as providing accountancyservices for property developers, both at home and abroad. Ian feelsthat the partnership should set up its own subsidiary in India, enjoyingthe benefits of much cheaper accountancy staff and avoiding the costsand complications of outsourcing their core accounting services. Iansees fee income growing to Â£2 million in five years' time.
David has been asked by his bank to provide it with a business plan setting out how the partnership intends to grow and develop.
(a)Write a short report for Davidgiving the key features that you consider to be important and that youwould expect to see in the business plan for the Gould and Kingpartnership that David has to present to his bank.
There is considerable evidence that small firms are reluctant to carry out strategic planning in their businesses.
(b)What are the advantages and disadvantages for Gould and King Associates in creating and implementing a strategic plan?
(Total: 25 marks)
2 The environment and competitive forces
Question 2 Dunvegan Ltd
Dunvegan Ltd is a forestry company operating in the UK, mainly inScotland. In addition to forests at various stages of maturity, thecompany also owns many hectares of undeveloped land.
So far Dunvegan Ltd's timber has consisted almost exclusively ofspruce trees which produce softwood used extensively in building work.Spruce sells for the equivalent of about Â£200 per cubic metre. However,genetic engineering has produced a remarkable new tree which has thegrowth characteristics of spruce, but which produces hard wood with theappearance and qualities of mahogany. This species, the Maho spruce,should grow quite happily in Scotland and produce worthwhile crops afterten years, each Maho spruce tree producing about 2 cubic metres.Currently, mahogany sells for the equivalent of Â£900 per cubic metre.
The company which developed the Maho spruce has ensured that thetrees are sterile and has also successfully applied for worldwidepatents on the genetic material. Seedlings are available only from thatcompany at a cost of Â£200 each.
Dunvegan Ltd is considering whether to invest in Maho spruce. Landalready owned by the company would be used (market valueÂ£1,000/hectare) and the company's planting and drainage equipment wouldbe assigned temporarily to the project. Because the seedlings are soexpensive, relatively light planting would be used at 1,500 seedlingsper hectare. Annual maintenance and security would Â£1,000/hectare foreach of the ten years of the project. Dunvegan Ltd is consideringplanting 1,000 hectares with Maho spruce.
In the UK Dunvegan Ltd has three main competitors; mahogany is alsoimported from four countries in the tropics where it is a valuableexport. Some of the wood is from managed plantations, but some is fromnatural forest. Recently the price of mahogany has been rising assupplies become short and plantations have to be renewed. Dunvegan Ltd'saccountant has read an article in a recent edition of Lumber About, themonthly trade paper of the timber business, in which the economiceffects of the Maho spruce were discussed. If around 3,000â€“4,000hectares were planted in the UK, then the price of mahogany would beÂ£500 per cubic metre at the end of ten years. If around 2,000 hectaresonly were planted, then the price would be Â£800 per cubic metre. Thebreakeven price is estimated to be Â£639/cubic metre.
From the viewpoint of an independent consultant, write a report tothe directors of Dunvegan Ltd on the proposed Maho spruce plantation.Your report should include a PESTEL analysis.
Question 3 T Plc
T plc is a well-established company providing telecommunicationsservices both nationally and internationally. Its business has beenconcerned with telephone calls, the provision of telephone lines andequipment, and private telecommunication networks. T plc hassupplemented these services recently by offering mobile phones, which isan expanding market worldwide.
The company maintains a diverse customer base, includingresidential users, multi-national companies, government agencies andpublic sector organisations. The company handles approximately 100million calls each working day, and employs nearly 140,000 personnel.
The Chairman of T plc stated within the latest Annual Report thatthere are three main areas in which the company aims to develop in orderto remain a world leader in the telecommunications market. He believesthat the three main growth areas reflect the evolving nature of thetelecommunications market and will provide scope for development. Theareas in which development is planned are:
- expansion of the telecommunications business in the national and overseas markets, both by the company acting on its own and through partnership arrangements with other suppliers
- diversification into television and multi-media services, providing the hardware to permit telephone shopping from home and broadcasting services
- extension of the joint ventures and strategic alliances which have already been established with companies in North America, Europe, India and the Far East.
The Chairman explained that the company is intent on becoming aworld leader in communications. This will be achieved throughmaintaining its focus on long-term development by improving its servicesto customers, developing high quality up-to-date products and beinginnovative, flexible and market-driven. His aim is to deliver aworld-class service at competitive cost.
Comparative statistics showing extracts from the company'sfinancial performance in its national telecommunications market over thelast two years are as follows:
The Chairman expressed satisfaction with the increase in turnoverand stated that cost efficiencies were now being generated followingcompletion of a staff reduction programme.
The Chief Executive of T plc has stated that the major opportunities for the company lie in the following areas:
- encouraging greater use of the telephone
- provision of advanced services, and research and development into new technology, including the internet and systems integration
- the increasing freedom from government control of worldwide telecommunication services.
An extensive television and poster advertising campaign has beenused by the company. This was in order to penetrate further theresidential market by encouraging greater use of the telephone withvarious charging incentives being offered to residential customers.
Markets and competition
The company is currently experiencing an erosion of its marketshare and faces increasingly strong competition in the mobile phonemarket. While T plc is the leader in its national market, with an 85%share of the telecommunications business, it has experienced a reduceddemand for the supply of residential lines in the last five years ascompetition has increased. The market for the supply of equipment in thenational telecommunications market is perceived to be static.
The government has established an industry regulatory organisationto promote competition and deter anti-competitive behaviour. As a resultof the activities of the regulator and aggressive pricing strategies,it is anticipated that charges to customers will remain constant for atleast the next three years.
(a)Explain the nature of thepolitical, economic, social, and technical forces which influence T plcin developing its business and increasing its market share.
(b)Apply Ansoffâ€™s Product/Marketmatrix to assess the extent of the potential market developmentopportunities available to T plc.
(Total: 25 marks)
Question 4 CSC Clothing
The Clothing Supply Company (CSC) is seen as a market leader in thedesign and manufacture of garments such as knitwear and weatherproofclothing for outdoor sports. The company is over a hundred years old andis based in rural islands of Scotland where it originally used to makeand supply hill farmers with outdoor working clothes. CSC prides itselfon the use of traditional fabric designs, the craftsmanship of itsgarment workers and the fact that it buys much of its cloth from localweavers, so supporting the local economy.
In recent years CSC has achieved a degree of dominance over otherspecialist Scottish clothing manufacturers. The CSC product range nowenjoys an international reputation based not only on design and thequality of handmade tailoring but also on the attractive and well knownbrand name, which is perceived to be associated with the countrylifestyle of wealthy society leaders. CSC garments are distributed toand sold at premium prices through the best department stores in London,New York and Tokyo and are especially popular with overseas touristsvisiting the United Kingdom.
CSC had been a family-owned business until 1997 when it was sold tothe KZ Corporation, a Pacific Rim-based multinational conglomerateinvolved in shipbuilding, construction and consumer electronics. The KZCorporation is keen to maximise what it sees as the global brandpotential of CSC and to justify what some KZ managers see as theexcessively high price paid to the owner's family for their controllingshares in CSC.
To address these issues, the vice-president of global operations atKZ has commissioned a strategy study to identify ways in which CSC canbe integrated into the KZ Corporation.
(a)Using Porter's diamond, examine theextent to which international location might determine the competitiveposition of the Clothing Supply Company.
(b)The strategy study was concerned atthe relatively high production cost of CSC clothing products andbelieved that costs could be substantially reduced by moving productionto South East Asia. Evaluate the risks and opportunities presented bythis suggestion.
(Total: 25 marks)
Question 5 Scottish Holidays
A small business operating holiday homes in Scotland wishes toforecast next year's sales for the budget, using moving averages toestablish a straight-line trend and seasonal variations. The accountanthas assumed that sales are seasonal, with a summer season and a winterseason each year.
Seasonal sales for the past seven years have been as follows:
New government incentives are due to promote Winter holidays inScotland for three years, starting in 20X9. The company hopes to beprepared for these and as a first step it has prepared the followinganalyses as a way of preparing a forecast for sales for Winter 20X9:
Seasonal variations need to add up to zero in the additive model. The seasonal variations calculated so far are:
The average increase in sales = $50, 500 each season
Trend in Winter 20X9 = 527.5 + (2 x 50.5) = 628.5
Forecast = 628.5 â€“ 53.1 = 575.4
Explain the forecast method used by the company and evaluate its validity.
Question 6 Marcus Aurelius
Marcus Aurelius Ltd is a small supermarket chain, that has 6 shops.Each shop advertises in their local newspapers and the marketingdirector is interested in the relationship between the amount that theyspend on advertising and the sales revenue that they achieve.
The company has just taken on 2 new stores in the same area and thepredicted advertising expenditure is expected to be $150,000 for onestore and $50,000 for the other.
The marketing director has collated the following information for the 6 shops for the previous year:
She has further performed some calculations to determine forecast sales revenue for the two new shops as follows:
Coefficient of determination = 0.984
Explain the calculations and comment on the reliability of the forecasts.
3 Internal resources, capabilities and competences
Question 7 MW and FS
MW and FS are both supermarket chains which operate in differentparts of a country. Both are listed on the country's Stock Exchange. MWoperates in the north of the country while FS stores are locatedpredominantly in the south. Recently the Chairman of FS has approachedthe Chairman of MW and suggested that MW may wish to present a takeoverbid for FS. The Chairman of FS has indicated that such a bid would befavourably received by his Board of Directors and would pre-empt a bidbeing made by other less desirable predators in the industry. Accordingto the Chairman of FS, there would need to be some staff rationalisationand about 10% of the total number of stores of the combined group wouldneed to be sold as a result of demands which would be made by thecountry's competition regulatory organisation. However, he believes thatthere would be increased profitability for the combined group as awhole which would lead to improved shareholder value. At this stage, nopublic announcement of the possible takeover has been made and all theinformation relating to it is being treated as strictly confidential.
MW was established over 100 years ago by Mr W. His son (KW), who isnow over 70 years old, is the Chairman of the company. The W family hasmaintained strong control over the business and still owns nearly 40%of its shares. The main principle established by Mr W was that ofoffering quality products at a reasonable price and this principle hasbeen rigidly maintained throughout the company's history.
Organisationally, MW stores are split into two operating areas â€“the North West and the North East â€“ although it is controlled from itsHead Office by KW and his management team. Each individual store ismanaged locally by a Store Manager and an assistant. In addition, thereare supervisors, till checkout staff, store keepers and shelf stackersworking in each store. Other skilled trade staff are also employedincluding butchers, bakers and fishmongers.
Recent results have shown that MW has increased its sales by 8% andits net profit by 15% over the previous year. MW has become a popularshare as a result of the company's ability to cut its operating costsand increase its profitability each year.
KW follows the sound principles of business development establishedby his father. He prefers to rely on a capital structure which is lowgeared and has generated organic growth rather than undertaking largetakeovers. The last time MW undertook a takeover was 25 years ago whenit bought six supermarkets. If a bid is made for FS then it is mostlikely that KW will wish to offer a share exchange rather than pay anycash. He is acutely aware of competition in the industry within thecountry and has been advised by the Finance Director that there are twoother main competitors which may put forward counter-bids if MW makes anoffer for FS.
FS's stores operate within the South West and South East of thecountry. Approximately 55% of its shares are held by ten majorinstitutional shareholders who have been disappointed in recentperformance. These institutional shareholders have been impressed by thesuccess of MW and instructed the Chairman to begin takeovernegotiations with KW.
Performance of both companies for the last financial year
For simplicity, the data supplied below represents the average foreach store in the relevant area. All stores for each company are builtto a standard layout. On average, FS stores are 20% smaller in terms ofarea than MW stores.
The profit attributable to ordinary shareholders in the lastfinancial year was $225 million for MW and $200 million for FS.Inventory is held centrally by each company in its own secure warehouse.It is issued on a daily basis to each store. On average, each MW storehas an inventory turnover of 2 days while each FS store has an inventoryturnover of 3.5 days.
|(a)||(i)||Produce a SWOT analysis for MW.|
| ||(ii)||Explain how such an analysis can assist the company in achieving its organisational objectives.|
(b) In your capacity as ManagementAccountant for MW, prepare an initial briefing report for the Board'sconsideration prior to any combination of the two businesses whichcompares the performance of the two businesses. Your report shouldinclude an analysis of the data provided in the scenario by makingwhatever calculations you think appropriate.
(Total: 25 marks)
Question 8 Qualispecs
Qualispecs has a reputation for quality, traditional products. Ithas a group of optician shops, both rented and owned, from which itsells its spectacles. Recently, it has suffered intense competition anderoding customer loyalty, but a new chief executive has joined from oneof its major rivals Fastglass.
Fastglass is capturing Qualispecs' market through partnership with ahigh street shopping group. These shops install mini-labs in whichprescriptions for spectacles are dispensed within an hour. Somecompetitors have successfully experimented with designer frames andsunglasses. Others have reduced costs through new computer-aidedproduction methods.
Qualispecs has continued to operate as it always has, letting theproduct 'speak for itself' and failing to utilise advances intechnology. Although production costs remain high, Qualispecs isfinancially secure and has large cash reserves. Fortunately, thecountry's most popular sports star recently received a prestigiousinternational award wearing a pair of Qualispecs' spectacles.
The new chief executive has established as a priority the need forimproved financial performance. Following a review she discovers that:
(i)targets are set centrally and shopsreport monthly. Site profitability varies enormously, and fixed costsare high in shopping malls
(ii) shops exercise no control over job roles, working conditions, and pay rates
(iii)individual staff pay is increasedannually according to a pre-determined pay scale. Everyone alsoreceives a small one-off payment based on group financial performance.
Market analysts predict a slowdown in the national economy but feelthat consumer spending will continue to increase, particularly among 18to 30 year olds.
(a)Produce a corporate appraisal ofQualispecs, taking account of internal and external factors, and discussthe key strategic challenges facing the company.
(b)Corporate appraisal offers a'snapshot' of the present. In order to focus on the future there is aneed to develop realistic policies and programmes. Recommend, withreasons, strategies from your appraisal that would enable Qualispecs tobuild on its past success.
(Total: 25 marks)
Question 9 Wargrin
Wargrin designs, develops and sells many PC games. Games have ashort lifecycle lasting around three years only. Performance of thegames is measured by reference to the profits made in each of theexpected three years of popularity. Wargrin accepts a net profit of 35%of turnover as reasonable. A rate of contribution (sales price lessvariable cost) of 75% is also considered acceptable.
Wargrin has a large centralised development department whichcarries out all the design work before it passes the completed game tothe sales and distribution department to market and distribute theproduct.
Wargrin has developed a brand new game called Stealth and this has the following budgeted performance figures.
The selling price of Stealth will be a constant $30 per game.Analysis of the costs show that at a volume of 10,000 units a total costof $130,000 is expected. However at a volume of 14,000 units a totalcost of $150,000 is expected. If volumes exceed 15,000 units the fixedcosts will increase by 50%.
Stealth's budgeted volumes are as follows:
In addition, marketing costs for Stealth will be $60,000 in yearone and $40,000 in year two. Design and development costs are allincurred before the game is launched and has cost $300,000 for Stealth.These costs are written off to the income statement as incurred (i.e.before year 1 above).
(a)Explain the principles behindlifecycle costing and briefly state why Wargrin in particular shouldconsider these lifecycle principles.
(b)Produce the budgeted results forthe game 'Stealth' and briefly assess the game's expected performance,taking into account the whole lifecycle of the game.
(c)Explain why incremental budgeting is a common method of budgeting and outline the main problems with such an approach.
(Total: 20 marks)
4 Stakeholders, governance and ethics
Question 10 Digwell Explorations
Eastborough is a large region with a rugged, beautiful coastlinewhere rare birds have recently settled on undisturbed cliffs. Sincemining ceased 150 years ago, its main industries have been agricultureand fishing. However, today, many communities in Eastborough suffer highunemployment. Government initiatives for regeneration through tourismhave met with little success as the area has poor road networks,unsightly derelict buildings and dirty beaches.
Digwell Explorations, a listed company, has a reputation formaximising shareholder returns and has discovered substantial tinreserves in Eastborough. With new technology, mining could beprofitable, provide jobs and boost the economy. A number of interest andpressure groups have, however, been vocal in opposing the scheme.
Digwell Explorations, after much lobbying, has just receivedgovernment permission to undertake mining. It could face difficulties inproceeding because of the likely activity of a group called theEastborough Protection Alliance. This group includes wildlife protectionrepresentatives, villagers worried about the potential increase intraffic congestion and noise, environmentalists, and anti-capitalismgroups.
(a)Discuss the ethical issues thatshould have been considered by the government when granting permissionfor mining to go ahead. Explain the conflicts between the mainstakeholder groups.
(b)By use of some (mapping) framework,analyse how the interest and power of pressure and stakeholder groupscan be understood. Based on this analysis, identify how DigwellExplorations might respond to these groups.
(Total: 25 marks)
5 Strategies for competitive advantage
Question 11 A University
A University which derives most of its funds from the governmentprovides undergraduate courses (leading to bachelors' degrees) andpost-graduate courses (leading to masters' degrees). Some of its fundscome from contributions from student fees, consultancy work andresearch. In recent years, the University has placed emphasis onrecruiting lecturers who have achieved success in delivering goodacademic research. This has led to the University improving itsreputation within its national academic community, and applications fromprospective students for its courses have increased.
The University has good student support facilities in respect of alibrary, which is well-stocked with books and journals and up-to-date ITequipment. It also has a gymnasium and comprehensive sports facilities.Courses at the University are administered by well-qualified andtrained non-teaching staff that provide non-academic (that is, notlearning-related) support to the lecturers and students.
The University has had no difficulty in filling its courses to thelevel permitted by the government, but has experienced an increase inthe numbers of students who have withdrawn from the first year of theircourses after only a few months. An increasing number of students arealso transferring from their three-year undergraduate courses to othercourses within the University but many have left and gone to differentuniversities. This increasing trend of student withdrawal is having adetrimental effect on the University's income as the government paysonly for students who complete a full year of their study.
You are the University's management accountant and have been askedby the vice-chancellor (who is the chief executive of the University) toreview the withdrawal rate of students from the University's courses.
(Candidates do not require any knowledge of University admission and withdrawal processes to answer this question.)
Apply Value Chain Analysis to the University's activities, andadvise the vice-chancellor how this analysis will help to determine whythe rate of student withdrawal is increasing.
6 Other elements of strategic choice
Question 12 News Reel Inc
News Reel Inc was incorporated in 1958 and has been wholly owned bymembers of the Xiang family since that date. The board of directorsconsists solely of family members. The company manufactures newsprintfor sale in the newspaper and magazine industry at a single site inHoyan Province, to the north west of Eastlandia. Eastlandia is a smallisland, approximately 200 kilometres off the coast of the mainlandcontinent. In terms of the paper industry, News Reel may be regarded as asmall to medium-sized manufacturing company.
The company profile
The company's major customer has for many years been theEastlandian Evening Star (EES), for which it is the sole supplier ofnewsprint. The contract is renewable each year and the price isdetermined on a cost plus basis.
Historically the EES contract has made up about 30% of thecompany's revenue, but during the economic recession other business hassuffered significantly. As a result the EES contract made up 40% oftotal revenue in News Reel's last accounting year.
The remaining 60% of sales was mainly to magazines and freenewspapers published and circulated across Eastlandia. Frequently ordershave been won by News Reel's willingness to provide small quantities ofnewsprint from short production runs and its promise of promptdelivery.
The major raw material for News Reel is pulp. Rather than rely onthe major pulp manufacturers, which import timber from Canada andScandinavia, the company is supplied exclusively under short-termcontracts from a privately-owned Eastlandian mill, Quickpulp Inc, whichpossess local softwoods.
In recent years News Reel Inc's purchases have accounted for 8% to10% of Quickpulp Inc's revenue. Whilst these supplies of pulp areslightly more expensive than those that can be purchased from the largermanufacturers, they have the advantage of short and certain deliverytimes, enabling News Reel to carry negligible inventories of rawmaterials.
News Reel makes a single product, reels of newsprint. The company'smanufacturing operations have been built up over time; as a result asmall proportion of its operating non-current assets are replaced eachyear. Given the scale of its activities, the business is not as capitalintensive as many of its larger competitors in the industry;consequently it has a higher proportion of labour costs per tonne ofoutput than the industry average.
In fact, News Reel struggles to compete when tendering for majororders as it uses more pulp per tonne of output than would be the caseif it could operate large scale, modern machinery. In compensationhowever, set-up costs are much lower, and this enables small productionruns to be accommodated, ensuring greater flexibility in productionscheduling. Due to weak trading volumes the company has only beenoperating at 70% of productive capacity this year, and a similar levelof 30% surplus capacity is expected next year.
The competitive environment
The Eastlandian paper industry is dominated by ten listedcompanies, whose operations are primarily based on the mainlandcontinent. All produce both commodity newsprint and a variety of brandedpaper products for specialist markets.
There are also a number of smaller companies, of a similar size toNews Reel, which mainly specialise in niche markets. A new phenomenonaffecting all sectors has been the growth of low-cost, low-qualityrecycled paper, supported by subsidies from some foreign governments fortheir own producers.
The paper industry has been affected significantly by therecession, with most companies operating with excess capacity. This inturn has led them to cut margins when tendering for contracts. Thefollowing are the features of the competitive environment:
- Depressed pulp and paper prices ( a reflection of their historic value)
- The failure of one or two small operators and downsizing by survivors as they rationalise their operations
- An increased tendency towards diversification
A strategic dilemma
The chairman of News Reel has recently been informed that the EEShas been acquired by a multinational and that when the existingcommitment expires at the end of this year, the contract to supplynewsprint will be put out to tender on an annual basis.
He has also been told that the terms of the new contract will bethat all newsprint which the EES requires next year will be supplied bythe successful bidder at a predetermined tender price per reel. The bidshave to be submitted by 30 November and the successful bid will beannounced a month later. The contract will not be awarded solely on thebasis of price, but this is likely to be a major factor. At the boardmeeting to discuss these developments the following views wereexpressed:
The marketing director
'It has long been my view that we have been over-dependent on EESas a customer. Even if we do win the contract next year, there is noguarantee that we will be able to retain it in the future. In my view itis therefore essential that we seek out new markets and new products.
'In particular we are too small to be a commodity producer ofnewsprint without the EES contract. We need to develop into nichemarkets within the paper sector by producing differentiated brandedproducts.
'In fact there is currently an opportunity for us. A small localfirm, MedicNote Inc, is currently looking for a buyer. It has been veryprofitable, specialising in exploiting the growing demand in the marketfor pharmaceutical paper products, but it has experienced severe cashflow problems recently due to overtrading.'
The production director
'I agree with the need to diversify, but making newsprint is whatwe are good at. We have no experience in other markets. I have just beentold that Quickpulp shareholders are looking to sell the company due torecent losses arising from weak world pulp prices. In my opinion thisrepresents an ideal opportunity to secure pulp supplies at a low cost. Iam also in favour of more modern large scale machinery in order todrive down marginal costs. This will enable us to compete in the longrun in our core activity.'
The finance director
'Even if an acquisition strategy is felt to be appropriate, it isvery difficult to evaluate the feasibility of the two options in precisemonetary terms as much will depend on the prices of the two businesses.In my judgement News Reel is sufficiently liquid to fund one or otherof the options suggested but, given current uncertainties, it would bedifficult to raise finance for both of them.'
As a management consultant you have been commissioned to preparebriefing notes for the directors of News Reel covering the followingareas:
(a) Analyse the company's current strategic position
(b) Evaluate the future strategic options available to the company by appraising
- the potential growth strategies that the company could pursue, and
- the particular diversification/acquisition strategies suggested.
The chairman of News Reel Inc is concerned that the demand orthe core product is likely to decline further as people move to digitaltechnologies as means of getting news and information. He is keen toplan ahead for the next ten years so that he can ensure the long termviability of the company for coming generations.
(c) Johnson, Scholes and Whittingtonidentify three strategy lenses; design, experience and ideas. Examinethe different roles these lenses might play in the process of long termstrategy development at News Reel Inc.
(Total: 50 marks)
7 Methods of strategic development
Question 13 Pelatihan
Pelatihan is a privately-owned training college, which specialisesin providing courses in business subjects. Pelatihan was founded in 1992by its current Chief Executive, who is a qualified lawyer. Pelatihangrew rapidly to become one of the largest and most highly regardedcolleges in A, an Asian country.
The general situation in A
The last two decades have been a period of rapid social change forthe residents of A. The country's economy has developed from beingmainly based on subsistence agriculture (that is, agriculture carriedout with the aim of feeding the farmer and his/her family), to beingmuch more progressive in all respects. The population is now fairly welleducated, with literacy levels much higher among the under-20 age groupthan inthe older population. This is partly as a result of government policy(introduced in the 1970s) aimed at making education to age 16 availableto all citizens of A. While subsistence agriculture has declinedsharply, commercial agriculture still contributes about 40% of thecountry's Gross National Product (GNP). The fastest developing sectorsare manufacturing, food production, tourism, financial services andretail.
A is now regarded as a developed Asian economy, with awell-established business and financial community. A is home to manylarge industrial and commercial corporations, many of which operateglobally. Recently, the economy of A has been growing at a rate of about15% each year. This is better than the growth rates in neighbouringcountries. A has a stable, democratic, political system. Its governmenthas been in power for the last six years. A general election is expectedat some time in the next two years, and the government is concernedthat the main opposition party may be elected. Unlike a number of othercountries in the region, A has no recent history of violent unrest orterrorist activity.
The business training market in A
The business training industry is dominated by three major colleges (of which Pelatihan is one).
There are also a number of smaller colleges. The estimated market shares are shown below.
Pelatihan has grown to its current size by means of organic growth.Both Koulos and Opleid, on the other hand, have made severalacquisitions of smaller colleges in the last five years. Indeed, therehave been rumours of a possible merger between Koulos and Opleid, butthere is no evidence to support this. Koulos was founded in 1990 by agroup of academics from a university. Opleid was founded in 1994 by anex-director of Koulos, to specialise in Finance courses. Opleid hassince recruited a number of experienced tutors from elsewhere in theindustry, including an ex-director of Pelatihan.
An independent survey, reported in the press in early 20X1, made the following comments about the market:
â€œThe business training industry in A is very buoyant in mostsectors. Demand for courses in Law and HRM is rising quite rapidly,while the market for Finance courses is also growing (though at a slowerrate). Marketing is the only sector in decline, possibly as a result ofthe growth in online 'e-learning' courses provided by The MarketingInstituteâ€.
'The Marketing Institute' (mentioned in the comment) is theprofessional body responsible for the development of marketingprofessionals in A. It is not a college. Currently it is the onlyprofessional institute in A to offer its own courses, whether online or'face-to-face'. Other institutes are known to be considering theprovision of online courses. Koulos is known to be developing onlinecourses, though Pelatihan has no plans to do so.
The structure and performance of Pelatihan
The Board of Directors of Pelatihan now consists of the ChiefExecutive and four other directors. They are all senior tutors. Each ofthe four directors is responsible for a 'faculty' of the college, eachof which provides courses in a specialist professional area.
The courses provided by Pelatihan range from one day 'insight' or'update' courses, on a theoretical or practical topic, to much longercourses leading towards exams for academic and professionalqualifications. Courses for diplomas, degrees and professionalqualifications require students to attend the college for up to 60 daysin any one year. Pelatihan does not provide any full time courses anddoes not provide any student accommodation.
Almost all the students on one day courses have their courses paidfor by their employers. Some students on longer courses are also fundedby their employers, but approximately half pay their own tuition fees.The college does not discriminate on price between employer-fundedstudents and those who pay their own fees on individual courses.However, some large employers receive a discount for 'bulk purchase' ofplaces on courses.
The performance of the college during its most recent financial year is summarised in Table 1.
Comparison of results
- No budget was set for staff numbers
- A student day is one student attending for one day
The recent Board meeting of Pelatihan
At a recent Board meeting, the following issues were raised:
- The directors responsible for the F&A and Marketing faculties each raised concerns about a small number of large employer organisations which represent a significant proportion of their faculty's business. These organisations are starting to demand discounts in excess of 20%. This is far higher than the discounts given to other corporate customers. The director of the Law faculty said that one of the law firms she deals with often books up to half of the places on a course, but now demands a discount of 20%.
- The director responsible for the Law faculty reported that two of her tutors had recently resigned, in order to take up positions with Koulos.
- The Chief Executive expressed concern at the poor financial performance of Pelatihan, when compared to the budget for 20X0-X1. He asked for a volunteer to take responsibility for financial planning and control for the new financial year. The director of the F&A faculty said that he could not help, as he was too busy teaching students and dealing with clients. There was no volunteer, so the Chief Executive reluctantly agreed to continue overseeing the work of the three finance staff.
(a)Using the Boston Consulting Group (BCG)matrix, evaluate the product portfolio of Pelatihan. In the light ofthis matrix and the information contained in Table 1, comment on theperformance of the business.
(b)Using a technique such as SWOT analysis, analyse the company's overall position.
(Total: 25 marks)
Question 14 WG plc
WG plc was formed four years ago following the merger of two largepharmaceutical companies. Prior to the merger the two companies had beencompetitors: they believed that by combining forces the shareholders ofeach company would benefit from increased profits arising from therationalisation of manufacturing facilities, distribution networks, andconcentration of resources towards more focused research anddevelopment.
With operating outlets in Europe, Asia, the United States ofAmerica and Africa, WG plc regards itself as a global company. Itemploys approximately 50,000 people worldwide and has developed a wideportfolio of products. Its profits before tax last year increased by 20%and represented approximately 35% of turnover. The company declaredthat its earnings and dividends per share in the same period eachincreased by 15% over the previous financial year.
All manufacturers of pharmaceutical products claim that theirpricing policies need to be set at a level to achieve high profitabilityin order to attract funds from investors. They argue that this isnecessary to meet their high research and development commitments. Inrecent years, WG plc and other pharmaceutical manufacturers haveencountered public and governmental challenges to their high levels ofprofitability.
WG plc encounters strong competition from other world-classpharmaceutical manufacturers, but these are few in number. High researchand development costs present a major obstacle to potential competitorstempted to enter the industry.
Mission and objectives
The directors of WG plc have defined their overall corporatemission as being to 'combat disease by developing innovative medicinesand services and providing them to healthcare organisations for thetreatment of patients worldwide'.
The directors have confirmed their main objective is to sustainprofitability while achieving the company's overall mission. They havealso explained that WG plc aims to work towards eliminating thosediseases for which the company is engaged in providing treatments.Achievement of the profitability objective is continually threatened bypatents coming to the end of their lives. Patents give the sole right tomake, use and sell a new product for a limited period.
A large proportion of the company's turnover in recent years hasbeen derived from one particular drug. The patent for this drug expiresnext year and it is expected that its sales at that time will representno more than 10% of total turnover. Four years ago, the sales of thisdrug produced almost half the company's entire turnover.
A new product, Coffstop, has now completed its rigorousdevelopment phases and is being marketed to pharmaceutical storesthroughout the world by WG plc. It is in competition with a similardrug, Peffstill, produced and marketed by a direct competitor of WG plc.Medical research and opinion has concluded that Coffstop is generallymore effective than Peffstill in treating the condition for which theyare intended. Both drugs are available over the counter from pharmacies.The directors of WG plc are optimistic that Coffstop will become verypopular because of its improved effectiveness over other marketproducts.
WG plc has experienced slow growth in its mature markets of WesternEurope, North America and Japan. These markets contribute 80% ofoverall turnover but their governments have reduced expenditure onpharmaceutical products in recent years. The company has encountered arapid sales increase in its expanding markets of Eastern Europe, SouthAmerica, the Asia Pacific region, India, Africa and the Middle East. Thedirectors of the company hold the view that increasing populationgrowth in these markets is likely to provide substantial opportunitiesfor the company over the next two decades.
Research and development
Almost 15% of WG plc's turnover last year was spent on research anddevelopment. WG plc has the largest research and developmentorganisation of all pharmaceutical companies worldwide.
Much research is sponsored by national governments and world healthorganisations. A major piece of research which has recently beenundertaken relates to new treatments for malaria as the disease is nowdemonstrating some resistance to existing treatments. WG plc hasestablished a 'donation programme' for the new drug in virulent areasfor the disease. This means that the company is donating batches of thedrug to the health organisations in these areas. The cost of thisprogramme is offset by the sales of the new drug in other areas of theworld by making it available to people proposing to travel to theregions where malaria is widespread.
(a)Evaluate the nature and importance ofthe market threat which WG plc would face if it failed to providesufficient resources for product development.
(b)Discuss the practical issues whichthe directors of WG plc would need to consider if the company entered astrategic alliance with a competitor for the joint development of futurepharmaceutical products.
(Total: 20 marks)
8 Organisational structure
Question 15 Multinational company
A multinational company which makes and sells consumer durables isreviewing the future organisational structure of its Europeanoperations, which employ over 100,000 people.
Development of the company
The company has expanded rapidly in the late 1940s and 1950s.Separate marketing companies were established in all the main Europeancountries to serve the distinctive needs of the markets in eachindividual country, with some manufacturing facilities in the largercountries. Some exports to other smaller European markets had also beenmade. A divisional structure was adopted which permitted considerablefreedom to individual country managers, who were responsible for alloperations in their country. They could decide what models to design,make and sell, the marketing and pricing strategy, and the sourcing.
The industry background
There has been progressive integration of European economies,making cross-border transactions easier. The consumer durable industryhas also become much more competitive and cost-conscious, and is facedwith considerable overcapacity. New product models can no longer bejustified for one country only, but are designed for sale in allcountries, and made in one or two chosen plants (possibly in EasternEurope, with cheaper labour) to serve all markets.
The company now
Although the country-based divisional structure is still in place,most key decisions are now taken at European Head Office. These includethe selection of new models to make and sell, and the plants at whichthese models are to be made, whether these are existing plants or newplants in cheap labour areas.
Local markets are still distinctive with different taxation,distribution costs and pricing structures. Individual country managersstill set country selling prices, although comparisons of prices acrossEurope reveal considerable anomalies. Manufacturing facilities are stilloperated in major countries, even though it is difficult to justifycontinuing investment without government subsidy.
Discuss the potential problems of the present country-baseddivisional structure and its effectiveness as Europe becomes moreintegrated and cross-border transactions become easier.
Recommend, with reasons, whether the present divisionalorganisational structure should be retained, and if this is notsupported, recommend an alternative.
Question 16 QS Software â€“ Part 1
QS is a small software design company, set up in May 20X0 by twograduates, John Jones and Sam Smith. Since it started, it has built astrong local reputation, working with a range of small- to medium-sizedbusinesses to design and develop software applications. It alsooccasionally advises businesses on hardware installation. It also runs aretail shop, where it constructs and sells custom-made computers toindividuals and undertakes repairs and maintenance in a workshop locatedbehind the shop. The design and development team are located above theshop.
Both owners recognise that the quality of products and services isvital in such a highly competitive market and, to date, QS has managedto maintain a high quality of customer service by focusing only uponindividuals customers and small- to medium-sized businesses.
New business opportunity: Regal Global Advertising (RGA)
In August 20X6, John Jones met an old university friend who wasworking as the IT manager of a large local marketing company calledRegal Global Advertising (RGA). It emerged that RGA was looking toinvest in setting up a new customer database and website. RGA was alsoconsidering re-investing in new hardware throughout the organisation,which would require an on-going maintenance facility. The customerdatabase and website would need to be in place and fully operational by30 May 20X8.
On returning to the office, John began to put together an outlinetender document and an outline project plan. However, Sam Smith, theother partner, was reluctant to take on such a large project as they hadno previous experience of managing work on this scale and, moreimportantly, they already had sufficient work with existing clients forthe foreseeable future. John's response to Sam's concerns of maintainingquality for existing customers was: 'Don't worry, we'll fit it inaround everything else â€“ there's plenty of time to get it all done'.As John was responsible for new business, which in the past had alwaysbeen successful, Sam agreed to allow the tender to progress.
John Jones and Sam Smith both have ambitions to develop QS into amajor software company, and they are already considering how they shouldbe planning the structure of the organisation to cope with the demandsof growing and succeeding in the competitive software industry.
They believe that the future success of the company will dependprimarily on the initiative and ingenuity of the IT specialists that thecompany employs. They are hoping that within a few years, they will beable to take more of a 'back seat' role in the management and directionof the company.
Their ideas about organisation structure have been influenced bythe analysis by Mintzberg of an organisation into five elements.
(a)Analyse the current organisationalstructure of QS and identify any advantages and disadvantages thisstructural form might have in the business environment in which QSoperates.
(b)Describe the five elements in anorganisation into which Mintzberg suggested that employees can bedivided and suggest how this analysis by Mintzberg might apply to thefuture organisation structure of QS.
(Total: 25 marks)
9 Business process change
Question 17 Nikki Photocopiers
Nikki Photocopiers manufactures and sells photocopiers tobusinesses throughout Europe. The market is highly competitive withmajor global players present.
Despite earlier success, the firm has recently seen a downturn inits performance as typified by the following customer ratings in European Business Photocopier Magazine:
Last year the firm introduced a customer relationship management(CRM) software system so the fall in the service rating was a surprise.Before this survey had been published the directors had planned toredesign research and production processes but, based on this feedback,decided to look at the customer servicing and maintenance process first.Outsourcing was rejected as an option and the focus was placed onreengineering the process instead.
Proposed New Process
(a)Discuss whether service and maintenance should have been prioritised for reengineering.
(b)Assess the likely impact of the proposed changes on Nikki Photocopiers' competitive advantage.
(c)Outline the IT/IS implications of the proposal.
(d)Outline the arguments for and against outsourcing maintenance.
(Total: 25 marks)
Question 18 Institute of Information Systems Administrators
The Institute of Information System Administrators (IISA) holdsexaminations all over the world. Every six months 200,000 students in450 centres in 75 different countries take one or more papers in theInstitute's six-paper qualification. The examinations are conventionalthree-hour examinations with the candidates writing answers in scriptanswer books similar to those used by ACCA. The current system(described below) is both costly and time-consuming and so the Institutehas set up a project to look at the feasibility of on-line marking,where markers download images of the scripts and mark them on a PersonalComputer. An outline of the proposed system is also described below.
At present the script answer books completed by the students aretaken from the examination room by the invigilator and sent by securecourier to the IISA head office in London. From here, the scripts aresent by courier to examiners, who select and despatch scripts (again bysecure courier) to markers. Once the scripts are marked they arereturned to the IISA head office who arrange for them to be checked.This is an arithmetic check, making sure that the total for eachquestion and script is correct. Once scripts have been checked, themarks for each question answered on the script are entered into acomputer system. This system provides statistical analysis of the marksas well as printing certificates for successful candidates. A selectionof the scripts is sent (again by courier) to the examiners formoderation, i.e. to check that markers have correctly applied theapproved marking scheme. The examiners are also sent scripts wherearithmetic errors have been found. All scripts are stored at the IISAhead office. There are currently 6 examiners, 500 markers and 250checkers.
The On-Line Marking Project (OLMAP) proposes that all script answerbooks are taken from the examination room by the invigilator and sentby secure courier to a document-imaging centre in Singapore. Here, thehand-written scripts will be scanned into a computer system. Examinerswill be provided with on-line access (via the Internet) and they will beable to allocate a script to a particular marker. Once this allocationhas taken place, the script is available for on-line marking. The markeris given access via the Internet and is able to download allocatedscripts on the computer screen, where they may be marked using simplemouse movements. The software assists the marker by adding up the marksautomatically, so no arithmetic script checking is required. At any timean examiner can download marked scripts to undertake moderation. Thisis made particularly effective by the system allowing the 'hiding' ofmarks given to the script by the original marker. Certificates will alsobe printed from this system.
The project manager for the project is Margaret Mendoza. She isimpatient to progress the project and has identified a software packageEmark, marketed by a multinational software company, which appears tofulfil the requirements. She believes that all examination subjectsshould use the package commencing with the examination session in 12months' time. She is committed to a direct changeover/conversionapproach as 'parallel running is just not a possibility in thissituation'. However, the package is comparatively expensive, is untriedin a world-wide application, and has received some criticism from an ITexaminer, Sue Yorke, who has attended a demonstration of the Emarksoftware.
The sponsor of the project is Mike Palmer. Mike is concerned aboutMargaret's enthusiasm and impatience and wants a slower and morereflective approach to the project. He would like to see the softwareused in a pilot run, employing it on just one or two examinations atfirst. One of the reasons for this is his concern about the performanceof the software, as he is worried that a slow response time will makethe system unusable. Sue Yorke has suggested that it could be used onher IT paper, where markers are IT literate and enthusiastic to adoptthe new marking software. In contrast to Margaret, Mike is in favour of abespoke development (either in-house or using an external softwarehouse) with the eventual goal of making the software commerciallyavailable to other examining bodies.
(a)Margaret Mendoza advocates the purchaseof a software package, whilst Mike Palmer wishes to go for a bespokeapplication. Discuss whether a software package or a bespoke solutionshould be used.
(b)Mike Palmer has already expressedconcerns about potential performance problems with the software. Explainhow the on-line marking application could be tested.
(c)Discuss whether parallel running or direct changeover is more appropriate in this situation.
(Total: 25 marks)
10 The role of information technology
Question 19 SDW
The SDW Company has been trading for one year. It provides railtravel services between three major cities in the country in which itoperates.
Mr M, the majority shareholder and managing director, is keen toexpand its operations and, in particular, to use the internet as themajor selling medium. He has discovered, for example, that doublingsales on the internet usually results in no additional costs. However,doubling sales using a call centre normally results in a doubling ofstaff and an increase in costs.
All tickets are currently sold via the company's call centre. Thecompany has an internet site although this is used for publicity only,not for sales or marketing. Competitors currently use a mixture ofselling media, although detailed information on the success of eachmedium is not available to the SDW Company.
Mr M has asked you, as a qualified management accountant, to assisthim in upgrading the company's internet site and, in particular,showing how this will help to reduce operating costs.
(a)Advise Mr M on how to establish and implement an appropriate internet strategy for the SDW Company.
(b)Discuss the key customer-orientatedfeatures of an internet site, showing how these can be used to meet theobjective of cost reduction required by Mr M.
(Total: 25 marks)
Question 20 MACOMP
MACOMP is a small manufacturer of replacement machine componentsfor machinery used in the mining and oil exploration industries. It isbased in an African country, Zedland. It was formed in 1952, as apartnership between two engineers, and incorporated in 1977.
MACOMP now employs 120 staff, and has an annual turnover equivalentto one million US dollars. MACOMP is proud to offer the very highestlevels of customer service. Much of the machinery used by MACOMP'scustomers is quite old and, as a result, components are no longeravailable from the original equipment manufacturers (OEMs), most ofwhich are large multinational companies. MACOMP mostly supplies partsdirectly to the end-users but also receives a small but significantproportion of its business from OEMs, who then supply the components totheir customers.
The current business model
MACOMP has always run its business in a very traditional way. Thesales manager receives most orders by telephone or fax. The orderspecifies the OEM part number that the component is to replace. IfMACOMP has previously supplied that component, the sales manager checksthe price list and tells the customer the price. MACOMP holds very lowlevels of finished goods inventory, and then only of the most commonlyordered components.
Where MACOMP needs to make a component for the first time, anMACOMP 'estimator' (a qualified engineer, responsible for producing anestimate of the material and labour involved in manufacturing the item)obtains the original drawings of the component, either from MACOMP'sextensive archives or from the OEM. The estimator then produces detailedengineering drawings, a list of materials and parts required, and anestimate of the labour hours likely to be used at each stage of themanufacturing process. The estimate is passed to a costing clerk in theaccounts department who calculates the likely product cost (labour,materials and overheads), adds a 'mark-up' of 50%, and advises the salesmanager of the price. If the customer accepts the price, an order ispassed to the production department, which schedules and completes thework. If the actual cost of production is significantly different fromthat estimated, the price list is amended to reflect the actualmanufacturing cost.
Very occasionally, a customer sends (or brings in) an oldcomponent, which cannot be traced back to an OEM. The sales managergives the component to an estimator, who dismantles the component andproduces the necessary engineering drawings and estimate. This processis called 'reverse engineering', and is common in the componentmanufacturing industry. Reverse engineering currently accounts for about5% of MACOMP's business.
When an order is fulfilled, the component is delivered to thecustomer, together with an invoice. Most customers pay within 30 days,by cash or cheque. MACOMP does not have a problem with bad debts. Anincreasing proportion of MACOMP's business is now transacted in USdollars, as African currencies tend to be unstable.
MACOMP prides itself on the personal service it provides. The closecontact it has with its customers means that MACOMP receives asignificant amount of repeat business. MACOMP has never advertised itsservices, but grew significantly until 20X9 as a result of 'word ofmouth' recommendations by satisfied customers. MACOMP, however, has notexperienced growth for the last two years, although turnover and profithave remained stable.
MACOMP uses only very basic Information Systems (IS), and reportsits performance using a simple comparison between budget and actual,which is produced using a spreadsheet package. MACOMP's accountingsystem is not automated, and transactions are recorded in traditionalledgers.
Project E: Computerised accounting and e-commerce systems
The sales manager of MACOMP has noticed that customers areincreasingly mentioning that they would like to be able to order online.He knows that there has been a significant growth inbusiness-to-business (B2B) e-commerce in recent years. The sales managerhas recognised that in order to grow and to make a move into e-commercepossible, MACOMP's accounting system will have to be updated to acomputerised one.
Having spoken to a number of potential suppliers, the sales managerhas now received a proposal from SSS, a local company, to supplytailored 'off-the-shelf' systems for both accounting and e-commerce.
The sales manager believes that, following implementation of thenew systems e-commerce could lead to an increase in the company'sturnover of 10% each year for the foreseeable future. However, the salesmanager thinks that a cautious approach should be taken and that thesystem may only lead to strategic advantages for around 5 years, afterwhich time competitors are likely to have caught up and developedsimilar systems.
The sales manager also thinks that any increase in indirect costsas a result of this higher volume of business will be fully offset by areduction in administration workload as a result of the new computerisedaccounting system. The mark-up on products sold by e-commerce will bethe same as at present (that is, 50%).
(a)Briefly explain how e-commerce hasimpacted on the way business is conducted and briefly discuss how a newInformation Systems (IS) strategy might impact upon corporate andbusiness strategies.
(b)Using a model such as Porters value chain, explain how the e-commerce investment could benefit the activities of MACOMP.
(Total: 25 marks)
Question 21 Marketing
Prendips is a national company which has been built up over manyyears primarily through an acquisition strategy. It now has threedistinct subsidiaries in the UK and group head office is assessing howeach subsidiary's product should be marketed. The three subsidiaries areas follows:
- ABC Inc makes and sells machine parts which are used in the manufacture of 10 pin bowling machines
- DEF Ltd sells fridges, freezers and cookers to the general public
- GHI Inc manufactures and sells kids jelly sweet candy
Discuss how the marketing mix could be used to sell each of the subsidiaryâ€™s products.
Question 22 Motor Car Pricing
A producer of high quality executive motor cars has developed a newmodel which it knows to be very advanced both technically and in stylecompared to the competition in its market segment.
The company's reputation for high quality is well-established andits servicing network in its major markets is excellent. However, itsrecord in timely delivery has not been so good in previous years, thoughthis has been improving considerably.
In the past few years it has introduced annualvariations/improvements in its major models. When it launched a majornew vehicle some six years ago the recommended retail price was so lowin relation to the excellent specification of the car that a tremendousdemand built up quickly and a two-year waiting list for the cardeveloped within six months. Within three months a second-hand model hadbeen sold at an auction for nearly 50% more than the list price andeven after a year of production a sizeable premium above list price wasbeing obtained.
The company considers that, in relation to the competition, theproposed new model will be as attractive as was its predecessor sixyears ago. Control of costs is very good so that accurate cost data forthe new model are to hand. For the previous model, the company assessedthe long-term targeted annual production level and calculated its priceson that basis. In the first year production was 30% of that total.
For the present model the company expects that the relationshipbetween first-year production and longer-term annual production willalso be about 30%, though the absolute levels in both cases are expectedto be higher than previously.
The senior management committee, of which you are a member, hasbeen asked to recommend the pricing approach that the company shouldadopt for the new model.
List the major pricing approaches available in this situation anddiscuss some of the relative merits and disadvantages to the company ofeach approach in the context of the new model. Recommend which approachyou would propose, giving your reasons.
12 Project management I
Question 23 MN plc
MN plc has a rolling programme of investment decisions. One ofthese investment decisions is to consider mutually-exclusive investmentsA, B and C. The following information has been produced by theinvestment manager.
(a) Prepare a report for the management of MN plc which includes:
- a statement of the reasons for differences between NPV and IRR rankings â€“ use investment A to illustrate the points you make;
- a brief summary which gives MN plc's management advice on which project should be selected.
(b) One of the directors has suggestedusing payback to assess the investments. Explain to him the advantagesand disadvantages of using payback methods over IRR and NPV. Use thefigures above to illustrate your answer.
(Total: 16 marks)
Question 24 Ski Runs
A landowner in an area of the country which has high mountain peaksproposes to develop a number of ski runs down the side of a mountain.The runs will be approximately 5 km long, dropping 1,000 metres from themountain's summit to a car park. Two alternative strategies (eachgiving the same capacity) are being considered for the development:
Low investment, involving the construction of a series of tows tohaul skiers from the car park to the summit: the initial cost ofconstructing the tows will be $250,000 and tow motors will have to bereplaced after five years at a cost of $50,000; operating costs will be$90,000 per year (fixed) and $3.50 per skier (variable).
High investment, involving the construction of a cable-car systemgiving a non-stop ride to the summit: the initial cost of constructingthe lift will be $1,200,000; operating costs will be $30,000 per year(fixed) and $1 per skier (variable).
The regional tourist board will subsidise the initial constructioncost of the development (using either strategy) by providing a loan forhalf the value of the initial construction cost. The loan is at aninterest rate of 4% repayable over six years on an annuity basis. Thetourist board requires (as a condition of the loan) that a flat fee of$8 is charged for each skier towed/lifted to the summit.
Number of skiers
The number of skiers using the runs will be dependent on thequality of snow cover. The better the snow cover, then the more runs itwill be possible to open and the longer will the runs be able to stayopen. The landowner forecasts that in any ten-year period, and assumingan $8 fee, the seasons will be as follows:
The landowner has stated:
'Although the quality of snow cover is unpredictable for any oneyear, we can determine the expected outcome for an average year usingprobabilities and base our investment appraisal and business plan onthat.'
A business adviser has commented on this statement as follows:
'The whole problem about winter sports in this country is thevariability and unpredictability of snow cover. On average, conditionsare as good as any in on the continent. However, if your first threeseasons are poor then this could have a devastating effect on projectviability.'
The landowner's cost of money is 12% per annum and in appraisinginvestments he considers cash flows over a ten-year period only. He hasignored fixed costs from the assessment due to their nature, butincluded the cost of the loan repayments as a relevant cash flow.
His calculations are as follows:
Note on loan repayments: 4% 6 yr annuity factor = 5.242. Annual repayments = 125/5.242 = 23.8.
On this basis the landowner has decided to make the low level of investment.
(a)Explain and briefly assess thelandowners financial appraisal of the project. Your answer shouldinclude an explanation on why finance-related cash flows (loandrawdowns, interest payments and loan repayments) are normally excludedfrom project appraisal exercises, and identify the circumstances whensuch cash flows are included in the appraisal.
(b)Explain the full range of risks anduncertainties involved in the project at the outset. Explain how thesecan be incorporated and allowed for in appraisal of the project.
(Total: 25 marks)
13 Project management II
Question 25 QS Software â€“ Part 2
(Part 1 of this question was covered in an earlier chapter and should be read before attempting this part of the scenario.)
QS was awarded the contract to undertake the project at the end of October 20X7.
The project was to be completed by 30 May 20X8, 30 calendar weeksafter the award of the contract, with the design and delivery of acustomer database, which could be utilised by the customers throughaccess to a re-designed website. In addition, there was an option toextend the contract for a further 12 months for systems maintenance.This would be negotiated and finalised only after successful projectcompletion and systems performance evaluation.
Sam Smith was assigned the role of project manager, withresponsibility for managing the delivery of the final project to RGA. Itwas planned that three of the software engineers and one of theworkshop technicians would work full-time on the project. However, dueto QS already being committed to other jobs, Sam allowed these corestaff to be released from the RGA work when necessary. Other QS staffwere to be assigned temporarily to the RGA project as and when they wereneeded.
John Jones agreed to act as liaison between the project team andthe IT manager of RGA, as he considered it to be his project, having wonthe contract. However, John would not be directly involved in theday-to-day activities of the project.
Sam was not happy about being responsible for team management andco-ordination. He preferred the technical work to managing people andhad little experience of team leadership and delegation. No contractundertaken by QS previously had required this level of projectmanagement.
Phase one of the project began one week late, due to one softwareengineer working on another job. It was agreed at this point by Sam andJohn that, to save time, the purchase of the hardware could be broughtforward. However, the first stage payment had not yet been made and thepurchases had to be made by extending the overdraft facility. John wasconfident that the first key payment milestone would be reached and thefinancial concerns would be short-lived.
The website and customer database were completed on time, butprototype construction had to be delayed, as Sam allowed the technicianto work on other jobs during this time. (Sam was not fully aware of allthe details of the project plan as he had not been involved at theplanning stage, and he and John rarely saw each other. Sam himself wasoften absent visiting other clients.) The first stage deadline wasmissed. Although technically the project was progressing as planned, themain concern for Sam Smith was the availability of staff to completekey stages. Although other existing work being carried out by QS wassmall in comparison to the RGA project, these customers also required aquality service and commitment to deadlines. The second stage deadlinewas in danger of being missed.
In March, the IT manager from RGA contacted John Jones to demand anexplanation for the project delays. He was also concerned that so fewstaff of QS were working on the project, in particular the lack ofvisibility of the project manager. The IT manager demanded a meetingwith both Sam and John to review the current project status. John alsospoke to QS's bank manager who was concerned about the current overdraftfacility.
A small business adviser was assigned from the bank to assist QS for the remainder of the project.
Project review meeting â€“ 2 April 20X8
John called an emergency meeting with Sam, the other key projectteam members and the small business adviser. The main issues which arosefrom the meeting were as follows.
- The designers were concerned that they did not know which work to prioritise
- The project team members were not aware of any deadlines for the RGA project, as no one had shown them a project plan or schedule of work
- Sam argued that he was not a trained project manager and could not be expected to manage such a large undertaking and be responsible for all of the other smaller jobs in progress.
- The cash resources of the business were in a critical state. QS could not afford to miss another stage deadline or lose the lucrative maintenance contract.
(a)Identify the problems currently being encountered by Sam in managing the project team of the RGA Project.
(b)Recommend ways in which the managers of QS could improve the management of the project team.
(Total: 25 marks)
14 The role of finance in formulating and implementing business strategy
Question 26 Multinational and local authority
All organisations have objectives in some form or another. Themethods of setting these objectives vary depending on the nature of theorganisation. After they have been set and an appropriate period of timehas elapsed, organisations should assess to what extent theirobjectives have been achieved.
Two organisations with very different characteristics set strategicobjectives and evaluate their achievement. The two organisations are:
- a publicly-funded local administrative authority which provides housing, education, social and road maintenance services for an area within a country, and
- a multinational conglomerate company (MNC).
(a)Explain the differences between how the local administrative authority and the MNC should set their strategic objectives.
(b)Discuss how each organisation should assess how well it has performed in respect of the attainment of its strategic objectives.
(Total: 25 marks)
Question 27 Spartan Inc.
It is easier to revise sources of finance and ratios using a question.
Spartan Inc. is a medium-sized manufacturing company that plans toincrease capacity by purchasing new machinery at an initial cost of $3m.The following are the most recent financial statements of the company:
The investment is expected to increase annual sales by 5,500 units.Investment in replacement machinery would be needed after five years.Financial data on the additional units to be sold is as follows:
- Variable administration and distribution expenses are expected to increase by $220,000 per year as a result of the increase in capacity.
- In addition to the initial investment in new machinery, $400,000 would need to be invested in working capital.
- The full amount of the initial investment in new machinery of $3 million will give rise to capital allowances on a 25% per year reducing balance basis. The scrap value of the machinery after five years is expected to be negligible.
- Tax liabilities are paid in the year in which they arise and Spartan Inc. pays tax at 30% of annual profits.
- The Finance Director of Spartan has proposed that the $3.4 million investment should be financed by an issue of loan notes at a fixed rate of 8% per year.
- Spartan uses an after-tax discount rate of 12% to evaluate investment proposals. In preparing its financial statements, Spartan uses straight-line depreciation over the expected life of fixed assets.
- Average data for the business sector in which Spartan operates is as follows:
- Gearing (book value of debt/book value of equity) 100%
- Interest cover 4 times
- Current ratio 2:1
- Inventory days 90 days.
(a)Suggest alternative sources of finance that Spartan could use, outlining the advantages and disadvantages of each.
(b)Analyse and comment on the recent financial performance of the company.
(c)Calculate the effect on the gearingand interest cover of Spartan Inc. of financing the proposed investmentwith an issue of loan notes and compare your results with the sectoraverages.
Question 28 Bits and Pieces
Bits and Pieces (B&P) operates a retail store selling sparesand accessories for the car market. The store has previously only openedfor six days per week for the 50 working weeks in the year, but B&Pis now considering also opening on Sundays. The sales of the businesson Monday through to Saturday averages at $10,000 per day with averagegross profit of 70% earned.
B&P expects that the gross profit % earned on a Sunday will be20 percentage points lower than the average earned on the other days inthe week. This is because they plan to offer substantial discounts andpromotions on a Sunday to attract customers. Given the price reduction,Sunday sales revenues are expected to be 60% more than the average dailysales revenues for the other days. These Sunday sales estimates are fornew customers only, with no allowance being made for those customersthat may transfer from other days.
B&P buys all its goods from one supplier. This supplier gives a5% discount on all purchases if annual spend exceeds $1,000,000. It hasbeen agreed to pay time and a half to sales assistants that work onSundays. The normal hourly rate is $20 per hour. In total five salesassistants will be needed for the six hours that the store will be openon a Sunday. They will also be able to take a half-day off (four hours)during the week. Staffing levels will be allowed to reduce slightlyduring the week to avoid extra costs being incurred.
The staff will have to be supervised by a manager, currentlyemployed by the company and paid an annual salary of $80,000. If heworks on a Sunday he will take the equivalent time off during the weekwhen the assistant manager is available to cover for him at no extracost to B&P. He will also be paid a bonus of 1% of the extra salesgenerated on the Sunday project.
The store will have to be lit at a cost of $30 per hour and heatedat a cost of $45 per hour. The heating will come on two hours before thestore opens in the 25 'winter' weeks to make sure it is warm enough forcustomers to come in at opening time. The store is not heated in theother weeks.
The rent of the store amounts to $420,000 annum.
(a)Calculate whether the Sundayopening incremental revenue exceeds the incremental costs over a year(ignore inventory movements) and on this basis reach a conclusion as towhether Sunday opening is financially justifiable.
(b)Discuss whether the manager's pay deal (time off and bonus) is likely to motivate him.
(c)Briefly discuss whether offering substantial price discounts and promotions on Sunday is a good suggestion.
(Total: 20 marks)
Question 29 Teemo
The holding company of Teemo, a manufacturer, have had a shake upat all levels of Teemo's organisational organisation. A new board hasbeen appointed as well as many new senior managers. The newly-appointedManaging Director of Teemo has lots of experience in the industry butvery little accounting knowledge. She has received a variance report forMonth 6, which is shown below:
Month 6 Variance Report
The previous managing director was focused on cost control and wasless concerned about the performance of the sales department. The new MDhas asked the new finance director to provide some idea of theperformance of the sales team and to explain the variance report to herso that she can make a judgement on the performance of the company overthe last month. She would like to know what the budgeted contributionwas before she makes a judgement on the overall performance.
The finance director has gathered together the following information prior to preparing his report.
(1) Teemo produces one type of product. It operates a standard marginal costing system.
(2) The standard unit cost and price of the product is as follows:
(3) The variable overhead absorptionrate is based on direct labour hours. The company has budgeted fixedoverheads of Â£70,000 per month.
(4) Budgeted sales and production levels are 1,000 units per month.
(5) 1,200 units were actually produced and sold in month 6.
(6) The actual direct materialspurchased and used was 6,300 kg costing Â£132,300 and the actual directlabour hours worked were 5,040 hours.
Prepare a report for the Managing Director of FX that explains and interprets the Month 6 variance report.
Question 30 Tupik
A manufacturing company, Tupik, makes and sells two products A andB, each of which passes through the same automated productionoperations. The following estimated information is available for period1:
Production/sales of products A and B are 120,000 units and 45,000units with selling prices per unit $60 and $70 respectively. Maximumdemand for each product is 20% above the estimated sales levels. Totalfixed production overhead cost is $1,470,000. This is absorbed at anaverage rate per hour based on the estimated production levels.
One of the production operations has a maximum capacity of 3,075hours which has been identified as a bottleneck which limits the overallproduction/sales of products A and B. The bottleneck hours required perproduct unit for products A and B are 0.02 and 0.015 respectively.
The management have always been indifferent between the twoproducts and have not managed resources to manage one over the other.The sales manager argues that each product is designed to make the samenet profit per unit and that makes his job easier. He just divides hisresources between the products and doesn't do anything more complicatedas resource planning.
But the company's finance director believes that profits should behigher and wants to encourage the production director to consider morecareful resource planning and the sales director to have a clearer ideaof the company's priorities.
(a)Show why the sales manager of Tupikargues that he is indifferent on financial grounds as to the mix ofproducts A and B which should be produced and sold.
(b)Advise the company on which product(s) it should make and sell.
15 Strategy and people
Question 31 Jays
Jays is a former footwear manufacturer. The firm was started inMelbourne, Australia in 1900 by the grandfather of Jay, the presentowner. Over the years, Jays grew into a national retail chain withhundreds of shops. In 1996, cheap imports forced the sale of the shoeretail business but Jay retained 123 outlets and developed a'while-you-wait' shoe repair service in comfortable surroundings.
The formula proved very successful and the business has grown to325 outlets. By 1999, the market in shoe repairs was becoming saturated,so Jay added the high-margin businesses of key-cutting and watchrepair, using the same outlets as used for shoe repair and adding moreas demand grew.
Though watch repair has traditionally been the preserve ofhigh-street jewellers, Jay found that the skill barrier to thisoccupation was not as high as jewellers claimed it to be. In fact, hefound that most watch repairs boil down to about ten simple operationsand anything more complex could be dealt with by specialists at anational centre. In two years sales grew from zero to three millionAustralian dollars.
Employees in each of these businesses are primarily craftsmen orsemi-skilled operators but, as a retailer, Jay recognises how criticalexcellent customer service is in this business. The outlets aretypically staffed by a handful of craftsmen, though in busy centres thenumber rises to ten or more. Seating is provided for customers, withmagazines and piped music to keep them occupied while waiting.
(a)Explain the human resourcemanagement implications of Jays' shift from shoe retailer to that of aprovider of services in shoe repair, key-cutting and watch repairs.
(b)Describe how Jays might go about motivating its workforce.
(Total: 25 marks)
16 Strategic development and managing strategic change
Question 32 Y
Y is one of the five main high street banks in the country. Sincebanking deregulation in the late 1980s, Y, like other banks, has beenfacing increasing competition, first from other existing financialinstitutions but more recently from new entrants who have started tooffer deposit accounts and a number of other financial services.
In seeking to respond to these competitive threats, the bank'ssenior management has started to implement a number of changes. Theseinvolve a significant restructuring of the organisation with the removalof a number of layers of management, and a consequent reduction instaffing levels in most divisions. The closure of a number of highstreet branches is also planned. The telephone-banking arm is beingsubstantially enlarged and a major investment in IT is being undertaken.The effect on staff will be considerable. A programme of voluntaryredundancy and redeployment is planned and, given the demand for newskills, a considerable amount of training will need to be carried out.Despite clear evidence of the threat of the future of the bank, theplans set forth by management are meeting resistance from the workforce.The banking unions in particular seem determined to obstruct thechanges wherever possible.
Required (with reference to the above scenario)
(a)Explain why the implementation of organisational change often proves to be so difficult.
(b)Advise Y's management about the ways in which change can be facilitated.
(Total: 25 marks)
Question 33 BHH Clothing
The European clothing industry is a mature industry characterised by the following:
- Powerful retailers resulting in high pressure on manufacturers' margins
- Increasing globalisation resulting in many manufacturers switching production to cheaper locations outside Europe to reduce their cost base
- Increasing competition from Chinese manufacturers due to their lower costs, an improving reputation for quality and the relaxation of quotas.
Retailers buy on three criteria and put pressure on manufacturers to improve each of the following:
- Speed to market/lead times
BHH is a clothing manufacturer based in Europe, making ladies andgirls' clothing aimed at the medium/high price segments of the market.The majority are sold under retailers' own labels. BHH's competitivestrategy to date has been to differentiate through close collaborationwith clients, good designs and hand finishing of garments. HistoricallyBHH has resisted the pressure to source garments from cheaper countriesoutside of Europe but falling margins have lead directors to questionthis stance.
Issues were brought to a head recently when BHH lost Forum, a majorcustomer, despite offering a 4% price cut. Forum claimed that theycould get similar garments supplied much cheaper by companies that useChinese factories to make them. Two other large customers are alsoputting pressure on BHH to cut prices without compromising quality.
At a recent board meeting directors decided that the only wayforward was to keep design and finishing in Europe but outsource themanufacture of the basic garment to China. Unfortunately news of thisdecision leaked out to the workforce before the board could make aformal announcement, causing widespread unrest amongst employees, someof whom have worked for BHH for over twenty years. There is thus now thethreat of strike action to try to resist feared redundancies.
Apply the change kaleidoscope model to BHH as follows:
(a)Examine the wider strategic contextfor change by assessing the main environmental influences andconsidering the alternative strategies available to BHH.
(b)Analyse, information permitting, the contextual features that the directors must consider.
(c)Discuss the design choices available to manage the change process and make recommendations.
(Total: 25 marks)
Test your understanding answers
Question 1 David Gould
(a)Writing a business plan is acritical stage in moving an idea for a business into a reality. Thereality includes presenting a convincing case to potential financers ofthe business, be they banks or venture capitalists. The key ingredientsinclude clearly saying what you plan to do and why people should want tobuy your particular service. Experts warn of starting with a detailedcash flow and then working backwards to make the numbers fit. You shouldregard the business plan as a management tool and not simply a salesdocument. Again, the advice is to make credible and achievableprojections; it is better to exceed low targets than fail to achieveover-ambitious ones. Many business plans are based on deeply flawedresearch. Key to your business success will be the size of your targetmarket. There is much evidence to suggest that it is the make-up of theteam presenting the plan and their commitment rather than the businessidea itself that will determine whether the necessary financial supportis made.
Clearly, you need to say how much money you require and why. Againthe advice is not to be afraid to ask for large amounts if your businessrequires it. Linked to how much you want is a clear statement of thereturn the investor or lender will get â€“ how much of the equity areyou willing to give or what security can you offer the lender? Figureare important and you need projected cash flows, profit and lossaccounts and balance sheets for at least three years ahead. Potentialinvestors and/or lenders are likely to be impressed by a plan whichclearly indicates where the major risks are to be found and thestrategies available to handle such risks.
There needs to be a clear statement of the major steps andmilestones on the way to achieving your goals. Where are you now, wheredo you intend to be and how are you going to get there. One expertargues there are three elements of the plan itself â€“ an executivesummary pulling together the key points in your proposal, secondly theplan itself and finally an 'elevator pitch', a one paragraph descriptionthat explains the business in the time it takes to go up in a lift.
In summary, your business plan should contain an executivesummary as explained above, the objectives of the business, includingkey financial targets and the philosophy of the business, the targetmarket and relevant forecasts, the range of products/services, themarketing strategy linked to the target markets, resource availability,people and organisation involved, performance measurement to measureprogress towards stated objectives and a summary of financialinformation.
One final point is to remember that no business plan ever wascarried out exactly! In many ways it is the quality of the thinking theplan includes and the actual process through which it is developed thatwill determine success.
(b)Clearly, there is a link betweenthe ability to write a business plan and the willingness, or otherwise,of small firms to carry out strategic planning. Whilst writing abusiness plan may be a necessity in order to acquire financial support,there is much more question over the benefits to the existing smallbusiness, such as Gould and King, of carrying out strategic planning.One of the areas of greatest debate is whether carrying out strategicplanning leads to improved performance. Equally contentious is whetherthe formal rational planning model is worthwhile or whether strategy ismuch more of an emergent process, with the firm responding to changes inits competitive environment.
One source argues that small firms may be reluctant to create astrategic plan because of the time involved; small firms may findday-to-day survival and crisis management prevents them having theluxury of planning where they mean to be over the next few years.Secondly, strategic plans may also be viewed as too restricting,stopping the firm responding flexibly and quickly to opportunities andthreats. Thirdly, many small firms may feel that they lack the necessaryskills to carry out strategic planning. Strategic planning is seen as a'big' firm process and inappropriate for small firms. Again, there isevidence to suggest that owner-managers are much less aware of strategicmanagement tools such as SWOT, PESTEL and mission statements than theirmanagers. Finally, owner-managers may be reluctant to involve others inthe planning process, which would necessitate giving them access to keyinformation about the business. Here there is an issue of the lack oftrust and openness preventing the owner-manager developing and sharing astrategic plan. Many owner-managers may be quite happy to limit thesize of the business to one which they can personally control.
On the positive side there is evidence to show that acommitment to strategic planning results in speedier decision making, abetter ability to introduce change and innovation and being good atmanaging change. This in turn results in better performance includinghigher rates of growth and profits, clear indicators of competitiveadvantage. If Gould and King are looking to grow the business assuggested, this means some strategic planning will necessarily beinvolved.
Question 2 Dunvegan Ltd
I have been asked to give advice on the proposal to plant 1,000 hectares of land with Maho spruce.
Mahogany currently comes from four countries in the tropics. As itis a valuable export, these countries can be expected to be willing tosell mahogany irrespective of local political changes.
In the UK, however, there is growing concern about thedeforestation of the tropics and suspicion about the source of manyhardwoods. It is possible that the UK or EC will tighten importlegislation.
Locally-grown, renewable mahogany substitute should be favoured in this ecologically-aware age.
Mahogany is principally used for building (window frames etc.) andfurniture (veneers). Both of these industries are very sensitive to thehealth of the economy. It is difficult to predict the economic health ofthe country ten years hence and so the project will have considerablerisk and uncertainty.
If home-owning continues to grow, it is to be expected that demandfor high-quality materials will also grow. As mentioned under thepolitical paragraph, using tropical hardwoods could become sociallyunacceptable and it would appear that the Maho spruce should provide apolitically acceptable substitute.
However, some people may object to using genetically-engineered material.
Although Maho spruce has been patented, there is no reason whyother manufacturers could not develop similar products. That would drivedown the cost of seedlings (a major cost of the undertaking) and hencethe price that would eventually have to be achieved to make theinvestment pay.
The industry competitive position
The industry competitive position can be analysed in terms ofrivals, buyers, suppliers, substitutes and potential new entrants to themarket.
The potential rivals are the other UK forestry companies and the suppliers from the tropics.
Whether other UK forestry companies will decide to compete is a very complex decision and is discussed below.
The foreign suppliers, which depend on their hardwood for valuableforeign currency, are likely to retaliate with price cuts when theyperceive Maho spruce as a threat.
It is likely that there are many relatively small buyers of hardwood. If so, there will be little pressure from them.
The main supplier to Dunvegan Ltd is the supplier of the seedlings.At the moment there is only one supplier and this would normally placethat company in a very strong position.
However, the supply pattern here is unusual. Once 1,000 hectaresare planted, the supplier has no power at all over this project as nofurther supplies are needed for it.
Future projects would need to be evaluated in the light of supplier attitudes at the time.
New entrants into the forestry industry are unlikely, but there issome risk if the crops become more lucrative and land is set aside fromnormal agricultural use (EC regulations). Much will depend on theperceived economies of the industry.
Maho spruce is an excellent substitute for mahogany. Substitutesfor Maho spruce might be other genetically-engineered trees with moreattractive or cheaper timber. Substitutes maturing more quickly would beparticularly serious as they would capture the market and drive downprices before Dunvegan's timber had matured.
If the present price of mahogany and mahogany substitutes ismaintained, then the project will produce a positive net present value.
If the price falls by more than about 30% to below Â£639, then the project will produce a negative net present value.
As mentioned above, it is likely that the foreign suppliers willcut their prices so as to keep earning foreign exchange. The reaction ofUK forestry companies will depend on their estimates of future pricesand supplies.
If the price of mahogany is expected to fall to Â£500, then theplantation should not be undertaken as there would be a negative NPV. Ifthe price is expected to fall to no less than Â£800 then the projectwould produce a positive NPV.
However, Dunvegan Ltd's competitors will have carried out similarcalculations. Their break-even points must be very similar to DunveganLtd's as the NPV calculation is dominated by the initial price of theseedlings and the final price of the timber.
The competitors can also be assumed to have read the economist's article in the trade journal.
All the players are faced with an investment paradox.
(a)If a player believes that theothers will invest, then investing is not worthwhile as the timber pricewill fall to an uneconomic level. (Of course, if they all believe this,no one will invest and the price would stay high.)
(b)If a player believes that theothers will not invest, then investing is worthwhile as the price wouldstay high. (Of course, if they all believe this, all will invest and theprice would fall.)
Conventional financial analysis is of little further help here. Itis crucial to try to find out the true intentions of the competition orto try to limit their scope for competition.
It is in the interests of the producers of the Maho spruce to bringstability to their market. If everyone is afraid to invest, then thatcompany will get no revenue. An agreement with the supply company tolimit the sale of seedlings each year would ensure that the pricesremained higher and that investment would be worthwhile.
Size of investment
The proposed investment is large, especially as there are manyimportant factors which could change over the project's life: theproject is high risk even if not using innovative technology.
Risk could be reduced by planting over several years rather than1,000 hectares at one time. That way the economics of the investmentcould be monitored and decisions taken about each slice of investment.Naturally, this approach would delay the maturity of some of the crop.There is a risk that this would reduce the final income (if mahoganyprices were to fall) but prices could also rise (strong reaction againstnatural mahogany, economic upturn). Delaying planting could also reducethe initial price of seedlings as other bioengineering companies launchnew products.
In so far as environmental factors can be judged, it would seemthat Maho spruce should be a popular product. The main risk arises fromtechnological advances which could produce similar cheaper timber.However, the economics of the project are very dependent on the futureprice of Maho spruce timber, its substitutes and the reactions ofrivals.
Question 3 T Plc
(a) PEST Analysis
The following external factors are relevant to T plc:
T plc currently dominates its national telecommunicationsmarket with an 85% share of the market. The company will be underpolitical pressure from the national government to reduce its dominanceby opening up the national telecom market to competition and reducingprices for telecom products charged to consumers.
The government has appointed an industry regulator to bedirectly involved in the control of the telecom industry and T plc nodoubt will be under close scrutiny. Political forces will be a majorfactor affecting the operations and plans of T plc.
There are three main economic elements that T plc needs to consider. These are:
- Shareholder wealth
T plc's shareholders are a major stakeholder group who will have economic objectives of profit maximisation and rising share value.
- The contribution of the telecommunications industry to the national economy
The telecommunications industry plays a major role in contributing towards economic growth and prosperity. T plc has a responsibility to develop new technology and to provide a reliable, value for money service to its users.
- The economies of foreign countries
The economic conditions in each foreign country T plc operates in should be considered e.g. foreign currency exchange rates and national economic boom and slump cycles.
Telecommunication products are social products used by peoplefor many reasons. The company should ensure that it understands thesocial role of the industry and provides a reliable service. The companyshould also portray itself as socially responsible, have a set ofsocial objectives and keep in close contact with the consumers e.g. byproducing a range of services for elderly citizens who are moredependent on telephones for obtaining help when needed.
The telecommunications industry is a high-tech industry that iscurrently very dynamic. T plc is the market leader in the industry andmust be innovative to maintain its competitive advantage. The companymust invest in research and development to ensure it has a constantsupply of new products in the years ahead to replace those going intothe decline stage of their product life cycle.
By relating products to markets, Ansoffidentified four main strategies for achieving long-term growth. Usingthis model the potential market opportunities are as follows:
Market penetration strategies
T plc currently has 85% of its national market. There is littlescope for obtaining any growth by increasing its market share. Mosthouseholds and businesses will have a conventional telephone line sosome of the company's products will be at the maturity stage of theirlife cycle offering little prospect of growth. Some market growth mightbe achieved by getting existing customers to use the telephone more.
A market penetration strategy only offers limited growth prospects.
Product development strategy
This strategy involves introducing new products in existingmarkets. T plc has already achieved a good track record for new productdevelopment and with continued investment in research and developmentshould maintain its momentum. There is a lot of market opportunity inthe industry for this strategy, for example further developments inmobile phone and Internet technology.
Market development strategy
T plc has pursued a successful strategy of expanding intoforeign markets with existing products. It currently has operations inNorth America, Europe, India and the Far East. In T plc's latest annualreport, the Chairman refers to developing these markets further.Tremendous opportunities exist in additional developing countries suchas those in Africa where the company currently has operations.
This involves introducing new products to new markets and is ahigh-risk strategy. T plc is a large profitable company with aprospector (innovative) culture. The company should evaluate carefullythe risk of any diversification strategy and if opportunities exist theyshould be considered e.g. digital television technology.
The company should pursue all four strategies with the mainemphasis on product development and market development, as these exploitthe company's main strengths of expertise in research and development,and growth in foreign markets.
Question 4 CSC Clothing
(a)The extent to which location hashistorically determined the competitive advantage of CSC and the extentto which it will do so in the future are issues of crucial importance toKZ. A historical analysis of location provides a deeper understandingof CSC's strategic position, and an analysis of the extent to which itis still relevant will assist KZ as it contemplates shifting CSCproduction and exploiting the CSC brand image.
The debate about location and comparative advantage is both long standing and ongoing. However, the work of Porter (Competitive Advantage of Nations) presents us with a useful framework in which to consider the attributes of advantage.
Porter identifies four interlocking elements which form a 'diamond' of location-based advantage. These four elements can be used to analyse the position of CSC as follows:
- Factor conditions. These are the resource inputs needed by the business and in particular the inherited factors of natural resources â€“ climate, labour and the evolution of knowledge and skills. CSC grew out of a business which originally both made and supplied outdoor clothing to Scottish hill farmers thus reflecting the influence of a climate and a geography which demanded tough weatherproof clothing (influences â€“ quality and fitness for purpose) and developed the knowledge and skills to design and manufacture such clothing.
- Intense home market demand conditions, led by sophisticated and numerous independent buyers, drive firms to innovate continually and improve their products. Over time, CSC has been required to meet the demanding product requirements of the Scottish hill farmers which means that its products have evolved features of superior weatherproofing and durability. Although the products may today be bought by people who will never venture on a mountain in winter, they are nevertheless buying into what is seen to be a product ownership image associated with the product's history and design attributes (similar to buying an off-road, four-wheel drive vehicle for use within a city environment).
- Related and supporting local industries, which through mutual support and collaboration enhance competitive potential, for example through design synergies achieved by close co-operation between firms operating within the value chain. CSC has enjoyed the support of local weavers which allows integration of cloth requirements such as supply and delivery, quality attributes and, in particular, the traditional pattern design used in the garment fabrics.
- Intense local demand rivalry which leads to the emergence of firms with strong competitive characteristics, in other words, the home market hones competitive skills which promote domination in worldwide markets. This appears to be the case within CSC's home market where CSC first emerged as the market leader among a number of competing Scottish firms within this specialist garment business.
Porter also identifies other factors, such as the role of government,which might assist through intervention â€“ industry support inresearch and development, or more often non-intervention â€“ creating abusiness environment which promotes competition. CSC has evolved througha one-hundred-year period of relative business stability and freedomfrom either intervention or subsidy. Finally, there is always an elementof chance within business success stories. CSC has achieved its successthrough a process of product development (moving from simple garmentsfor farmers to garment-based products for sports such as shooting andfishing), and market development (using existing products in new marketsâ€“ creating a fashion niche image). Both opportunities have in partbeen made possible by the chance adoption of its basic products by therich and famous, which in turn has made the products prestigious andtherefore ones which the not-so-rich and famous wish to acquire.
(b) CSC could reduce its product costs by moving garmentproduction from Scotland to South East Asia. However, it is doubtful towhat extent this move has a strategic fit with the competitive strategyadopted by CSC. The CSC strategy is based on focused differentiation,that is, creating a perception of high value to the customer andcharging a high price for it â€“ by implication such a strategy willlead to niche market segmentation. In this case, the niche is aglobal one which targets similar customers with similar aspirationsworld-wide (other product examples, Rolex, Gucci) and is independent ofcultural differences.
This is the context within which KZ must decide its production policy for CSC. The decision cannot be cost-based aloneand subsequently made in isolation of the values, needs andrequirements of the customers of CSC and their associated patterns ofbuyer behaviour. CSC products are not bought on the basis of price, buton the basis of buyers seeking to acquire reflected status associatedwith the product.
The fact that each garment is handmade in Scotland, usingtraditional materials and design, is a key part of what the customer isbuying into. CSC recognise this and its integrated marketing strategyreflects this â€“ price, product concept, distribution channels (thebest stores) and promotion are all in balance. Although it may bepossible to maintain product quality by moving production away fromScotland KZ would run a major risk of destroying the CSC product conceptand hence the differentiation element which allows the adoption of apremium pricing approach.
Question 5 Scottish Holidays
Explanation of the calculation
The business has used time series analysis to prepare its forecast as follows:
The first table has been used to calculate the underlying trend inthe data and any past seasonal variations. The first two columnsrepresent the actual recorded historic data.
The next two columns represent the trend calculation. Firstly amoving average has been calculated. A two period average has beencalculated (though a longer period may have been more appropriate inorder to 'iron out' any anomalies). It is moved forward by one periodeach time (by adding a new period and removing the oldest period) sothat an underlying trend can be identified.
These moving averages are then averaged (each pair is totalled anddivided by two) to give a centred moving average. This allows the movingaverage to tie together with actual data periods. This centred movingaverage is the trend line. A pattern is immediately obvious â€“ it wouldappear that there is an increase in the trend each period (of around$50,000). So we can tell that over the four years sales have shown aconstant underlying increase.
The seasonal variation
The final column is used to calculate the seasonal variation. Thisis the difference between the actual sales and the underlying trend. Forexample, in summer 20X8, we can see that sales were $52,500 above'trend'. This pattern recurs through all 4 years, with summer periodsshown seasonal peaks well above the trend, and winter periods showingtroughs well below the trend.
The second and third tables seek to calculate an average of theseasonal variations and conclude that, on average, summer sales are$53,100 above average and winter sales are $53,100 below average (slight mathematically adjustment has been made to ensure that theseaverages net to zero).
The forecast is in two parts. Firstly the trend line has beenextrapolated forward to Winter 20X9. This has been done by taking thelast recorded trend figure (52.7 in winter 20X8) and adding two moreperiods to it. An average increase in the trend has been calculated overthe four years using a high low method. This gives an average increaseof [($527,500 â€“ $123,500) / 8 seasons =] $50, 500 each season.
Once the underlying trend figure has been identified for winter20X9, this trend is then adjusted for the average seasonal variation(calculated earlier) to give the forecast sales for winter 20X9.
Validity of the calculation
There are some advantages in using this method of forecasting.Firstly, there appears to be a clear seasonal pattern to past sales andusing time series analysis is a good way of identifying and using this.Secondly, the trend seems very consistent so that using past data topredict future sales would seem to be theoretically sound. Thirdly, thebasis of the forecast seems sound in that the average increase in thetrend and the average seasonal variation have been used to produce theforecast sales.
But the method also has some disadvantages. The main disadvantageis that it ignores changes in the external environment. This isimportant in this scenario due to the political factors that couldpotentially boost sales in future periods. The government's initiativesmay mean that winter sales are not as low as in the past and thattherefore the underlying trend and seasonal variation may not beapplicable.
The method also doesn't account for any internal changes to theorganisation. It may well be that the business will carry out extramarketing or make some capital investments which might also 'buck' thetrend experienced in past years.
The technique used by the business is accurate and theoreticallysound. However, the business is likely to experience significant changesdue to new government plans which may mean that past data will not be agood predictor of future sales patterns.
Question 6 Marcus Aurelius
Linear regression analysis
The marketing director has used a forecasting technique known aslimiting factor analysis. This assumes that there is a linearrelationship between two variables. In this instance, it will assumethat as advertising expenditure increases, sales revenue will alsoincrease at a constant rate.
Line of best fit
To determine the rate of increase (donated by the letter 'b' inforecast calculations) a mathematical formula is used to find what isknown as the 'line of best fit'. This effectively calculates the averageincrease observed from the data that has been recorded.
It can be seen in these calculations that 'b' has been determinedto be 5. This means that, on average, based on the observations from thefive shops examined, for every $1 spent on advertising, sales can beexpected to increase by $5.
Using the average revenue and average advertising expenditurerecorded an estimate is then made of underling sales (donated by theletter 'a' in forecast calculations). This has been estimated at 300.This implies that even if there was no advertising carried out by ashop, sales would still be $300,000. For example, if we believe that 5is the best estimate of the relationship between the variables andexamine shop 4, we can estimate that the effect of advertising on thisshop is to generate $450,000 of sales revenue (i.e. 5 times the $90,000that was spent on advertising). This would leave $300,000 of sales thathave not been determined by any advertising expenditure.
Coefficient of determination
This tests the strength of the relationship between the variables(advertising expenditure and sales revenue in this scenario). A figureof 0.984 tells that 98.4% of any change in sales revenue can beattributed to a change in advertising expenditure. This is a high figureand should give some reassurance to the accuracy of the estimate of b.
Forecast sales revenue
The two calculated figures (5 for the line of best fit, and$300,000 for the underlying sales revenue) have then been used toforecast sales for the two new shops as follows:
Validity of the technique
As already explained, there does appear to be a strong relationshipbetween the variables â€“ as is shown by the high coefficient ofdetermination. However, it should be noted that even in this estimate itstill means that 1.6% of changes in sales cannot be attributed to achange in sales revenue and therefore an element of uncertainty/error+does exist.
The relationship does appear to hold true for the chops that havebeen observed and the period that has been examined. But linearregression does not take account of changes in the external environmentof the business. For example, changes in popularity of the product or aneconomic downturn may both affect sales irrespective of what happens toadvertising expenditure.
There may also be internal changes to the organisation such as themethods used for advertising the product or the outlets used. This willnot be reflected in the linear regression forecast, which assumes thatthe past will be a good indicator of the future and therefore ignoresboth internal and external changes which might affect the company.
The second prediction is the more reliable as it involvesinterpolation. The first prediction goes beyond the original data uponwhich the regression line was based and thus assumes that therelationship will continue on in the same way, which may not be true.There may be a maximum level of sales that a shop can handle, forexample, so that sales do not constantly rise at the same rate.
The forecasting method used is in itself sound. There appears to bea strong relationship between advertising expenditure and salesrevenue. But the company should carefully consider whether the new shopswill operate under the same conditions as the existing shops andwhether there are other internal or external factors or changes thatneed to be considered.
Question 7 MW and FS
(a) (i) Production of a SWOT analysis for MW
When developing a strategic plan it is useful toundertake a SWOT analysis. At the current time MW is seeking to enhanceits shareholder value, its main objective. Therefore the SWOT analysiscan be used to identify how the business can build on its strengths andtake corrective action for its weaknesses. This in turn will increaseboth profitability and market share for MW.
- Secure financial base.
- Well established in the North.
- Increased share price and profitability.
- Prior experience in takeovers is limited.
- Lack of experience in managing the takeover process itself.
- Not maximising use of capital resources.
- Not much opportunity for further organic growth in the North.
- The company cultures will be different, so will require integration.
- Takeover will mean improvements in both competitiveness and market share.
- An increase in gearing will mean that the company will make increased use of debt, in turn resulting in lower costs, as debt is cheaper than equity.
- Takeover of FS will mean expansion into the South.
- Staff morale may fall when stores are sold after the takeover takes place.
- The bid cost may rise if competitors are also interested in purchasing FS.
- If MW does not do the takeover, it risks stagnation in its own market.
- The family shareholding will be diluted if the takeover goes ahead.
- Another competitor could purchase FS, meaning that MW would see a reduction in its competitiveness as well as losing market share.
(ii) Usefulness of SWOT Analysis
The SWOT analysis for MW has highlighted thefact that the northern market is reaching saturation. This means thatfor MW to increase shareholder value it must increase both the marketgrowth rate and its market share, so consideration should be given tothe possibility of a takeover. However, care must be taken by MW toensure that the weaknesses identified in the SWOT analysis areaddressed. Therefore consideration should be given to how the takeoverprocess will be managed, given MW's lack of experience in this area.Also, it must consider that its bid may be unsuccessful, resulting inthe loss of expenses incurred prior to the decision being made.
(b)Assessment of FS
It is immediately apparent from thecalculations that the FS stores do not reach the level of absoluteprofitability enjoyed by MW. They do, however, have better gross profitto turnover levels. This means that MW is more efficient in terms of itsoverhead costs. If the takeover goes ahead shareholder value will beenhanced providing MW is able to achieve overall the same ratio of grossprofit to turnover that FS currently achieves. Also, in order toincrease shareholder value the net profit to turnover ratio of MW willneed to be achieved within the new company, by carrying out efficiencyimprovements within FS. Inventory turnover is a good example of where MWcurrently has greater efficiency than FS, as FS holds inventory for 75%longer on average, meaning there is a potential to reduce costs byputting MW's policies in place.
Looking at the sales, gross profit and net profits percustomer, it is apparent that FS uses premium pricing in comparison withMW. For example, if a comparison is made between the sales of northwestMW and the southwest FS stores the following calculation can be made:
This compares to 0.3 million customers of MW in the northwest,so reinforcing the fact that the higher sales and profits are a resultof premium pricing.
In FS stores the gross profit to turnover is higher than in MWstores, whilst the profit per square metre of FS stores in the southwestis comparable to the northeast MW stores, but lower in the southeast.Also net profit per square metre is lower for the FS stores. Thisdemonstrates that the increased gross profit to turnover ratio of FS isachieved by premium pricing and not efficient use of space. This meansthat this is another area where MW could add shareholder value, byincreased efficiency in the use of floor space in FS stores.
It is also apparent from the calculations that the staff of MWgenerate more turnover per employee than those of FS. This againsupports the fact that, if MW's efficiency can be implemented in FSstores, this will result in increased shareholder value. This lowerlevel of turnover per employee could be caused by the fact that FS staffget paid less than MW employees doing the same job, meaning that staffmorale could be low. I feel that this should also be looked at withinthe different geographical areas of MW, as at the present time there is adifference in salaries between those working in the northwest and thenortheast.
Calculations based on data provided in the scenario
Question 8 Qualispecs
(a) Corporate appraisal
A corporate appraisal is an overview of anorganisation's current position. It leads on from the internal andexternal analysis undertaken as part of the business planning process.
As the company works towards achieving its objectives, the corporate appraisal is a summary of the company's:
- strengths within the organisation relative to competitors
- weaknesses within the organisation relative to competitors
- opportunities available from the external environment
- threats from the external environment.
The company must develop a strategy which:
- capitalises on the strengths
- overcomes or mitigates the impact of weaknesses
- takes suitable opportunities
- overcomes or mitigates the threats.
In the case of Qualispecs:
- Reputation for quality
Quality is a major reason why people buy products, and continuing to build on this reputation will ensure customers continue to buy Qualispecs's products.
- Financially secure/large cash reserves
Qualispecs does not need to rush into the implementation of new strategies. It can take its time to ensure strategies chosen are appropriate for the business and implemented effectively. They also have funds to invest in new ventures without having to raise external funds.
- Backing of a famous sports star
This helps to improve the image of Qualispecs's products which in turn should result in higher sales, particularly amongst the younger market that might be influenced by the sports star.
- New Chief Executive
The group has a new Chief Executive who has joined from a rival, Fastglass. Fastglass has been a successful and innovative company and the Chief Executive may be able to bring new ideas and provide a fresh approach.
- Established group with many stores
The group has a good basic infrastructure including many stores and experienced staff. This allows them to implement new strategies quickly and easily.
- Slower dispensing of spectacles
Customer service is worse than competitors in this respect and may be a reason for the reducing customer loyalty.
- Less trendy products than competitors
Some competitors have successfully sold designer frames. These are likely to be stylish and trendy compared to Qualispecs' traditional products. Qualispecs may need to update products more often with the latest designs.
- Smaller product range than competitors
Some competitors have a wider product range than Qualispecs. This provides more choice which may attract customers and also gives competitors the opportunity to on-sell products, i.e. selling prescription sunglasses at the same time as standard spectacles.
- Older production methods causing higher costs
This will either cause prices to be higher than competitors or margins to be less. In either case competitors have a distinct advantage.
- Varying performance around the group
Little action is being taken to improve performance of poorly performing stores causing varying performance around the group. This indicates a weakness in internal control systems and perhaps also in development and training programmes.
- Little autonomy for shops
Without autonomy there is little a shop manager can do to improve local operations. In London, for instance, pay may need to be higher to attract the right staff. With no local control over pay levels, shop managers may find it hard to employ good staff and hence improve their business.
This lack of autonomy may also be demotivating to managers. Responsibility was one of the major factors outlined by Hertzberg in his motivation theory as a way to motivate staff.
- No incentive to improve for staff
The use of group-based bonuses means that people cannot be rewarded for good individual performance. Therefore, individuals have little incentive to improve.
Note: Opportunities should be in relation to the market as awhole. They therefore need to be available to all competitors in themarket.
- To adopt new technologies to reduce costs (see earlier)
- To stock a wide range of up-to-date products (see earlier)
- Consumer spending will continue to increase
Despite a slowdown in the economy, consumerspending is likely to increase suggesting an increasing market size inthe future. There is therefore further opportunity for all competitorsto increase sales.
- Targeting 18 to 30 year olds
The 18- to 30-year-old age group offers a particular opportunity since its spending is likely to increase especially quickly. There is therefore an opportunity to understand this group's needs and to target its specifically.
- Develop a partnership with a high street shopping group
Fastglass has already done this successfully and Qualispecs could follow suit. There are likely to be limited suitable partners so Qualispecs must act quickly before other firms make arrangements with the best partners.
- Intense competition/eroding customer loyalty
Existing competitors are adopting new strategies with great success (e.g. Fastglass developed joint ventures). This has resulted in Qualispecs's customers moving to competitors, thus reducing profits. This is likely to be a continued threat to Qualispecs who needs to respond.
- Downturn in the economy
In the long-term, if the downturn continues it will affect all industries and consumer spending will be likely to fall as people become more defensive in their spending habits.
Key strategic challenges
In summary, the key strategic challenges are to:
- Improve the current lack of clear generic strategy ('stuck in the middle')
Examining Michael Porter's Generic Strategies, Qualispecs appears to have neither a cost leader differentiation nor a focus on any particular niche. While traditionally quality has been their focus, new innovations from competitors have eroded its position as the highest quality spectacle retailer. In the long run it will find it hard to compete effectively if it does not rectify this.
Note: When asked to discuss current or future strategies Porter's Generic Strategies is always a good model to use. It is common in the exam to present failing companies (like Qualispecs) and you usually find such companies are 'stuck in the middle' and need to clarify their generic strategy in order to compete.
- Be more innovative in product and market development
Competitors have successfully developed new strategies while Qualispecs has done very little. This has seen it lose business to competitors. To be successful in the future it needs to update their product range regularly and be more innovative in developing new strategies (e.g. joint ventures).
- Improve performance on a divisional basis by updating internal policies and procedures
Current policies and procedures are demotivating staff and causing varying divisional performance.
(b) Strategies to move the business forward
Note: detailed tools for generatingstrategic options are discussed in chapter 6. At this stage you wereexpected to use your common sense.
Given the key strength of Qualispecs as having a reputation forquality spectacles, and their current weakness in the cost of productsproduced, it would appear logical for Qualispecs to refocus activitieson quality by producing very high quality spectacles (modern design,hard-wearing, up-to-date features) with a high-quality service (fastdispensing, knowledgeable staff).
Current product/current market
Qualispecs would benefit from consolidating its currentstrengths and refocusing on quality. It should invest in new technologyin order to reduce costs which will it to them be competitive. This alsocapitalises on its significant cash reserves.
It needs to improve its internal processes to ensure that staffare motivated through a good incentive scheme, quality training and bybeing given autonomy. This will capitalise on its skilled workforce andovercome the weakness in the way it is managed.
Current market/new products
Product development is a vital new strategy for Qualispecs tofollow. Its competitors have been successful in doing this. One aspectof providing a high quality service is being able to offer a wide rangeof products to meet varying customer needs. Qualispecs may need toinvest more in Research and Development and implement new productdevelopment programmes.
New market/current products
A joint venture strategy with a retailer who competes based onquality (e.g. Marks and Spencer) would both build on the reputation ofQualispecs and also introduce it to a new group of customers who willbuy its products through association with the retail group. The retailgroup may also have outlets in other parts of the country (or eveninternationally) which would allow Qualispecs to expand its markets.
There appears no need at present to diversify. Thedisadvantages of operating in new markets with new products (e.g. lackof experience and reputation) outweigh any possible advantages.
Question 9 Wargrin
(a)Lifecycle costing is a conceptwhich traces all costs to a product over its complete lifecycle, fromdesign through to cessation. It recognises that for many products thereare significant costs to be incurred in the early stages of itslifecycle. This is probably very true for Wargrin Limited. The designand development of software is a long and complicated process and it islikely that the costs involved would be very significant.
The profitability of a product can then be assessed taking all costs in to consideration.
It is also likely that adopting lifecycle costing would improvedecision-making and cost control. The early development costs wouldhave to be seen in the context of the expected trading results thereforepreventing a serious over spend at this stage or under pricing at thelaunch point.
(b)Budgeted results for game
On the face of it the game will generate profits in each of itsthree years of life. Games only have a short lifecycle as the gameplayers are likely to become bored of the game and move on to somethingnew.
The pattern of sales follows a classic product lifecycle with poor levels of sales towards the end of the life of the game.
The stealth product has generated $320,000 of profit over itsthree year life measured on a traditional basis. This represents 40% ofturnover â€“ ahead of its target. Indeed it shows a positive net profitin each of its years on existence.
The contribution level is steady at around 83% indicatingreasonable control and reliability of the production processes. Thisfigure is better than the stated target.
Considering traditional performance management concepts,Wargrin Limited is likely to be relatively happy with the game'sperformance.
However, the initial design and development costs were incurredand were significant at $300,000 and are ignored in the annual profitcalculations. Taking these into consideration the game only just brokeeven making a small $20,000 profit. Whether this is enough is debatable,it represents only 2.4% of sales for example. In order to properlyassess the performance of a product the whole lifecycle needs to beconsidered.
(W1) Split of variable and fixed cost for Stealth
(Note: the high-low method is unlikely to be examined in P3,but it should be a technique that students are familiar with fromprevious studies.)
Variable cost per unit = $20,000/4,000 unit = $5 per unit
Total cost = fixed cost + variable cost
$150,000 = fixed cost + (14,000 Ã· $5)
$150,000 = fixed cost +$70,000
Fixed cost = $80,000 (and $120,000 if volume exceeds 15,000 units in a year.)
(c)Incremental budgeting is a processwhereby this year's budget is set by reference to last year's actualresults after an adjustment for inflation and other incremental factors.It is commonly used because:
- It is quick to do and a relatively simple process.
- The information is readily available, so very limited quantitative analysis is needed.
- It is appropriate in some circumstances. For example in a stable business the amount of stationery spent in one year is unlikely to be significantly different in the next year, so taking the actual spend in year one and adding a little for inflation should be a reasonable target for the spend in the next year.
There are problems involved with incremental budgeting:
- It builds on wasteful spending. If the actual figures for this year include overspends caused by some form of error then the budget for the next year would potentially include this overspend again.
- It encourages organisations to spend up to the maximum allowed in the knowledge that if they don't do this then they will not have as much to spend in the following year's budget.
- Assessing the amount of the increment can be difficult.
- It is not appropriate in a rapidly changing business.
- Can ignore the true (activity based) drivers of a cost leading to poor budgeting.
Question 10 Digwell Explorations
Ethics are a code of moral principles that peoplefollow with respect to what is right or wrong. General examples mightinclude staying within the law, not engaging in bribery or theft orendangering other people.
Also a part of ethics is social responsibility; the dutytowards the wider community or society in general which includesenvironmental issues, public safety, employment and exploitation ofthird world workers.
In this case ethical issues which the government should have considered when granting permission for mining include:
(1) Employment in the local area
The government has a duty toward people toprovide them with jobs. In Eastborough there is significant unemploymentso it is particularly important to the government to generate jobs inthe area. The effect of the mining on employment levels should thereforebe considered.
(2) The local economy
The government has an obligation to the people ofEastborough to improve the wealth of the people there. This largelydepends on a successful economy. The local economy of Eastborough hasbeen performing badly despite various initiatives based around tourism.The effect of mining on the local economy generally must be considered(i.e. jobs create income which is then spent in local shops, demand forproperty increases and prices rise for all in the area).
(3) Environmental concerns
Eastborough has a beautiful coastline with rarebirds nesting there. The government has a debt towards society generallyto preserve areas of natural beauty for all to appreciate and enjoy,and a moral obligation towards other species on the planet to protectthem from extinction.
The effects of the mining operations on the rare birds, thebeauty of the coastline and any pollution caused in the locality shouldtherefore have been considered by the government.
(4) Rights of local individuals
Individuals have the right for their quality oflife to remain high. While employment and an improved economy mayimprove the quality of life of many, there may also be negative effectsfor some local people such as increased noise and traffic congestion.These broader effects on villagers is likely to have been considered.
(5) Right to free operation of business
Many capitalist countries believe in free tradeand removing barriers to trade. This may be seen as a right of thebusiness, and it may be considered as part of the decision to allowDigwell to open the mining operation.
Conflicts between stakeholder groups
Stakeholders are people who are affected or interested in some way by the mining operations.
In this case stakeholders include:
- national government
- local government
- local people
- wildlife protection groups
- environmental groups
- directors of Digwell
- employees of Digwell
- shareholders of Digwell.
The conflicts which may exist include the following:
(1) National v local government
Local government will be interested in Eastborough and its interests.National government have to balance those needs with the needs of allpeople of the country. There may be a conflict over the amount offunding available to support local initiatives such as to help start upthe mining operations.
(2) Unemployed v people based near mining operations/working people
Unemployed people of the area will notice a direct benefit from themining operations through increased jobs and are likely to support it.Other local residents may simply view the operations as disrupting theirexisting life (noise/congestion) and oppose the idea.
(3) Shareholders/directors of Digwell v environmental/wildlife protection groups
Both shareholders and directors of Digwell wish to make profits fromDigwell's operations. The mining operations will enable them to makefull use of an asset they own (tin reserves) and hence increase profit.They will wish it to go ahead, and may have very little interest in thebroader impact. Environmental groups aim to protect the environment andare likely to oppose any part of the mining operation which will affectthe environment irrespective of profitability.
(b) Stakeholder mapping
A useful model that can be used to examine stakeholders and how an organisation should deal with them is Mendelow's Matrix.
Mendelow said that there are two key aspects of understanding stakeholders:
This is the degree to which the stakeholder groupcan exert influence over Digwell, its operations and likelyprofitability. The local government, for instance, have the power togrant or refuse planning applications and hence have a lot of power inthe tin mining issue.
A local individual who feels strongly against the miningoperations may have little power because whatever they do they areunlikely to be able to influence the decision. A large local group ofpeople, on the other hand, have more power since they may be able toinfluence the local authority who must ensure the best interests oflocal people are met.
The greater the power a group has the more their views willbe considered when decisions are being made. Digwell, for instance,will have ensured that all local government concerns are met in order toget permission to undertake mining.
The level of interest which the stakeholder hasin the company (or in this case the mining operations) is also importantto the company. If a party is not interested then the company will notneed to concern itself with communicating with them or adapting to meettheir needs.
In this case, for instance, central government is likely tohave little interest in the local issue even though they havesignificant power. As long as the issue is not seen to affect nationalissues they are likely to remain unconcerned.
Stakeholders can be placed into Mendelow's Matrix according totheir interest and power. Depending on where they fall, a differentresponse will be necessary from Digwell.
The responses required are as follows:
Key player â€“ keep close
Key players must be kept close to the company in all majorissues relating to the mining operations. For example, closerelationships should be built with the local government so that they arecontinually kept informed of new plans. This ensures the plans areacceptable and within regulation. Any new requirements are also quicklyunderstood and can be dealt with promptly.
For example, the central government should be kept happy byensuring that the issue does not affect their main concern, nationalissues as a whole. So long as this is the case they are unlikely to getinvolved in this local issue and exert their considerable power.
For example, Digwell employees will be very interested in theeffect of the new operations on jobs. It may, for instance, create jobsecurity for them, or mean they have to relocate. It is therefore veryimportant to ensure they understand the impact on them and expectationsof them. Without formal notification, information will spread via rumourwhich may be inaccurate and cause undue concern.
It is important to clarify which groups have little power orinterest to avoid unnecessary effort being made. An example here is thegeneral public outside Eastborough. They are likely to have littleinterest or power and so no effort needs to be made to keep them happyand there is little benefit from keeping them informed.
Question 11 A University
Value activities consist of all those activities a firm undertakes,from the moment of initial purchase of raw materials and other inputs,to the moment of final receipt of payment from the customer. Value chainanalysis (VCA) looks at each of the processes that make up the chain ofactivity and asks both how important it is in a given company'sproduction or service activity, and how the company compares in thatrespect to its competitors. The value chain model divides anorganisation's activities into nine generic activities, five primaryactivities and four support activities.
To review the withdrawal rate of students from the University'scourses a clear statement of the University's objectives and what theyare trying to achieve needs to be drawn up by the management team. Themanagement accountant will then analyse the primary and supportactivities in the University's value chain and identify areas that arecausing the greatest level of concern.
- Inbound logistics â€“ are the activities concerned with handling the inputs. From the University's point of view the analysis will cover:
- the intake of students, e.g. whether entry requirements have changed. A lowering of standards may lead to students being unable to cope with the work, while a raising may find students' expectations of the course is not fulfilled. An increase in the intake could lead to more revenue but less individual attention for students with short-term problems.
- the courses offered and whether they have changed over the period of increased withdrawal.
- Operations â€“ concerned with the transformation of the inputs and will look in detail at:
- how the University compares with competitor institutions â€“ do they have similar withdrawal rates in the first year? If not, then the University needs to determine what they are doing differently and what they must do to improve the service. A review of the students that leave might show a pattern to the transfers, e.g. students leaving to go to particular universities.
- the calibre of staff â€“ are the lecturers able to communicate effectively and do they show an interest in helping the students in their studies? Also, does their treatment of students vary between the first year and subsequent years?
- Outbound logistics â€“ are concerned with the finished product, i.e. the skills and abilities of the graduates after completing their courses and the perception of the customers â€“ the government and employers.
- Marketing and sales â€“ are responsible for communication with the customers, e.g. advertising and promotion. The analysis should assess what attracts the students and why an increasing number believe that the course is not living up to their expectations.
- Service â€“ covers all of the activities that occur after graduation and includes arranging milk rounds, job fairs and other links to potential employers. The management accountant should analyse the types of contact with the graduate and the retention rates for students moving on to other courses in the University.
- Procurement â€“ is the process of purchasing inputs. Areas that will be analysed include the efficiency and adequacy of the supplies and the level of administrative support provided to the lecturers and students.
- Technology development â€“ covers not just machines and processes, but also know-how. Improved technology development may be employed in delivering course material to students. Technology may also be used in undertaking marketing research into the attractiveness of types of courses to prospective students.
- Human resource management transcends all primary activities. It includes all the activities involved in the recruitment, training, development and remuneration of staff.
- Infrastructure â€“ which supports the entire value chain, includes the systems of planning, finance, quality control and estate management.
Managing the linkages
- Primary-primary. Inter-departmental co-operation between, say, inbound logistics and marketing to ensure that prospective students are given sufficient information about courses.
- Support-primary. Computer-based operations, involving co-operation between information technology and lecturers. For example, teaching aids and course notes made available.
- Support-support. Computer-based information systems automatically monitoring recruitment policies.
The VCA analysis will help to determine why the rate of studentwithdrawal is increasing and to decide how individual activities mightbe changed to improve the value of the University's offerings. Becauseof the linkages it is important that the organisation's activities arenot dealt with in isolation. Choices will have to be made about therelationships and how they influence strategic capability e.g. therecruitment of staff with more teaching rather than research experiencemight have a positive effect on the students' experience but a negativeeffect on the University's reputation within its national academiccommunity.
Linkages between the University's support and primary activitiesmay also need strengthening, e.g. if some of the lecturers are lackingin communication skills it could be a direct result of management styleor a failure of human resources policy. Any inadequacies in support willhave a detrimental effect on lecturers, which may be a contributoryfactor leading to the problems of student withdrawal facing theUniversity.
Question 12 News Reel Inc
(a) Strategic position analysis
There are a number of tools that can be used toanalyse a company's position such as the value chain, PESTEL or 5 Forcesanalysis. The first of these models analyses the internal position ofthe business whereas the other models focus on its external position andprospects. The models can be brought together in a SWOT analysis and itis this model that will be used to assess News Reel's position.
Key strategic strengths
- News Reel is a focused differentiator. It stands out (differentiates) on its flexibility and delivery times. This has been arrived at by having less automated production, flexible suppliers and flexible production methods. This should allow the company to gain a competitive advantage and adapt quickly to changes in customer needs.
- Despite being a family owned business, News Reel's past performance has allowed it to accumulate cash and put itself in a strong financial position. It has created a cash reserve sufficient enough to finance an acquisition and allow the company to partake in the opportunities available to it.
- News Reel's reputation and association with EES will further enhance its competitive position and may create a barrier to entry to some foreign rivals.
Key strategic weaknesses
- News Reel is very dependent on EES who make up 40% of the company's revenue. The contract is up for renewal and the loss of such a significant proportion of income could seriously affect the company's viability.
- The company's core market is mature. There is unlikely to be further growth in sales of reels of paper. News Reel need to seek out new markets and or new products.
- In order to achieve its competitive advantage of flexibility, News Reel have had to accept higher costs of production. Unfortunately this will require higher selling prices which may be difficult to sustain in a tough economic climate.
Key strategic opportunities
Key opportunities for acquisitions have been identified by thecompany and these will be explored in more detail later. Otheropportunities for the business might include expansion into the mainlinecontinent or developing recycled paper. These will also be explored inmore detail later. But overall there are a number of opportunities thatNews Reel could pursue.
Key strategic threats
- The economic downturn in Eastlandia is a threat to New Reel. During such times customers might abandon differentiators and switch to cheaper suppliers in order to cope with falling sales.
- In the longer term, technological changes such as the growth of news aggregators and ereaders might reduce the need for such large volumes of paper products that provide news and entertainment.
- New competition from the mainland may enter the market. They are likely to be bigger than News Reel and have economies of scale which can further drive down selling prices.
- Recycled paper may be more culturally acceptable and in some instances cheaper than traditional paper reels. This substitute could win customers away from News Reels traditional market.
Overall strategic position
News Reel has a strong history and a strong competitiveposition. But it is over-reliant on one product and one customer in amaturing market. As its market continues to change its strategicposition is likely to worsen. It therefore needs to seek out newopportunities in order to secure the long term future of the business.
(b) Future strategic options
Appropriateness of strategic diversification
There are a number of strategic options open to News Reel, butnot all of them will satisfy the three criteria of being feasible,suitable and acceptable. Ansoff summarised strategic growth options intofour categories and these are explored below.
This involves gaining market share by enhancing a competitiveadvantage through competitive strategies such as cost leadership anddifferentiation. Cost leadership is unlikely to be feasible for NewsReel due to its low economies of scale (when compared to rivals) andflexible production methods. It would also appear that News Reel havealready differentiated the business well and there would be fewopportunities for further differentiation. Market penetration wouldtherefore be an unsuitable strategy.
News Reel could attempt to develop a recycled paper range.However they are likely to lack skills and experience in this area aswell as sufficient supply and production facilities. They are alsolikely to encounter more developed and reputable competitors who willhave potentially developed barriers to entry through customer tie-upsand branding. Furthermore, it would appear that the demand for recycledpaper is in the low-cost, low-quality sector, which would not suit NewsReel's competitive advantage.
Overall, both the feasibility and suitability of a product development strategy can be questioned.
Market development could be achieved through expansion into themainland continent. However News Reel are likely to experience similarcompetitive problems as those experienced in product development asthere will be established rivals with better reputations and lowercosts. Also, the mainland market is likely to be experiencing similarmaturity to the Eastlandian market with the same long-term threats. Itwould therefore appear to be neither suitable nor acceptable for thelong-term future of the business.
Feasible acquisitions have been identified by the company andthese appear to be acceptable to the board. As already discussed, NewsReel need to change their strategic position and diversification wouldappear to be the most suitable way to achieve this.
Acquisition of Quickpulp
This is a form of backward integration. News Reel would takecontrol of a supplier and it is likely that they would source morematerials from this supplier.
Quickpulp seem eager to sell and News Reel may thereforeacquire the business at a favourable price. It is also appealing to theproduction director as this is a way to secure supplies and possiblydrive down production costs in order to compete better and win moretenders.
But the suitability of this strategy must be questioned. It islikely Quickpulp are willing to sell because they are experiencing thesame market maturity and downward pressure on prices that News Reel areexperiencing. In effect, an acquisition of Quickpulp would only deepenNews Reels problems and make the company more entrenched in an industrythat is mature and that News Reel should be looking to remove itselffrom long-term. News Reel would still be reliant on EES and face thesame competitive threats that it is currently experiencing. BuyingQuickpulp would also increase the exit barriers from the industry ifNews Reel was to attempt an exit in the future.
Furthermore, News Reel's key competitive advantage is itsflexibility. However, tying itself in with a supplier would potentiallyreduce flexibility and destroy News Reels competitive advantage.
Overall, it would be advised that News Reel avoids an acquisition of Quickpulp.
Acquisition of Medicnote
An acquisition of Medicnote also appears feasible andacceptable to the board. Once again they are looking for a buyer andtheir overtrading difficulties might again mean that News Reel can makethe acquisition at a favourable price.
But Medicnote would appear to be much more suitable as anacquisition than Quickpulp. It is experiencing growing demand, is veryprofitable and is in a unique, specialised market position. It is also amove away from a reliance on EES and the problems that News Reel areexperiencing in their current market.
This acquisition is likely to remove a number of News Reel'sweaknesses (mature market, over-reliance on EES) and avoid some of thefuture threats (such as social and technological changes which may makenewsprint obsolete). Overall it appears to be feasible, suitable andacceptable and it is recommended that News Reel pursue an acquisition ofMedicnote.
(c) Strategy lenses
The design lens views strategy as thedeliberate positioning of an organisation as the result of some'rational, analytical, structured and directive process'. Through thedesign lens it is the responsibility of top management to plan thedestiny of the organisation. Lower levels of management carry out theoperational actions required by the strategy. The design lens isassociated with objective setting and a plan for moving the organisationtowards these objectives. In the context of the scenario, this processhas already begun. News Reel has analysed its strategic position andbegun to make strategic choices. It will have a deliberate 'design' toreduce dependence on news print and move towards pharmaceutical paperand other products and markets. It needs to set clear, long termobjectives for the business and a mission statement of where it wants tobe in ten years time.
Strategy as experience provides a more adaptive approachto strategy, building on and changing the existing strategy. Changesare incremental as the organisation adapts to new opportunities andthreats in the environment. The experience lens views strategydevelopment as the combination of individual and collective experiencetogether with the taken-for-granted assumptions of cultural influences.
For News Reel, it will not completely abandon news print,especially not in the short run. The move towards diversification willbe an incremental one and it will continue to tender for contracts andwin business in news print.
It also needs to use the experience it has gained from thisindustry and apply it to new strategies. For example, its flexibilitycould be used to improve the performance and competitive advantage ofMedicNote. This experience will be built into the design lens and therewill be some crossover between the two. The company will have a definitedesign on where it wants to go, but this will be built on pastexperience and knowledge.
Strategy as ideas has a central role for innovation andnew ideas. It sees strategy as emerging from the variety and diversityin an organisation. It is as likely to come from the bottom of theorganisation as from the top. Consequently, the organisation shouldfoster conditions that allow ideas to emerge and to be considered forinclusion in a 'mainstream strategy'. Certain conditions, such as achanging and unpredictable environment foster ideas and innovation.
News Reel cannot be expected to predict what technologies willarrive in the market place and the social changes that might arise inEastlandia and the mainland continent. But it needs to be prepared toreact to these. Staff should be encouraged to develop ideas andinnovations that take account of technological and social changes. Theten year design will not predict or plan for these changes, but thestrategic planning process has to ensure that, as these ideas and marketneeds emerge, the company are in a position to react to them.
Overall, the strategic planning process is likely to combineelements of all three lenses. The chairman can create a long termmission of where the business should be in ten years time and designstrategies to get it to that position. But these strategies should buildon the experiences that the company has had and be ready to accept newideas that might emerge both internally and externally.
Question 13 Pelatihan
(a) Assessment of the company's performance
The product portfolio
The Boston Consulting Group Matrix (BCG) categorises products(or SBU's) according to their market growth on the one hand, and theirrelative market share on the other.
Finance and Accounting
According to BCG, Finance and Accounting courses would beclassified as a cash cow, having a relatively high share of what is alower growth market according to the independent survey. Since thesurvey states that the market is growing at a slower rate than Law andHRM this will make it less attractive to new entrants. This SBU shouldnot therefore need cash to defend its position, but instead be able toprovide funds to finance other areas of the business.
According to BCG, Marketing would be classified as a dogproduct, having a relatively low share of a low growth (and henceunattractive) market. The market is actually in decline according to thesurvey. This would normally imply a product with few prospects whichshould be discontinued in the long term.
According to BCG, Law would be classified as a star product,having a high share of a high growth (and hence attractive) market. Astar needs to be defended since new entrants will be attracted to themarket and potentially steal Pelatihan's market share.
According to BCG, HRM would be classified as a problem childhaving a relatively low share of a high growth (and hence attractive)market. To continue with a problem child and grow market share, cashwill need to be taken from other SBU's and invested.
Overall Portfolio Evaluation
On first glance Pelatihan's portfolio appears balanced withFinance and Accounting courses generating cash to fund HRM and Law. OnlyMarketing has a questionable future, with competition from onlinecourses forcing the market into decline. However, the BCG appraisal issimplistic and Pelatihan's profits are significantly below budgetsuggesting there are issues with the present portfolio.
Strengths and Weaknesses of Pelatihan's performance
Performance of law and finance
The Law SBU has achieved its sales revenue target of $4m. As a'star' with 35% of the market in a buoyant sector, this is encouragingfor Pelatihan. The competition in this market is strong, with Koulos andOpleid having 30% and 25% of the market respectively. These othercolleges are likely to try to increase market share going forward andPelatihan will need to defend their position in order to safeguard Lawas a future cash cow (when demand slows.)
Student day numbers (defined as one student attending for oneday) are up on budget in both the Law faculty (5% above budget) and theFinance faculty (1.5% above budget). This would suggest that Pelatihanhas been successful in attracting students to these courses (despite thefact that these additional days have not translated into extrarevenue.) This may be due to the fact that both Law and Finance areareas where 'update' courses will be popular as legislation oraccounting standards change. All qualified personnel in country A couldpotentially be targeted to attend such courses.
HRM on the other hand, has seen a student day reduction of 23%against budget. Despite this, corresponding revenue is only down by11.4% or $0.4m. Budgeted revenue per student day in this faculty was$2333 and a figure of $2696 has actually been achieved. The increasingdemand for HRM courses as mentioned in the independent survey mayexplain why Pelatihan has been able to charge more per student day thanbudgeted. However, since this is a problem child SBU, requiringsignificant investment, Pelatihan will need to work on attracting morestudents on to courses to bring actual days in line with the budget.
Revenue from each faculty
Pelatihan is not overly dependent on any one sector forrevenue, however Finance represents the biggest contributor at 34.7%(budget 34.6%). Since finance is the Cash Cow, the generation of extrarevenue is a positive. The percentage of revenue coming from marketing(the dog SBU) has fallen to 6.6 (budget 7.7) which shows a goodstrategic direction is being taken in order to become less reliant onthis product.
Efficiency of each faculty
The finance faculty staff are the most efficient, with 88student days per staff member. This is a relative strength and isfurther borne out by the mix statistics which show that the financefaculty teaches 36% of Pelatihan's student days with only 32% of thestaff. Since Pelatihan is the market leader in Finance and Accounting,building on such economies of scale is essential. Finance, as a cash cowSBU, needs to provide funding for the other faculties and the staffefficiency would seem to give good grounding for this to occur.
The law faculty, with rapidly rising demand has also been ableto generate a relatively high number of student days per staff member at81 (against an average of 75.)
Overall sales revenue is down 6.9% or $0.9m against budget. Themarketing sector is the worst performer, missing the target by 20%(which explains $0.2m of the total shortfall.)
This is disappointing since presumably the online coursesoffered by The Marketing Institute were considered when the budget wasset and more student days would appear to have been lost than envisagedat that time (marketing student days are down 9% on budget).
The discounts being demanded by large employer organisationscould be an explanation for the loss of expected marketing revenue aswell as the 6.6% fall against budget of finance faculty revenue.
Budgeted profit before interest and tax ($2.3m) is all butwiped out in Pelatihan's actual results. An overall margin of 17.7% wasexpected but in reality only 0.8% was achieved. The weaknesses whichhave led to this result are explored further below.
There are significant weaknesses in cost control in eachfaculty with all 4 exceeding budgeted costs despite revenue targets notbeing hit (this weakness can also be seen in the 16.7% increase incentral costs over budget.) Overall sales revenue is down 6.9% asmentioned above but for this to translate into a 96% drop in expectedprofits is indicative of total inefficiency.
What is unclear from the analysis is why, in a mainly fixedcost business, such massive increases in cost should have occurred atall. The problem is compounded by the fact the CEO has been unable tofind a senior member of staff willing to take responsibility forfinancial planning and control. An investigation into the reasons forsuch high costs is therefore unlikely.
The marketing faculty, classified as a 'dog' by the BCG is lossmaking despite an expected 50% PBIT margin. All other margins aresignificantly lower than the budgeted figures with HRM falling from28.5% in the budget to 12.9% in the actual results. This does suggestthat the problems with cost control span the entire organisation.
Revenue per staff member
Staff members are seemingly unable to generate as much revenueas expected. Despite the director of the Finance faculty spending somuch time teaching students and dealing with clients, staff in his SBUare 6.6% below budget in terms of revenue per staff member.
Mix of days/staff and revenue
Inefficiencies can be seen in the marketing faculty, employing8% of the staff to generate only 7% of Pelatihan's revenue and studentdays and also the Law division, using 36% of the staff to generate 33%of the revenue. Pelatihan should consider using 'multi skilled' tutorswho can teach across faculties to try and increase utilisation of allstaff.
Revenue and costs per student day
The finance and marketing faculties have both experiencedadverse variances in terms of revenue per student day, presumably due,at least in part to the excessive discounts demanded by corporateclients. The law faculty has also seen a 5% adverse variance in pricinghowever, and it may be that the competition from Koulos and Opleid hasbeen stronger than expected, driving prices down.
The cost per student day is of real concern, particularly inthe marketing faculty where it is double that budgeted. The HRM facultyhas also failed to control costs, with cost per student day 41% higherthan expected. Action will need to be taken immediately to deal with theproblems faced by this division.
Reliability of budgets
Finally, it is worth mentioning that there may be a weakness inthe budget itself. With no senior member of staff willing to take onresponsibility for it, it is possible that the targets set were notrealistic in the current climate, or that mistakes have been made (forexample the budgeted cost per student day in Marketing which does appearlow compared to the other faculties and has led to the almost 100%adverse variance mentioned earlier.)
(b) Overall strategic position and performance of Pelatihan
Pelatihan is one of the largest and most highly regardedcolleges in country A. Its brand name will be a significant strength andshould serve to attract students to enrol on its courses. Pelatihan hasa stronger position in the Finance and Accounting and Law markets dueto its superior market share.
Pelatihan is operating in country A which has a well educatedyounger population and a stable government likely to continue itsinvestment in training. The fact that many of Pelatihan's students arefunded by employers gives Pelatihan some security in respect of demandlevels. Employers are more likely to pay for 'block' training or seestaff through to the end of a qualification despite economic conditions.They will also provide significant student numbers in many instances(as is the case in the Law faculty.)
Country A is much more stable than many of its neighbours withno history of violence or unrest. This is likely to be attractive tooverseas students who cannot access training in unstable home nations.
The structure of Pelatihan is divisionalised with four seniortutors each heading up a faculty and the CEO overseeing the entireoperation. This will create focus, with each 'expert' director makingdecisions tailored to their market. The fact that Pelatihan has grownorganically (as opposed to via acquisition like Koulos and Opleid) willfurther add to the cohesiveness of its structure and the ability topresent a uniform culture with none of the integration problems likelyto be faced by other acquisitive competitors.
The economy of A is growing at 15% a year. This meansincreasing numbers of organisations requiring training are present.Since Pelatihan doesn't specialise in one sector, it is able to cater tothe training requirements of all organisations. Companies which do notrequire accountancy or legal training may still take advantage of HRMcourses or marketing. Pelatihan's broad product range is however, alsopresent in its biggest competitors.
Pelatihan has a major weakness in financial planning andcontrol, with inaccurate budgets and no real understanding of why the07/08 results are so far below budget. In such a highly competitiveindustry this is a serious problem, leading to poor decision makingacross the organisation.
Pelatihan provides similar products to its main competitors andthis lack of differentiation makes it difficult for Pelatihan tocompete on anything other than price. Pelatihan's pricing strategy isbeing threatened by a small number of employer organisations demandingdiscounts in excess of those usually offered. The inability to negotiateand build up ongoing relationships with clients to protect against suchdemands is a weakness.
Most of Pelatihan's costs will be fixed (for example, staffcosts and premises) and this exposes the business to great risk ifrevenue falls. Any such fall (for example through discounts) will impactimmediately on profit.
Pelatihan would appear to be less innovative than its maincompetitors. The introduction of e-learning by the Institute ofMarketing has been enough to push the marketing sector which Pelatihanoperates in into decline. Koulos is known to be developing on onlinecourses but despite this, Pelatihan has no plans to do likewise.
There are staff issues within Pelatihan. Firstly, the loss ofstaff from the law faculty to join a main competitor signals a lack ofloyalty amongst what should be, in a training organisation, the biggestasset of the business (namely tutors). Without the reputation oftalented tutors, Pelatihan will find it difficult to attract studentsand it is also the case that students may follow tutors to their newemployer further weakening Pelatihan's position.
The second staff issue is apparent from the inability of theCEO to find a volunteer amongst his senior colleagues to take over thefinancial planning and control of the organisation (a weaknesshighlighted above). The director of the finance faculty, an obviouschoice for the role, claims to be too busy dealing with clients despitehaving a relatively large contingent of 23 staff. To leave the CEO (alawyer) in charge of this particular area would appear to be unwise,particularly for an organisation which presumably employs many qualifiedaccountants, the director of Finance being just one, who could take onthe role.
Firstly, Pelatihan could choose to invest in the Law and HRMfaculties in line with the findings of the BCG matrix. Demand forcourses in both areas is rising rapidly and Pelatihan will needsignificant investment to maintain its current leading market share inLaw and build up its relatively low market share in HRM.
On-line courses are a potential area for investment and havealready proved successful for the Marketing Institute in country A. Itis likely to be the case in the future that provision of such coursesbecomes 'expected' by students and moves very quickly from being a corecompetence to a threshold competence. Pelatihan needs to begin investingnow, in all faculties to bring this kind of training into theirorganisation. Online courses could enable them to sell courses tooverseas students, allowing market development without the costsassociated with setting up new colleges.
Since Pelatihan has staff and premises, they could look toprovide other courses and increase the utilisation of both. For example,there may be a demand for bespoke training courses which Pelatihan,with a talented tutor team, could easily provide. It may even bepossible to carry out these courses at client premises, saving even morecosts. Such courses, if successful, would impact greatly on revenuewithout a corresponding increase in costs. Koulos and Opleid both have asignificant share of the 'other' course market (40% and 20%respectively) and Pelatihan could use its reputation as a highlyregarded training provider to cross over into this market.
Pelatihan is one of the three dominant training organisationsin country A, however there are smaller colleges operating in every oneof Pelatihan's sectors. An opportunity may arise to purchase one or moreof these smaller colleges, particularly if they have a significantshare of the 'other' courses market (small colleges hold 40% marketshare). Although Pelatihan has never grown this way before, it wouldprovide a quick entry into a potentially lucrative market.
Country A has a growing economy and no history of violence orterrorist attacks. Many neighbouring countries are not so stable andsince Pelatihan does not currently offer full time courses oraccommodation, they could attempt to attract students from neighbouringcountries by offering both.
A strategy to increase the utilisation of tutors could bedevised with teaching across faculties becoming part of the culture atPelatihan. Finally, developing relationships (and contracts) withcorporate clients so that they are not in a position of power to demandhigh discounts is an opportunity Pelatihan should try to exploit.
A is a developed Asian country whose government has been inpower for 6 years and has been responsible for making education morewidely available as well as supporting the development of newindustries. A general election is however coming up and there are fearsthat the opposition party may be elected. This could change the positionof training companies significantly if they no longer have the supportof the ruling party, they may find that taxes increase or their marketcontracts.
There are threats to the Finance and Marketing faculties from asmall number of corporate clients who are demanding high discounts.This is also apparent in the Law faculty where one particular clientbooks up to half the places on a course but demands a 20% discount. IfPelatihan does not offer these discounts there is a very real chancethat clients will be lost to the competition, since, as alreadymentioned, the product itself is unlikely to be differentiated and pricewill be the main bargaining tool.
As well as the potential loss of clients, more tutors could belost to competitors. The Law faculty operates in a fast growing marketand at present Pelatihan is the market leader. Koulos is however only 5%behind in terms of market share and since students will often followpopular tutors to a new training organisation, there is a possibilitythat Pelatihan will lose its market leader position as a result of thisloss of staff.
Provision of online courses by the Marketing Institute isprobably the reason why the marketing sector has gone into decline.Koulos operate in all four of Pelatihan's sectors and are already in theprocess of developing online training. There is a risk that theprovision of online training by a competitor pushes the other'traditional' sectors into decline, leaving Pelatihan with very littleto fall back on.
In addition, there are rumours of a possible merger betweenKoulos and Opleid. If this were to go ahead, Pelatihan would lose theirmarket leader position in both the law and finance faculties. The newmerged operation would be able to exploit significant economies of scaleand Pelatihan would find it impossible to compete.
Finally, poor financial control and ultimately, disappointingperformance against budget may be enough to damage Pelatihan'sreputation.
Question 14 WG plc
(a) Product development
For any company to retain its position as marketleader, it must introduce a continual stream of new products, servicesor ideas to replace those that are declining. WG plc holds a position asone of the leaders in the global pharmaceutical industry, so it isimportant that it is able to introduce new products to replace existingones when patents expire. Because the development phase in thepharmaceutical industry is very long and very risky, it is importantthat WG plc invests regularly in a programme of research and development(R&D). This will help to ensure that it has new products andservices that will meet both its profitability objective and its aim ofdeveloping innovative medicines and services.
It has been a well-established idea for many years that products and services follow a 'life cycle'that affects the current rate of sale and, more importantly, hassignificant implications for the strategic options for the future. Thetheory breaks the economic life of a product into a number of stages.Being aware of the fact that a product has a life cycle can become thefoundation for policies and practices aimed at building up the market.The best advantage it gives is in the launching of a new product.
The Boston Consulting Group (BCG) matrix attempts torelate critical strategic issues to the different phases of the productlife cycle. Using the rate of market growth and relative market share,the matrix classifies products as either cash cows, stars, problemchildren or dogs. It is likely that, at any time, companies will haveproducts in all these categories. The position of the product or servicewithin the matrix has implications for the cash flows of the companyand it is therefore important that the managers monitor the positioncontinuously. They must recognise that products that are currentlyclassified as cash cows will eventually become dogs and cease togenerate cash. To avoid having too many products in a low growth and lowmarket share category, it is essential that steps are taken to ensurethat the company is always developing new products that have thepotential to become stars. For companies like WG plc it is imperativethat adequate resources are allocated to R&D in the strategic plan.
An example of the effects of the stages in the life cycle and inthe Boston matrix can be illustrated by one of WG plc's products. Fouryears ago one particular drug produced almost half of its turnover.Because the patent expires next year, it is expected that sales willdrop to represent no more than 10% of turnover. This type of problemmakes the company vulnerable to competition in the dynamic environmentof the pharmaceutical industry. It is essential for WG plc to becontinually developing new products, if it is to retain its dominantposition in the industry.
Almost 15% of WG plc's turnover last year was spent on researchand development. They have the largest research and developmentorganisation of all pharmaceutical companies worldwide. It is clear thatthe managers have taken a decision to allocate resources to researchactivities to ensure that the company retains its competitive advantage.They are also determined to produce and develop new and innovativemedicines and services worldwide to enable the company to achieve itscorporate mission and objectives.
If the company did not provide the necessary resources to fundR&D, it is likely that the number of new products would not keep upwith demand and the company would lose its dominant position in thepharmaceutical industry. This could lead to competitors enjoyingincreases in their sales, market share and, possibly, profits at WGplc's expense. R&D is evidently the source of WG plc's competitiveadvantage and so sufficient resources must be allocated to this activityif the company is to retain its current dominance in the pharmaceuticalindustry.
(b) Strategic alliances
Strategic alliances play an important part inglobal strategies where competitors lack a key success factor for somemarket. It may be distribution, a brand name, a selling organisation,the technology, R&D capability or manufacturing capability. Thepharmaceutical industry requires large inputs of both technicalexpertise and resources, as R&D activities are crucial to thesuccess of the companies. There are many practical issues that thedirectors of WG plc would need to consider if the company entered astrategic alliance with a competitor for the joint development of futurepharmaceutical products.
If the strategic alliance is an informal arrangement it can beimplemented faster and be more flexible. As conditions change and peoplechange, the alliance can be adjusted. The problem with this type ofarrangement is that with low exit barriers and commitment, there may be alow level of strategic importance and a temptation to pull out whendifficulties arise.
A formal joint venture involving equity and legaldocumentation, on the other hand, has a different set of problems. Whenequity sharing is involved, there are issues about control, return oninvestment and achieving a fair percentage of the venture. A majorconcern is whether or not such a permanent relationship will beequitable in the face of uncertainty about the relative contributions ofthe partners and the eventual success of the venture. Before thecommencement of the strategic alliance it is important that an equitableand agreed method of contributing to and sharing the venture's outputsis finalised.
Basically there are usually two sets of systems, people,cultures and structures that need to be reconciled, so it is essentialthat the control and management of the venture is discussed andfinalised to minimise the possibility of serious disputes during thecollaboration. It may be necessary to allocate special managers to thecollaboration, but there will still be issues that arise in relation tothe fundamental loyalty and commitment of the staff that participate inthe venture. The main areas for the directors of WG plc to consider arethe extent of the alliance in terms of markets and products and thesharing of costs and expenses between the two participants. It isimportant that these are agreed so that the position is clear to bothparties.
One of the main issues facing the directors of WG plc is likelyto be the input of resources, both intangible and physical. Theintangible assets such as skill, expertise and patents are likely to bethe cause of more disputes than the capital and machinery in anorganisation. It may be necessary to share confidential and sensitiveinformation that might prove to be difficult before trust is built upbetween the parties involved at both the personal and corporate levels.To enhance the chances of a successful strategic alliance, both sidesmust gain. They should protect and enhance the assets and skills beingcontributed and not let a partner take over.
The directors should also consider the effect on competitorsand regulatory bodies to avoid any legislation or regulations that willaffect the alliance adversely. By recognising that there may potentialproblems in this area, it may be possible to minimise the impact ofthem.
All of these practical issues will need to be agreed by thedirectors from the outset if the alliance is to be successful. However,if the companies are able to manage this effectively, a strategicalliance provides the potential of accomplishing a strategic objectiveor task quickly, inexpensively and with a high prospect for success. Itshould result in major benefits.
Question 15 Multinational company
The company currently operates with two different structures:
- A centralised structure with the European Head Office maintaining responsibility for product design, manufacturing and the product range.
- A decentralised structure based on national divisions within Europe, with each division's managers being responsible for setting the selling prices of each product and the distribution of products.
This organisation, using joint responsibility, has the following weaknesses:
- Conflict and resentment between head office managers and divisional managers will arise because some decisions are imposed on divisional managers whilst they must make others. It is likely that when things go wrong, managers spend a lot of time blaming each other instead of trying to solve problems.
- Divisional managers are likely to be de-motivated by the removal of their authority over the years as the European Head Office has taken over responsibility for decisions they used to have.
- As European business practice becomes more integrated and greater harmonisation between countries occurs, there will be less benefits that can be obtained from having a divisional structure based on different countries. Duplication of work will result, particularly associated with marketing. Further integration within Europe is likely to result in a single European Currency, harmonisation of taxes and pricing within Europe becoming more uniform.
The company should restructure and reconfigure itself as adivisional structure based on related product groups. The company isquite large with over 100,000 employees in Europe.
The company should be divided into three or four product divisionscomprising about 30,000 â€“ 35,000 employees with head office retainingresponsibility for administration. Each division should be responsiblefor product design, production decisions and marketing for the whole ofEurope. Each division can be further sub-divided into small productgroups each having its own management team.
The structure will have the following benefits:
- Each division can be established as an investment centre with its own performance targets. This will enable head office to monitor each division and, at the same time, will enable divisional management to make their own decisions.
- Head Office will be less involved in all operational decisions allowing decisions to be made by divisional managers who know about their product range.
- Each division will be more involved in all operational decisions allowing decisions to be made by divisional managers, who know about their product range.
- Each division will be large enough to benefit from economies of scale. This will ensure that inefficiencies of having too many small national divisions can be eliminated.
- The managers of each division will be motivated to ensure that their division operates effectively and economically, as the performance of their division can be benchmarked against its competitors.
- It will be easier to divest a division at a later time if required or add a division should an acquisition or merger be made.
- The European Head Office can be reduced in size because some of its current responsibilities will be taken over by the divisions.
It should be emphasised that this is a strategic structural changeand will take time to accomplish. It will need the support of thecompany's managers and employees and its success will depend upon theintegration of the European business environment. If this does not takeplace the current structure should be retained with minor improvements.
Question 16 QS Software â€“ Part 1
(a) Organisational structure
The formal structure of QS, as described in its organisation chart can be analysed as follows.
(i)(Departmentation is primarilyon a functional basis, although it also reflects product categories(web, software, hardware, repairs). The management partnership is alsofunctionally divided.
(ii) The overall configuration is what Mintzberg calls a 'simple structure'.
- The strategic apex (the partners) exercises direct control over the operating core: sales assistants, technicians, software engineers and web designers.
- Other functions are pared down to a minimum. There is no middle line or technostructure, and only a one-person support staff (the administrator).
(iii)The organisation is flat, with (as far as we know) only two levels of hierarchy.
The advantages of QS's structure for its environment may be summarised as follows.
- It has short lines of communication and authority, with direct connection between the strategic apex and operating core. This should lead to responsiveness to client demands and environmental changes (e.g. developments in web-based technologies), as decisions can swiftly be made in response to upward communication and feedback.
- Mintzberg suggested that simple structures are suited to dynamic environments, because they are able to co-ordinate by direct supervision.
- Clients requiring individual products or services are likely to benefit from the clarity of the functional departments (and their distinct locations).
The disadvantages of QS's structure for its environment may be summarised as follows.
- Direct supervision from the strategic apex may become dysfunctional where the span of control and the number of tasks to be supervised gets too large. The two owners may not be able to supervise the complex multiple tasks required if QS wins the RGA contract.
- QS does not (as far as we know) have alternative co-ordination mechanisms in place. In order to co-ordinate project work (such as the RGA contract), some element of matrix organisation will be required, with software engineers, web designers, administrators and managers working together on the project team.
- Functional organisations can create vertical barriers to the 'horizontal' expectations of customers who require multi-functional expertise on a project (Peters).
(b) Developing the organisation
Mintzberg identified five basic parts or elements within an organisation:
- There is a strategic apex, consisting of the managers who make the key policy decisions.
- There is an operating core, consisting of the employees who do the basic operational work of making goods or providing services for customers.
- The middle line consists of the middle managers who link the strategic apex to the operating core.
- There is a technostructure, which consists of the technical experts and analysts who plan and control the work of others in the organisation (such as accountants).
- Finally, there are support staff who provide internal services, such as building cleaning and maintenance, car fleet management and legal services.
Mintzberg suggested that the organisation structure for anyorganisation will depend on the extent to which one or more of theseelements dominates within the organisation. For example, if thestrategic apex is dominant, the organisation will tend to beentrepreneurial. If the technostructure is strong, the organisationmight be a 'machine bureaucracy' focusing primarily on improvingdeficiency. When the middle line is strong, the organisation will tendto be diversified and conglomerate in nature. When the operating core isstrong, for example in a hospital or in schools, the organisation willlean towards professional proficiency in its operations.
It would appear that the owners of the company want to allow theirIT specialists a large degree of initiative, suggesting thatprofessional proficiency will be an important feature of the company. Itis not totally clear, however, whether the owners plan to create astrong middle line (consisting perhaps of IT specialists-cum-managers),or whether they expect to retain a fairly large amount of managementcontrol themselves.
If the owners intend to develop a strong middle line over time, itmight be expected that the company will expand through diversificationand innovation, retaining an emphasis on proficiency in developing ITsoftware.
Question 17 Nikki Photocopiers
(a) Whether service and maintenance should have been prioritised for reengineering.
Critical success factors for Nikki should include the following:
- Production cost
- Quality control
- Value for money
- Servicing and maintenance.
Servicing is just one of a number of key areas that could be a candidate for reengineering.
Using Harmon's strategy/process matrix, servicing would be classified as follows:
Processes that lie at the upper-right are complex, dynamic andof high strategic importance. These are usually the processes thatprovide the organisation with its competitive advantage and should benurtured accordingly.
The main arguments for reengineering servicing and maintenance first are as follows:
- It has seen the largest fall in the magazine ratings.
- Nikki have their worst score in the ratings in this respect.
- The new CRM system does not appear to be generating the benefits it should have.
It could be argued, however, that value for money should have beentargeted first, with its implications for pricing and production, asfalling from being rated 1st to 2nd has major implications forcompetitive advantage. A fall from 5th to 7th in servicing is unlikelyto be the main factor in Nikki Photocopiers' decline.
(b) Impact of the proposed changes on competitive advantage.
We are not given enough information in thescenario to classify the firm's competitive strategy as eitherdifferentiation or cost leadership. However, the process change can beexplained in terms of its impact on cost and / or quality as follows:
- By avoiding having to explain issues over the phone, there is less chance of the engineer being misinformed about the nature of the customer's problem. The likelihood of them turning up without relevant components and having to pay more than one visit is thus reduced.
- The system allows for more detailed customer requirements to be sent to the engineer than could be communicated effectively by phone.
- A cut in administration input and the elimination of the role of call-takers could lead to job cuts and cost-savings
- Invoices will be able to be prepared instantly rather than at the end of each week. This should result in quicker cash receipts from customers and improved cash flow, thus reducing financing costs, for example.
- Savings in postage and printing costs as the system becomes more paper-free
(c) IT/IS implications
The main IT/IS implications of the proposal are as follows:
Software â€“ the CRM system
- The proposal involves the CRM system automatically generating work orders and sending details to engineers' PDAs. Furthermore, details are automatically sent to accounts once the job is done.
- While none of these are technically difficult, it is not known whether the current system has these capabilities. If not, then additional add-on applications (either off-the-shelf or bespoke) may have to be purchased.
- Even if present, new templates may have to be designed and training given to call-takers and engineers on filling them in correctly.
Hardware â€“ using PDAs
- Presumably new PDAs (and associated software) will have to be bought and training given to engineers on their use.
- An automatic phone system where calls are made between PDAs and the CRM system may also be needed.
(d) Should maintenance be outsourced?
Arguments for outsourcing maintenance
- Photocopiers are relatively simple machines, so it is likely that external firms will have the expertise to be able to maintain them.
- External firms may have economies of scale â€“ for example, having more engineers makes it possible to see customers sooner.
Arguments against outsourcing maintenance
- The most suitable processes for outsourcing are repetitive and transaction-intensive. Maintenance may have aspects of the former but does not fit the latter criterion.
- Dealing with customer queries is a critical success factor so should be kept in-house.
- Also there is a high risk of damaging the firm's reputation and goodwill if problems are not handled properly.
- The process of maintenance may generate useful information for designing new/improved photocopiers.
On balance, the critical nature of service and maintenance means it should be kept in-house.
Question 18 Institute of Information Systems Administrators
(a) A bespoke solution is one developed specifically for anorganisation. In this instance the Institute of Information SystemAdministrators would comprehensively specify their requirements for the On-Line Marking Project(OLMAP). This requirements specification would be used by the internalInformation Systems (IS) department or by an external software house toproduce a system that exactly matched the requirements. The softwarewould be owned by the Institute, who could make changes to it in thefuture to reflect changes to the original requirements.
A software package is a generalised solution to an application areaoffered for sale by a software vendor. In this instance a softwarecompany has recognised that a number of educational and trainingorganisations would benefit from on-line marking software. They haveconstructed their own specification of requirements and developed asoftware package called Emark which they now market and licensethroughout the world.
Advantages of the software package approach to systems development might include:
The software package is a proven product that has undergonesystems testing (in development) and user acceptance testing (by theusers who have already bought and used the package). Hence the productshould be bug-free, as well as fulfilling most of the functionalrequirements of the application. The implementation should not beaffected by the programming errors and misconceptions that are normallyassociated with bespoke systems development.
The bespoke systems development needs to be tightly specified,designed, programmed and tested. These parts of the lifecycle are verytime-consuming and during this period requirements may change, socomplicating the process even further. The software package is a productthat already exists. It can be purchased and implemented almostimmediately. There is no requirement for design, programming, unit andsystems testing.
Other perceived advantages include:
- High quality documentation and training available for inspection
- Maintenance and enhancement provided at a fixed price under an agreement
- Try before you buy, because the software is already available
Disadvantages of the software package approach to systems development might include:
Failure to completely fit requirements
One of the most commonly claimed disadvantages of the softwarepackage approach is the inability of the product to fit all of theusers' requirements. This means that either:
(1)Users have to make compromises and accept that they will not get all the functionality they require, or
(2)Tailored amendments will have to be made to the software product to deliver the required functionality.
Whichever way is chosen, it is clear that most softwarepackages do not fulfil all the user requirements defined for aparticular application. Furthermore, they often include facilities andfunctions not required by a particular user, which only serve to confusewhen the product is implemented into the organisation. In contrast, thebespoke solution should completely fulfil all the user's requirementsand, if it doesn't, will be amended until it does.
Financial stability of the supplier
Internal Information Systems (IS) departments do not go out ofbusiness. However, external software suppliers are subject to thevagaries of management and the markets. There is a risk that they may goout of business, or experience financial problems that affect thequality of their support and development services. It is possible toreduce these risks (through Escrow agreements) but the disruption likelyto accompany the enactment of such an agreement should not beunderestimated.
Other disadvantages include:
- Inability to generate a competitive edge because the package is also available to competitors
- Ownership is retained by the supplier
- Legal redress is virtually impossible because of the licence agreement
(b) In the context of the OLMAP project, performance testing will mean
- Testing the scanning time of a batch of scripts.
- Testing the response time of the system when a specified number of examiners and markers simultaneously access scripts for marking and moderation.
Testing the scanning time of a batch of scripts.
A test can be set up where a certain number of scripts aretaken from the IISA Head Office and scanned into the system. The timetaken for scanning can be recorded and further tests may be undertakento confirm this time. This time can then be scaled up to estimate thetime for scanning the scripts of 200,000 students. Scanning time shouldscale linearly with the number of scripts scanned into the system.
Testing the response time of the system
This test is difficult to simulate. It is likely that a limitedtest can be arranged with markers and examiners asked to access thesystem and record the results. However, the use of load testing softwarewould be more effective. This software allows the testers to simulate alarge number of 'virtual' users and to diagnose any bottlenecks. Anyproblems can be addressed before the software is released. The pointhere is that the response time of the system is unlikely toscan linearly with the number of users accessing it.
(c) In Direct Changeover/Conversion, the new system isimplemented completely and the old system is withdrawn. Thus processingof the current system may end on a Friday night and all transactionspass through the new computer system from Monday morning onwards. Wherepossible, direct changeovers should occur in slack periods and takeadvantage of natural breaks in the operations of the organisation, suchas industrial holidays.
Direct Changeover/Conversion is particularly appropriate to the OLMAPapplication because there is a natural break in processing within theapplication. It is not a continual process (like order processing,invoicing and payroll) but an application that runs for a limited amountof time every six months. Direct Changeover/ Conversion demands verythorough testing, but it is the quickest and cheapest implementationstrategy.
In parallel running the old and new systems are runsimultaneously for an agreed period of time and results from the twosystems are compared. Once the user has complete confidence in thesystem the old system is abandoned and transactions are only passedthrough the new one. Parallel running places a large administrativeoverhead on the user department because every transaction has to be donetwice â€“ once through the established procedures and then againthrough the new computer system.
Parallel running makes very little sense in the OLMAP applicationbecause the proposed and current systems are so different. The proposedapplication area (marking) is currently not computerised and anyattempt at a parallel run would be costly (involving courier and markingcosts) and time consuming. It is unlikely that the results would bevery valuable (for example, what lessons could be gained from marking apaper script and its screen-based equivalent?) and they could not beachieved in the tight time constraints of the marking process. The OLMAPapplication will need thorough testing, but there is little to gainfrom parallel running. If direct changeover/conversion fails, it wouldbe relatively easy to switch back to the current process as all thepaper examination scripts will still be available in a warehouse inSingapore.
Question 19 SDW
(a)Establishing the website
Before Mr M tries to establish an internet strategy, he should lookat his overall business strategy. In doing this he should find answersto a number of questions, such as:
- Is he only going to continue to operate between three domestic cities?
- How far does he want to expand both internally (in the home market as indicated) and beyond (internationally)?
- Does he have the capacity to take on more bookings should they arise?
- Is he aiming at a different market sector?
- Does he have a business plan?
Checking this strategy is essential because the IT strategy must beseen to support the overall strategy of the company and not drive it.In the case of the SDW Company, this does not appear to be an issue; theowner wishes to develop an e-commerce facility on the internet site.However, care must be taken to ensure that the site does not causeunnecessary disruption to other systems within the company.
Having determined his business strategy, he needs to look athis IT strategy. Would an internet site for bookings be part of hisoverall IT strategy or simply an add-on? Piecemeal implementation couldaffect other areas of his business systems.
The SDW Company already has an internet site, so development ofany new site must take this into account along with the overallrequirements of the business. Expert advice needs to be obtained as towhether or not to amend this site or design a new one. Experts in webdesign may have to be employed if this expertise is not availablein-house.
Additional care will be required in implementing the IT, forexample in ensuring that no incompatible systems are introduced. The ITsystems being used in the new internet site must be able to connect tothe existing call centre systems. Similarly, the initial focus of thesite must be on selling seats on the company's trains; other servicesmay be offered later, but establishing the core business first isessential.
Deciding on e-commerce may have an impact on other parts of thebusiness. For example, setting an objective of a given percentage ofbusiness through the internet will decrease percentages of business inother areas. Within the SDW Company, there will (hopefully) be a fall inthe use of the call centre. This change must be anticipated and plannedfor. Staff in the call centre must be kept informed concerning thesetting up of the internet site, and then assurances given regarding jobprospects and training, either within the call centre or other areas ofthe company. Where reductions in staffing are required, it is better toobtain these naturally rather than by compulsory redundancies.
Mr M should also attempt to obtain information on competitors'sites (and more broadly, sites relevant to the travel industry), toassess particularly their design and ease of use. This would berelatively easy to do â€“ he could even visit the sites himself. Thiswould not tell him how successful the sites were, although somecompanies boast about the use of their sites in published information.Some travel operators even offer discounted fares for booking this way.He should be careful that any claims are verifiable, and not justanother way of attracting publicity. It may be possible to commissionsome survey information to obtain potential customers' views on bookingthrough a website.
Given the need for security and the current lack of in-houseknowledge, setting up an e-commerce system will require specialistassistance, either by recruitment or outsourcing the writing andmonitoring of the site.
The services to be offered through e-commerce must also bedetermined. Decisions regarding services will have a direct impact onthe writing of the website, as the authors will need to ensure that therequired services can be made available. As already noted, the initialfocus must be on travel bookings. Additional services and products maybe made available after this core business activity has been satisfied.
Whichever method of writing the website is chosen, budgets mustbe set for this activity and agreed at Board level. If necessary, acost-benefit analysis will be required, partly to justify the cost ofwriting the site and partly to show the potential benefits from usingthe website rather than a call centre.
The charges (if any) for providing services to customers mustalso be determined. If ecommerce is to be encouraged, then some discountor other benefit can be expected to attract customers to this service.Given that this method of booking results in lower costs than whenbooking via a call centre, then the SDW Company can pass on these costsavings to its customers.
Prior to the e-commerce service being made available, it willhave to be advertised. The Board will need to decide where to advertiseand how much the advertising budget will be. Possibilities will includemail-shots to existing customers, perhaps by e-mail, and advertising onthe websites of other organisations.
One of the aims of the provision of e-commerce is to try toremain competitive. A review of competitors' and other online sites isadvisable to help determine the content and structure of the SDW Companysite. This review may also help to identify other areas wherecompetitors currently have an advantage so that the Board can addressthis.
(b)Features of internet sites focusing on cost reduction
The site must, of course, be very easy to use. SDW should specifysimple instructions on a site that is easy to understand and quick toload. The omission of detailed graphics and providing an 'uncluttered'site will also decrease programming costs.
Incentives to book on-line such as obtaining loyalty benefits,cheaper prices or being able to book earlier (which may not be availableon off-line bookings) could be offered. Although this may not savecosts on the internet, it will provide overall cost savings bydecreasing reliance on the call centre, thus limiting the number ofstaff employed.
Removing reliance on other more expensive selling media, suchas the call centre, removes not only salary costs but alsoaccommodation, pension, equipment and similar costs. Focusing on onebooking medium becomes easier to support as only one cost structure isrequired.
Providing appropriate support to customers within the websitewhich does not involve additional human contact. For example, provisionof FAQs, a good help system and advice on each stage of the bookingprocess. Customers are encouraged to resolve their own problems, whichlimits intervention from expensive staff.
Provision of other information on the website to attractcustomers to it, for example details of company performance or similarinformation already available within the organisation. Placing theinformation on the website is relatively inexpensive given that theinformation is already required in-house. Setting up web-specificinformation would be more expensive.
Innovative uses of Internet technology, for example suggestingdestinations on a limited budget rather than customers specifying wherethey want to go. Providing these ideas as unique selling points willattract more customers to the website, again limiting reliance on othermedia.
Question 20 MACOMP
(a) Benefits of e-business
E-commerce refers to all transactions between anorganisation and external parties using electronic media. It is morethan just buying using the internet.
The main ways that e-commerce has impacted on the way business is conducted are:
(1) Sales have been made in newmarkets since geographical limitations have been removed by e-commerce.Orders via a website can be placed from anywhere in the world and thusorganisations are able to expand their businesses cheaply and easily.
(2) Business is being conductedmuch more quickly, with instant orders and purchases possible viae-commerce. Next day delivery is common in many cases or at least'estimated delivery times' from orders being placed.
(3) Costs are being reducedthrough e-procurement. Orders to suppliers can be directly triggeredonce inventory reaches a certain level. This saves time and reduces therisk of 'stock out' as well as inventory holding costs.
(4) Suppliers have been made tocompete on price since e-procurement software can check pricesautomatically through the internet and configure purchase orders to thecheapest suppliers. This means business is conducted in a morecompetitive way than ever before.
(5) Business can be conducted viaon line catalogues when one business is purchasing or selling fromanother (B2B). Quotes and estimates can be communicated via the internetwhich means that customer service has in many cases improved. Queriesare dealt with immediately and there is an automatic 'audit trail' interms of order information.
Information systems strategy is concerned with seekingstrategic advantage from Information Technology (IT). For MACOMP, a newInformation Systems strategy might impact upon corporate and businessstrategies in the following ways:
Impact on Corporate Strategy â€“ IS strategy should belong term in nature and so impact on the overall strategy of theorganisation. The board of directors may look at how information systemscould support existing strategies, for example expansion of componentmanufacturing in MACOMP or how it could help develop entirely newdirections for the company, for example a move into second handcomponent sales via the internet.
It is important that IS strategy is demand-led and soenvironmental analysis already carried out at a corporate level will beuseful. Via PESTLE and 5 forces, the company can identify opportunitieswhich could be exploited by a new information systems strategy.
Impact on Business Strategy â€“ The strategy of thestrategic business unit (SBU) will be affected by a new InformationSystems strategy. The organisation will consider objectives at thebusiness level, for example how the processes undertaken by managers inthe OEM sales business could be speeded up in MACOMP. It will then lookat what information would be needed for this to happen and how thatinformation will need to interconnect and interact with otherinformation in the organisation.
The reverse engineering SBU is likely to need standard orderinformation from the customer and the ability to input measurements and'draw' straight onto the system. Estimates can then be carried out muchmore efficiently.
Overall, IS strategies must be capable of delivering tangible benefits and ultimately enhanced profits.
(b) Impact on the value chain
The proposed e-commerce business will impact onevery activity in MACOMP. Using Porter's value chain, the benefits toeach part of the organisation can be evaluated.
Inbound Logistics â€“ MACOMP builds components for oldmachinery. In order to establish which raw materials will be requiredfor a part not made before, a qualified engineer either searchesMACOMP's archives for drawings or obtains them from the OriginalEquipment Manufacturer (OEM). This is only the beginning of the costingprocess carried out by the engineer who must then pull together anestimate to be approved by the customer. An e-commerce system wouldallow archives to be held on the system, possibly with links to OEMarchives as well. The internet would be a key resource to see ifcomponents were being supplied by competitors and at what price. MACOMPcould therefore ensure a competitive quote or even access drawings fromother sources.
If the parts required for each component were listed on thesystem, together with supplier details, it is possible that automaticorders for raw materials could be generated once a customer accepts aquotation. It would also be possible to give customers prices forcomponents made previously by MACOMP immediately; price lists could beavailable via email for example.
The work the qualified engineer carries out before the price isaccepted by the customer needs to be kept to a minimum to maintaincompetitive advantage. By transferring purchasing information onto ane-commerce system and computerising archives with links to externalinformation via the internet, as well as making electronic price listsand on line ordering available to customers, MACOMP should be able tocut costs and so benefit strategically.
Operations â€“ The production department is not able toschedule work until an accepted order is passed to them by a salesmanager. If MACOMP had an e-commerce system in place and orders wereplaced electronically, these orders could interface with the productionschedule which could update automatically. This would be of particularstrategic benefit if the system recorded standard labour hours for each'known component'. The customer could be given an accurate completiondate electronically, improving MACOMP's core competence in customer careeven further.
The small proportion of MACOMP's business which comes from thelarge multinational OEM's may grow once these companies are able to dealwith MACOMP electronically. Since profits have been stagnant for thepast 2 years, this would be hugely beneficial.
For items not made before, the estimate of the labour hourscould also be built into the production schedule. One of the mainstrategic benefits to MACOMP would be the ability to calculate instantvariances using the e-commerce system. Since the production schedulewill have standard or estimated hours built in to it, any overrun can beimmediately flagged and investigated. Similarly, any estimate which isnot correct can be altered to produce a realistic standard cost goingforward.
Outbound Logistics â€“ MACOMP holds low levels offinished goods inventory already since goods are made to order. The mainstrategic benefit of an e-commerce system where outbound logistics isconcerned will be the ability to give customers an accurate idea of whentheir components will be ready for delivery. In this way, MACOMP canmaintain their competitive advantage of minimal inventory holding costs.
At present, inventories of the most commonly ordered componentsare kept. With an e-commerce system, MACOMP will have accurate, up todate management information as to which components should be included inthis category. The system of holding such components as inventory couldbe replaced by a 'predictive' ordering system where MACOMP assigns eachcomponent a realistic 'life expectancy' and a repeat order to acustomer is automatically generated by MACOMP's system at the end ofthat life. MACOMP receives a significant amount of repeat business andregular customers are likely to see this as very beneficial.
Sales and Marketing â€“ MACOMP has not experiencedgrowth for the last two years and this could be down to a lack ofadvertising and a reliance on 'word of mouth'. If MACOMP invests in ane-commerce system and has its own website, growth is likely to resultfrom potential customers searching the internet for suppliers. Atpresent, with no internet presence, such potential buyers do not knowthat MACOMP exists. A website would be advertising in itself and couldbe used to inform customers about MACOMP's core values and missionstatement as well as answer 'frequently asked questions'.
Service â€“ If customers are given access to a websiteand an email address, they will be able to submit queries to MACOMP.Dealing with customer enquiries on a timely basis will enable MACOMP tomaintain the personal service they pride themselves on. In addition, itwill be possible to maintain customer mailing lists on line and tocommunicate on a regular basis with those businesses that have purchasedcomponents from MACOMP.
Procurement â€“ As previously mentioned MACOMP will beable to save money with e-procurement, automatically searching theinternet for the cheapest supplier of raw materials and thereforeforcing suppliers to compete on price.
Information Technology â€“ MACOMP's accounting systemsare not automated and transactions are recorded in manual ledgers.Investment in a computerised system means that MACOMP can implementinternal controls, reduce the risk of human error and become morecompetitive as a result. The quality of management information producedon an IT system will far outclass anything the company has at present.
Order processing could move to being systems based so thatsales staff can trace the progress of orders on the customer's behalf.
HRM â€“ In the future, MACOMP is likely to need feweremployees since much of the manual work will be done automatically onthe system. Currently, MACOMP has 120 staff who, if they are retainedmay find they have more time to work on growing the business as their'manual' workload decreases.
Infrastructure â€“ The e-commerce system may bringbeneficial changes to the culture and structure of MACOMP, allowing itto be more flexible. Since far more information will be available on thesystem, it may be possible to alter working practices and gaincompetitive advantage. New roles could be created looking after overseascustomers for example, who are now able to order via the internet.
The strategic and competitive benefits of the new e-commercesystem to MACOMP can be seen throughout all of the businessesactivities. In the long term, these benefits will enable costs to be cutand efficiencies to be exploited. Ultimately, MACOMP will be able toprovide a better service to more customers.
Question 21 Marketing
ABC Ltd â€“ selling machine parts
These goods are likely to be supplied to order rather than fromstock. Technical performance and reliability of the product are likelyto be of primary importance. Price may be of secondary performance.There are likely to be only a small number of customers and thereforethe company will only require a small sales team. Promotion andadvertising are likely to be of minor importance and distribution islikely to be direct to the customer.
The company should concentrate resources in improving productperformance (more regular quality controls, newer machines, well trainedlabour etc.) than on promotion. Economies of scale may be possible toreduce costs and selling prices.
DEF Ltd â€“ selling consumer durables
This market is very competitive with both large national stores and local specialists competing for market share. However most productswill have a manufacturer's retail price which will most companies willstick to in order to avoid price wars (even timing special sale periodsto coincide with competitors). The division will sell direct to thepublic so place is not a vital concern for the marketing mix. Theimportant factors are likely to be product and promotion. Consumers willbe interested in areas of the product such as its efficiency, power,size etc. which the company cannot really change as it does notmanufacturer the product. However DEF can augment the product with areassuch as guarantees and installations. With so much competitionpromotion of the products will be important. Promotion should be madethrough adverts in newspapers, direct mailing and the use of trade inpolicies.
In such a competitive market, the company should concentrate itsmarketing on promotion and augmenting the product so that it is seen tobe different from that of competitors (who are selling the same basicproduct).
GHI Ltd â€“ producing and selling kids jellies
The first decision the company has to make is the place that itsells it's goods. There are three possible options: throughsupermarkets, through independent traders (corner shops etc.) ordirectly to the public. There are disadvantages in all three strategies:supermarkets are powerful and will demand lower prices, independenttraders are likely to give a lower volume, and selling direct to thepublic would involve setting up a network of retail shops which would bevery expensive. It is suggested that the company aims to sell tosupermarkets as this is likely to give a higher volume and agreementscan be made for national coverage. If the company decides it wants tosell to supermarkets then it will have to compete for shelf space. It istherefore recommended that it follows at strategy of price penetrationi.e. starts off at a low price to stimulate demand and then builds theprice up as brand loyalty and awareness increase. The product should bedesigned to be colourful and jolly to appeal to kids.
The company should focus and place and price within its marketingmix and promotion is seen as a less important factor within the mix.
Question 22 Motor Car Pricing
The following are the major pricing approaches which may be used in this situation:
This involves charging a high price relative tocompetitors. The advantage is that the contribution earned per unit ishigh. The potential disadvantage is that market share will berestricted. In this situation this restriction in market share would bebeneficial in the early stages since it is expected that production inthe first year is to be restricted. This would also avoid charging toolow a price as happened previously. It would be necessary to advertiseto promote the technological and style advantages to potential customerswhich would help to justify the higher price.
(ii) Penetration pricing
Here the aim is to charge a lower price thancompetitors in order to obtain a high market share at an early stage inthe product life cycle. The advantage is that a lower price willencourage people to 'try out' a new product rather than keeping with afamiliar 'existing' product. This incentive would appear unnecessary inthis case on two counts. Firstly, the reputation of the company is wellestablished and the car's predecessor was well received six years ago.Secondly, the car is very advanced both technically and in stylecompared with the competition. This 'non-price' advantage may besufficient to encourage people to choose this vehicle.
The main advantage of penetration pricing â€“ a high marketshare â€“ would be a disadvantage for this particular car since it couldresult in excess demand in the first year, a waiting list and furtherdamage to reputation regarding delivery. Another disadvantage ofcharging a low price is the small contribution generated on sales. Itmay be necessary to charge a lower price at a later stage if a superiorquality competitor comes on to the market.
(iii) Match competitor's prices
In this case there is a further pricing optionwhich is to charge a price at a similar level to that of competitors.The better technology and style of the car would act as selling featureswhich could result in increased market share which would be adisadvantage in the early stages when production capacity is restricted.
Advantages are that market share may be obtained withoutoffering a discount against competitors' prices and that a price similarto competitors' will not 'rock the boat'. A low price could start a'price war' which could be very damaging.
Recommended pricing strategy
In this situation the approach proposed is to charge a highprice relative to competitors in the first year and a price similar tothat of competitors in later years because:
- It enables a high contribution to be earned per car in the first year to compensate for the higher average cost caused by volume being lower and to aid recovery of development costs.
- It is likely to match demand with production, i.e. low in first year and increasing thereafter.
- High prices in the first year should prevent excess demand and waiting lists forming.
- A high initial price may make it easier to boost market share in the second year when prices are reduced.
Care must be taken to equate demand with supply to avoid deliverydelays or excess inventories. Average unit costs may be calculated foreach year but this is likely to be of limited use compared withassessment of competitor prices and demand.
Question 23 MN plc
The investment manager has analysed three mutually-exclusive investment opportunities A, B and C.
Reasons for differences between NPV and IRR rankings
There are two main reasons that NPV and IRR rankings differ:
(1) The magnitude of the cash flows.
(2) The timing of the cash flows.
Magnitude of cash flows
Imagine we were faced with a choice between the following two projects:
The cash flows in Project A1 are approximately 1,000 times bigger than those in Project A2. Hence the NPV of Project A1 will be approximately 1,000 times bigger than the NPV of Project A2. The NPV of Project A1 is Â£14,376, but the NPV of A2 will be just over Â£16.86. NPV would therefore suggest that Project A1 should be preferred.
Consider the IRRs of A1 and A2. In project A2 the return is Â£48,000 p.a., whereas project A2 yields Â£49 p.a. The relative percentage return from Project A2 is thus higher than that of Project A1. Hence A2 has a greater IRR than A1.
The inconsistency in ranking has been caused by the magnitude of the figures.
Timing of cash flows
The actual time periods when the cash is generated can produce conflicting results.
Again consider two projects.
The NPV of Project A2 is Â£13,170 (130 Ã— 0.909 â€“ 105).
This NPV is lower than the NPV of Project A1.
The magnitude of the cash sums is very similar in both projects.
If we consider how the NPVs of the two projects reduce as the discount rate rises.
The NPV of A1 will fall rapidly as the cash flows inthe years 2 and 3 very quickly reduce in present value terms. The NPVof this project becomes zero at a 17.5% discount rate.
The cash in Project A2 is all received in the first year. This cash sum is only Â£130,000, compared to cash in flows of Â£144,000 in Project A1. However the value of the year 1 cash flow remains strong even as the discount rate rises.
Indeed, at a discount rate of 17.5% the NPV of A2 is still positive at Â£5,630 (130 Ã— 1/1.175 â€“ 105).
Hence the IRR of Project A2 MUST be greater than 17.5%.
Again there has been a conflict in the rankings, this time because of the timing of the cash flows.
These examples should illustrate that it is just as importantto consider WHEN the cash flows arise as to consider HOW MUCH the cashflows are. It is very important to obtain cash in the early years of aproject whilst it holds a high present value.
Comparison of opportunities A, B and C
The capital outlay in Project C is much greater than the other two projects. Cash inflows are generated for 9 years.
At a low cost of capital this project is worth the most to thecompany. The cash in years 6â€“9 maintains a high value when discountrates are low.
However, this project is very sensitive to increases indiscount rates. As the cost of capital rises the NPV of Project Cdeclines rapidly. This is illustrated in the graph at the beginning ofthe report.
Project A is less sensitive to increases in discount rates. Allits cash is received in years 1 to 3. These maintain a strong value asthe discount rate increases. Project A could be said to be the leastrisky of the three choices if interest rates are volatile.
Which project should be selected?
The company has a cost of capital of 10%. At this rate Project Cproduces an NPV of Â£31,432. This is of higher benefit to MN plc thaneither projects A or B. Hence this project should be selected.
Assumptions: cash flows are known and certain. The cost ofcapital is known. Taxation and inflationary aspects have been ignored.
If MN plc is very risk averse, Project A may be considered asits NPV is more robust to increases in the cost of capital than projectsB or C.
If you require any further information on this matter, please do not hesitate to contact me.
Signed: Management Accountant
(b) The payback period is the time that elapses before the initial cash outlay is recovered.
The paybacks in the example are:
Advantages of payback
(1) Exposure to risk. It is widely recognised thatlong-term forecasting is less reliable than short-term forecasts.Projects with short paybacks tend to be less risky than projects withlong paybacks. A project with a one-year payback is less risky than aproject with a 10-year payback. Management can have very littleconfidence in forecasts of events ten years from now.
(2) Liquidity. Investment opportunities often requiresignificant capital outlay. It may be important to recover this capitalexpenditure quickly for the company to maintain a strong position.Payback illustrates how quickly the capital can be recovered.
(3) Simple measure. The payback period is not a complicated measure. Technical expertise is not required to understand the meaning of payback.
(4) Not subjective. Payback period uses cash flows.Some investment appraisal methods use the rather more subjective measureof accounting profit (the accounting rate of return).
Disadvantages of payback
(1) The time value of money isignored. Each of the projects being considered by MN plc generatesÂ£48,000. Payback period fails to recognise that as time elapses thepresent value of this cash diminishes. It would be possible to overcomethis problem by calculating a discounted payback period.
(2) Cash flows after the paybackare ignored. Option C has a payback of a little over five years. Thisinformation does not reveal that Project C continues to generate cashfor four further years.
(3) Not a measure of absoluteprofitability. Payback fails to indicate HOW MUCH each project is worth.It seems naÃ¯ve to select a project on the basis of payback withoutconsidering the amount of benefit received.
In the example Project A has a payback of just over two years, however its NPV is only Â£14,376.
Project C yields an NPV of Â£31,432 â€“ more than double A's NPV. Payback period ignores this fact.
Question 24 Ski Runs
(a) The landowner has used a netpresent value (NPV) technique. This is the best technique to use for aproject which is expected to last so far into the future. It means thatthe time value of money will be accounted for and that an estimate ofthe overall benefit (in current terms) of each investment can be used.The project with the highest NPV should be the project which is chosenfor investment. This explains why the landowner has suggested that thelow level of investment is the best decision.
The key elements of the calculation are:
(1) Fee income
This has been calculated on the basis of expectedvalues (if 3 out of 10 seasons will be good, for example, thisrepresents a 30% probability.
Expected number of skiers per year = [(30% x 60,000) + (40% x 40,000) + (30% x 5,000)] = 35,500
Expected fee income = 35,500 * $8 = $284,000
(2) Annual costs
The variable costs have rightly been included andcalculated properly. But there is no reason to ignore fixed costs. Itwould be relevant to ignore fixed costs if they were not affected by theinvestment and were the same for each project. But that is not the casein this scenario. This is a fundamental cost for this project. It isone of the key differentiators between the investments â€“ making thehigh investment might mean a higher initial lay out, but the landownerwould benefit from fixed costs which are $60,000 per annum lower.
At a discount factor of 5.650 (for 10 years at 12%), thepresent value of the fixed costs would be $508,500 for the lowinvestment but only $169,500 for the high investment. This would changethe whole nature of the decision because the NPV of the low investmentwould fall to $142,600, whilst the high level investment would become$163,800. It would mean that the project decision would change and thatthe high investment is the better project path to follow.
(3) Loan repayments/finance cost
Discounting a project's operating flows at theinvestor's cost of capital allows for the meeting of finance costs ofthe investment (at that cost of capital) out of the inflows beforegiving the investor a benefit, as measured by the NPV.
An alternative approach would be to prepare a 'loanstatement', showing year by year the interest clocking up, cash inflowsand loan/interest payments, reaching a final net balance at the end ofthe project.
Including the finance cash flows with the operating cashflows in an NPV calculation would be a combination of these twoapproaches and would be a waste of time, if the finance cost of theinvestment was equal to the rate at which the flows were beingdiscounted. This is because the NPV of the finance flows at this ratewould, by definition, be 0 (see tutorial illustration below).
However, if the specific finance for the project is notpart of the investor's general funds, with a cost at a rate differingfrom that used in the NPV calculation, it should be regarded as aseparate set of cash flows to be included within the NPV calculation. Inthe case of the skiing project, half of the finance is provided bymeans of a subsidised loan from the Tourist Board, at 4%. Discountingthese flows at the landowner's cost of capital, 12%, would actuallyresult in a positive NPV, representing the benefit gained by receiving aloan at below average cost.
For example, suppose a loan of $400,000 was taken out at aninterest rate of 10%, with annual interest payments and the principalto be repaid after two years:
(b) Virtually all the data used in theassessment of the project NPVs could be subject to variation, or risk.The most significant variable is probably the quality of snow cover,which in turn affects level of demand, and an attempt has been made toquantify this variability.
Other potential variables are costs, both initial and subsequentcapital expenditure and annual operating costs. The discount rate (costof capital) and fees may also be subject to variation and may have to bechanged if anticipated demand levels are not realised at the originalfee set.
The extent to which variability can be built into the projectappraisal depends upon whether it can be expressed in quantifiableterms. If possible values for the variable can be predicted, withrelative likelihoods (probabilities) then the approach may be to
- use an expected value within one NPV calculation; or
- calculate several NPVs based upon the different values to give a range of possible outcomes.
The advantage of the first approach is that it will give a precisedecision; however, that decision will be based upon a value that willoften not coincide with an actual possible value. It is instead along-run average value that may not be appropriate for a one-offsituation.
The second approach will allow the investor to review allpossible actual outcomes, and their likelihoods, in order that he canmake a decision based upon his own risk-return preferences. This will beaffected, inter alia, by the size of the investment relative to theinvestor's wealth and the amount he can afford to lose.
If the degree of uncertainty of an input variable cannot bereasonably quantified, the variability cannot actually be built into theNPV computation itself. However, sensitivity analysis may be used toassess the extent to which the value could change from that used in theNPV computation before it changes the decision â€“ i.e. before it turns apositive NPV negative or vice versa.
Information about the sensitive variables in a problem will help the investor to make an informed decision.
Question 25 QS Software â€“ Part 2
(a) Project management problems
Successful management of a project team requires:
- clarity about the project's scope and objectives, and about team member roles within it
- up-to-date awareness of (changing) project plans and feedback on current progress in regard to defined gates and milestones
- focused commitment and availability to the project (including visibility to stakeholders)
- the encouragement of multi-directional communication between team leader and members
- leadership skills: particularly in team-building, motivation and negotiation.
Sam apparently has the following key problems in these areas.
(1) He lacks clarity about theproject's objectives and milestones. Not having been involved in theplanning stage, and not being in direct contact with the RGA IT manager,he appears to be unaware of the project plans and crucial stagedeadlines. He has therefore been unable to brief his team, who in turnhave problems prioritising, co-ordinating and scheduling work.
(2) He lacks focused commitmentand availability to the project, having to divide his time between RGAand other clients. This is reflected in his lack of 'visibility' to keyproject stakeholders (particularly the IT manager of RGA), which causesconcern about the level of commitment and resource being devoted to theproject. It is also likely to convey confused priorities to his teammembers â€“ especially since he supports this by allowing core staff tobe released from RGA work 'when necessary'.
(3) He lacks the skills andorientation for project team management. He is 'not happy' about hisrole as team manager/co-ordinator, as his preference is for technicalwork and he has little experience of people management or projectmanagement on this scale.
(4) There appears to have beenlittle communication between team members, or between the team (asrepresented by Sam) and other stakeholders, either in the form ofproject plans or team meetings. This makes it difficult for the team toco-ordinate work, monitor progress and solve problems. It also makes itdifficult for them to feel committed to the project â€“ especially giventhe mixed messages from Sam.
(5) The unclear and dysfunctionalproject management structure exacerbates these problems. John Jonesconsiders it to be 'his' project and therefore adopts the role ofliaison between the project team and RGA â€“ even though this is theproject manager's (Sam's) role, and he himself has no day-to-dayinvolvement in the work. John fails to communicate regularly oreffectively with Sam.
(b) Improving project management
Recommendations for improvement in the team management, which should take effect from this point on, are as follows.
(1) Sam should be empowered totake up the project manager's role. He should be the one to be inregular contact with the client (in the person of the IT manager of RGA)â€“ not John. Sam is already in the best position to appreciate thescheduling priorities and conflicts of the technical team, so he is inthe best position to negotiate with the client. However, this requiresthat he also receives more information on the project scope andobjectives, plans, progress and adjustments.
(2) Sam needs to dedicate his timeto the RGA project and ensure that he is more 'visible' to the keyproject stakeholders (as a symbol of QS's commitment of resource to theproject). There is genuine conflict with QS's objective of maintainingquality to other clients, but RGA must be classed as QS's key accountâ€“ quite apart from the costs of continuing delays. If Sam is unwillingor unable to devote the time to RGA, QS should consider shifting theproject management role to John â€“ or to a contracted project manager.
(3) Sam needs to deploy projectteam members in a more focused fashion. He cannot afford to release RGAteam members over the next seven or eight weeks: instead, he may have tonegotiate delays with other clients. Alternatively, he may be able tosub-contract work or to hire additional specialist staff on ashort-contract or freelance basis. RGA's own IT staff might also becomemore involved (e.g. in testing and installation).
(4) QS staff working on RGA shouldbe regarded as a dedicated temporary project team, focusing solely onRGA work, collaborating and communicating on a regular basis. Sam shouldattempt, even at this stage, to do some 'team building' to enhance theteam's commitment to the project, through a project re-launch (involvingcomprehensive briefing on the client, project scope, project plans andso on), team meetings and other techniques.
(5) Communication mechanismsshould be set up to ensure regular, multi-directional flow ofinformation about plans, adjustments and progress. Daily team reviewmeetings might be held at QS, with regular progress reports, liaisonwith the IT manager of RGA and stakeholder reviews.
Question 26 Multinational and local authority
(a) The objectives of any organisation should relate to its mission. A mission statementis frequently formally stated, but this is not always the case.Sometimes this mission statement is informal i.e. it is not set out inunequivocal terms but is widely known and understood. The organisation'smission encapsulates the 'raison d'Ãªtre' of the organisation andshould focus on the demands of the principal stakeholders. Followingfrom this, the objectives of the organisation can then be stated withinthe framework of the rational planning model.
Within the MNC the main stakeholder group would be theshareholders, whereas within the local administrative authority the mainstakeholder group would probably be the local community.
It might well be that central government prescribes objectives for the local administrative authority, permitting some degree of freedom.
In order to determine exactly what the strategic targets shouldbe, those responsible for the local administrative authority must make adetailed assessment of the needs of the local community. Thus thereexists the need to liaise with a number of other organisations with alocal presence. Whatever strategic targets are set they will be set withthe over-riding need to satisfy the objective that economic, efficient and effectiveservices are provided by the local administrative authority. Thetargets should be set in a manner that enables performance measures tobe made as to the extent to which the three Es have been attained.
It is quite conceivable that the needs of the local populationwill vary between different areas within the overall boundaries of theauthority. Statistical information should be used in order to assess theactual level of service provision against the perceived level of need;for example, in assessing whether the provision of local housing in aparticular location met the demand for such accommodation. This willassist in the setting of future objectives. Perhaps it may be necessaryfor housing to be established as the primary objective because there is asignificant under-provision of locally administered housing. If thiswere to be the case then it is probable that other services would beaffected.
By way of contrast, an MNC is likely to find its objectivesmuch easier to establish. The shareholders are the major stakeholdergroup in the business. The primary objective of an MNC will be tomaximise its long-term wealth and increase the value attached to itsshareholding. It is probable that the MNC has secondary objectivesrelating to issues such as social responsibility, ethical tradingpractices and the quality of goods and services. These are usually setwith the attainment of the primary objective, i.e. creation of long-termwealth for its shareholders in mind.
(b) The measurement of performance levels achieved by anorganisation must relate to the nature of the objective that has beenagreed. Objectives should be capable of being measured, and thus onethat is non-specific in nature is likely to prove problematic as regardsits measurement. Consequently, the extent of its attainment isdifficult to quantify with any degree of exactitude. It is probable thatthe local administrative authority will establish targets, therebyenabling measurement of the extent to which objectives have beenachieved. Carefully chosen performance indicators will be monitored. Forexample, with reference to locally administered housing, thenappropriate performance indicators would be the number of residentswaiting for accommodation and the average waiting time to be housed. Inthe event that a reduction were to occur in the number of residentsawaiting housing due to the increased provision by the authority, thiswould indicate that the objective of effective service provision wasbeing achieved with regard to housing in the area.
It is also possible for performance measurement to be made utilising the 'balanced scorecard'approach. This would be applied in respect of the financialperspective, internal business processes, learning and growth andcustomer perspective. In order to determine how economically the localadministrative authority is providing its services, it should not onlycompare its results with those of previous years, but also make detailedcomparisons with the results of other authorities. The authority mayreview its business processes for the provision of various services andstate how it has made changes to these processes as a consequence oflearning from experience. The conduct of customer surveys will enablethe measurement of the satisfaction of local residents to be measured.
As part of the objective setting process, it isappropriate for the representatives of the authority to determine howobjectives will be measured. The appropriateness of performance measureswill need to be reviewed in order to take into account the changingnature of the service provision in respect of the dynamic businessenvironment.
The local administrative authority should give consideration toinviting members from within the local community to contribute to themeasurement of its performance. For instance the local press, charitygroups and other local interest groups would invariably seek a role inmeasuring the performance levels achieved by the authority. It would bemuch more positive for them to work in conjunction with the authoritytowards the attainment of agreed objectives as opposed to adoption of amore combative posture.
The MNC will probably have significantly lower levels ofstakeholder participation in the measurement of its primary objective.Objectives defined in terms of profitability will be set within a giventimeframe. The MNC will report on the levels of its earnings and theimpact upon shareholder value. The financial markets will primarilydetermine the extent to which the MNC is successful in achieving itsobjectives. In contrast, the view of the local community will be theprincipal determinant as to whether the objectives of the localadministrative authority have been attained.
Local vested interests will inevitably be visible within alocal community, whereas the shareholders of the MNC will not haveinterests of such a nature. The shareholders will comprise a group withdisparate interests. The MNC will therefore be subject to marketpressures. The market will view the worldwide activities of the MNC, andthe prevailing share price of the MNC will reflect the attitude of themarket to those activities.
The 'balanced scorecard' approach could be used by the MNC inorder to measure its overall performance. The principal aim of thisapproach is the quantification of how much shareholder value has beenadded. In essence, the market determines this value.
Question 27 Spartan Inc.
Retained earnings â€“ the most important form of finance inpractice for both smaller and larger businesses. However, while retainedearnings may seem an easy source of finance for a company, there is adanger that if it does not achieve an adequate internal return on theseretained earnings, it may become the subject of a take-over bid fromanother company that considers that it could manage the capital of thebusiness more effectively. This does not apply to Spartan because theydo not have sufficient funds to finance the growth.
Equity â€“ is the net value of a company after deducting itsliabilities from its assets. However, in financing language, equity isusually taken to be the share capital in the business, and a slice ofequity can be sold to raise money either to invest in the business orfor shareholders to realise some cash for themselves, or a mix of these.Spartan have already issued shares but could release some more. Thepotential benefits are:
- raise money without the burden of interest payment or compulsory capital repayment (although dividend payments will be required)
- Spartan can bring strategic partners into the company, which can help with credibility
- the new shareholders may well participate in further rounds of financing
- they can provide expertise, e.g. as non-executive directors.
Further sources of equity include:
- Personal resources, friends and family.
- Corporate venturing â€“ where a major company invests in a smaller one, to gain access to innovation and ideas.
- Government-sponsored funds
Grants â€“ Grants are available for all sorts of projects, although the main targets are businesses involved in:
- heritage and arts
- technology and training and
- those based in 'disadvantaged' areas.
The biggest disadvantage is identifying what grants are available, and completing the paperwork required.
Loans â€“ there are many types.
- Regular institutional loan â€“ from banks, etc. â€“ money is advanced for a specific purpose and is repayable over a fixed period at a fixed or variable rate. The maximum loan amount will be based on available security (often personal) and the ability to 'service' (pay) interest and capital repayments. It may be possible to negotiate stepped payments and capital repayment holidays. The lender will want to see credible financial forecasts, especially cash flow projections.
- 'Soft' loans â€“ from government sponsored funds â€“ a number of loan funds have been established, financed by a mix of public and private money, to help certain defined industry sectors or regions. These loans are usually unsecured, and the terms are often easier than regular loans.
- Mezzanine funds â€“ available from various sources including banks, venture capital firms and specialist mezzanine loan providers. This type of debt sits between equity and regular loans (hence the name). The loan is unsecured, and in return for the increased risk the interest rate will be higher and typically the lender will require the right to buy shares in the company on favourable terms (known as 'equity kicker', warrants, or share options).
The advantages and disadvantages are outlined below:
Outside of equity, loans and grants, the following sources offinance should be considered â€“ although these will not be suitable forSpartan's investment.
Overdraft â€“ a facility to borrow up to a prescribed amount for a defined period (usually one year renewable).
Factoring or invoice discounting â€“ a factoring agent,usually a bank subsidiary, pays a company up to 85% of the invoice valuewhen the invoice is originated, i.e. when the goods or services aredelivered by the company. The balance is paid, less fees, when thecustomer settles the invoice.
Leasing, HP, contract purchase â€“ all forms of loan where the security given is over the asset purchased.
The return on capital employed of Spartan has declined as a resultof both falling net profit margin and falling asset turnover: whilecomparable with the sector average of 25% in 20X5, it is well below thesector average in 20X6. The problem here is that turnover has remainedstatic while both cost of sales and investment in assets have increased.
Despite the fall in profitability, both current ratio and quickratio have improved, in the main due to the increase in inventory levelsand the decline in current liabilities, the composition of which isunknown. The current ratio remains below the sector average, however.The increase in both inventory levels and inventory days, together withthe fact that inventory days is now 53% above the sector average, mayindicate that current products are becoming harder to sell, a conclusionsupported by the failure to increase turnover and the reduced profitmargin. The expected increase in sales volume is therefore likely to beassociated with a new product launch, since it is unlikely that anincrease in capacity alone will be able to generate increased sales.There is also the possibility that the static sales of existing productsmay herald a decline in sales in the future.
The decrease in receivables days is an encouraging sign, but theinterpretation of the decreased sales/working capital ratio isuncertain. While the decrease could indicate less aggressive workingcapital management, it could also indicate that trade creditors are lesswilling to extend credit to Spartan, or that inventory management ispoor.
The gearing of the company has fallen, but only because reserveshave been increased by retained profit. The interest cover has declinedsince interest has increased and operating profit has fallen. Given theconstant long-term debt, the increase in interest, although small, couldindicate an increase in overdraft finance.
Ratio analysis offers evidence that the financial performance ofSpartan Inc. has been disappointing in terms of sales, profitability andinventory management. It may be that the management of Spartan see theincrease in capacity as a cure for the company's declining performance.
The current gearing of Spartan Inc. = 100 Ã— (3.5m/4m) = 87.5%
Total debt after issuing $3.4m of debt = 3.5m + 3.4m = $6.9m
New level of gearing = 100 Ã— (6.9m/4m) = 172.5%
Current annual loan note interest = $350,000 (3.5m Ã— 0.1)
Current interest on overdraft = 400,000 â€“ 350,000 = $50,000
Annual interest on new debt = $272,000 (3.4m Ã— 0.08)
Expected annual interest = 400,000 + 272,000 = $672,000
Current profit before interest and tax = $1.5m
Current interest cover = 3.75 (1.5m/0.4m)
Assuming straight line depreciation, additional depreciation = $600,000 per year
Expected profit before interest and tax = 1.5 + 1.43 â€“ 0.6 = $2.33m
Expected interest cover = 3.47 (2.33/0.672)
This is lower than the current interest cover and also assumes no change in overdraft interest.
Thus, Spartan's gearing is expected to rise from slightly below thesector average of 100% to significantly more than the sector average.Spartan's interest cover is likely to remain at a level lower than thesector average of four times, and will be slightly reduced assuming nochange in overdraft interest.
Question 28 Bits and Pieces
(a) The decision to open on Sundays is to be based on incremental revenue and incremental costs:
On the basis of the above it is clear that the incrementalrevenue exceeds the incremental costs and therefore it is financiallyjustifiable.
(W2) Purchasing and discount on purchasing
Current annual purchasing is $18,000 Ã— 50 =$900,000
Extra purchasing from Sunday trading is $800,000 â€“ $400,000 = $400,000
New annual purchasing is ($900,000 + $400,000) Ã— 0â€¢95 = $1,235,000
Incremental cost is $1,235,000 â€“ $900,000 = $335,000 (a $65,000 discount)
Staff costs on a Sunday are 5 staff Ã— 6 hours Ã— $20 per hour Ã— 1â€¢5 = $900 per day Annual cost is $900 Ã— 50 days = $45,000
Lighting costs are 6 hours Ã— $30 per hour Ã— 50 days = $9,000
Heating cost in winter is 8 hours Ã— $45 per hour Ã— 25 days = $9,000
This is based on the incremental revenue $800,000 Ã— 1% = $8,000 (or $160 per day)
Only relevant cash flows should be taken into considerationwhen making this decision, i.e. the future incremental cash flows thatoccur as a result of Sunday opening. Prepare a summary of the relevantcash flows and reference in workings, where required.
(b) The manager's rewards can be summarised as follows:
This appears far from generous. The other staff are being paidtime and a half and yet the manager does not appear to have this optionand also is only being given time off in lieu (TOIL) at normal rates.Some managers may want their time back as TOIL so as to spend time withfamily or social friends; others may want the cash to spend. One wouldhave thought some flexibility would have been sensible if the manager isto be motivated properly.
The bonus can be calculated at $8,000 per annum (W6); on a dayworked basis, this is $160 per day. This is less than that being paid tonormal staff; at time and a half they earn 6 hours Ã— $20 Ã— 1â€¢5 =$180 per day. It is very unlikely to be enough to keep the presumablybetter qualified manager happy. Indeed the bonus is dependent on thelevel of new sales and so there is an element of risk involved for themanager. Generally speaking higher risk for lower returns is far frommotivating.
The level of sales could of course be much bigger than iscurrently predicted. However, given the uplift on normal average dailysales is already +60%, this is unlikely to be significant.
(c) When new products or in this caseopening times are launched then some form of market stimulant is oftennecessary. B&P has chosen to offer substantial discounts andpromotions. There are various issues here:
- Changing buying patterns: It is possible that customers might delay a purchase a day or two in order to buy on a Sunday. This would cost the business since the margin earned on Sunday is predicted to be 20% points lower than on other days.
- Complaints: Customers that have already bought an item on another day might complain when they see the same product on sale for much less when they come back in for something else on a Sunday. Businesses need to be strong in this regard in that they have to retain control over their pricing policy. Studies have shown that only a small proportion of people will actually complain in this situation. More might not, though, be caught out twice and hence will change the timing of purchases (as above).
- Quality: The price of an item can say something about its quality. Low prices tend to suggest poor quality and vice versa. B&P should be careful so as not to suggest that lower prices do not damage the reputation of the business as regards quality.
Question 29 Teemo
This report aims to explain and interpret the Month 6 variance report.
Original planned profit
As can be seen from the original standard cost card, the originalplan was to sell the product for Â£250. With a cost per unit of Â£160(made up of material, labour and overhead costs), a contribution of Â£90was planned for each unit.
Teemo budgeted to produce and sell 1,000 units so totalcontribution was expected to be Â£90,000. Budgeted fixed overheads(which could include items such as rent and insurance) were expected tobe Â£70,000 so that a profit of Â£20,000 was the company's originaltarget.
As actual profit was only Â£11,140 there must have been somedeviation (or 'variance') away from the original plan. The variancereport aims to explain why and where this has occurred.
There have been a number of deviations away from the original planand each one is split into a different variance on the variance report.
Teemo sold 200 units more than was budgeted. So at a contributionof Â£90 per unit this should have created an extra Â£18,000 of profit.This is the 'volume variance' so that the expected profit on actualsales of 1,200 units was Â£38,000. This may have been caused by the fallin selling price (see next variance).
Sales price variance
The sales price variance is negative as it has been deducted fromthe expected profit â€“ it has had an 'adverse' affect on profit. Thistells us that the actual selling price of the product must have beenbelow the original budgeted price of Â£250.
As 1,200 units were sold and the variance totals Â£12,000, thereduction in price must have been Â£10 per unit. So the actual sellingprice must have been reduced to Â£240 per unit. Without furtherinvestigation we do not know why the price was lowered, it could havebeen a deliberate marketing strategy or a reaction to similar moves byrivals.
Materials price variance
This is another adverse variance â€“ in order to have an adverseaffect on profit the price per kg of material (budgeted to be Â£20/kg)must have increased. The company spent Â£132,300 on 6,300kg of materialwhich gives an actual price of Â£21/kg. This Â£1/kg increase for the6,300kg purchased has caused the Â£6,300 adverse variance. This mighthave been caused by an uncontrollable change in market price or a switchof supplier.
Materials usage variance
Teemo originally planned to use 5kg of material on each unit ofproduction. As 1,200 units were produced, 6,000kg should have been used.6,300kg were actually used which gives an adverse variance of 300kg. Ata standard cost of Â£20/kg, this caused the adverse usage variance ofÂ£6,000. This might have been caused by a change in the materials usedcausing unfamiliarity to staff.
Labour rate variance
A favourable labour rate variance means that there has been apositive effect on profits by a change in the labour rate per hour.Â£5,040 was saved on the 5,040 hours worked â€“ a saving of Â£1 perhour. The budgeted rate per hour was Â£10 so the company must have paidan average rate of only Â£9 per hour. Perhaps a lower grade of labourwas used â€“ which might also explain the adverse materials usagevariance.
Labour efficiency variance
Teemo budgeted for each unit to take 4 hours of labour. The totalexpected time for the 1,200 units actually produced would therefore be4,800 units. 5,040 hours were actually worked, giving 240 extra hours oflabour that weren't expected. At a standard cost of Â£10 per hour thiscreates a total adverse variance of Â£2,400. This would be consistentwith the use of a lower grade of labour who may take longer to completethe task.
Variable overhead expenditure variance
There was no variance here which means that the planned expenditureon variable overheads per hour (Â£5) and the actual cost per hour musthave been the same.
Variable overhead efficiency variance
Variable overhead efficiency is linked to the labour efficiencyvariance (and will have an identical cause). Because labour worked 240hours more than expected, the company's machines, for example, will havehad to have been operated for an extra 240 hours â€“ this gives anextra cost to the company. At a standard cost of Â£5 per hour forvariable overheads, the total extra cost will be Â£1,200.
Fixed overhead variance
The adverse fixed overhead variance tells us that Teemo spentÂ£4,000 more than the Â£70,000 originally budgeted on these costs. Moredetailed analysis is not possible without a detailed breakdown of theindividual elements of the fixed overheads, but this could be caused byextra system costs of monitoring new staff, materials wastage etc.
The variance report highlights that the main cause of the downturnin profits was the cost overruns â€“ especially on materials. The nextstep should be to investigate why these variances occurred.
Question 30 Tupik
(a) The net profit for each product is calculated as follows:
On the basis of profits, both products give the same net profitper unit and therefore the company would be indifferent as to which oneshould be produced.
Fixed production overhead is absorbed at an average rate per hour:
Total hours (120,000 * 0.25) + (45,000 * 0.15) = 36,750
Absorption rate per hour = $1,470,000/36,750 = $40
(b) Production plan
Decision making should be based on contribution rather than on netprofit. Also, when there is a scarce resource/bottleneck, thecontribution per usage of the scarce resource should be used inorder to reflect the bottleneck problem. For Tupik this would appearas follows:
The company should then prioritise sales and production of theproduct with the highest contribution per bottleneck hour. This meansthat product B should take priority.
Maximum demand of product B = 45,000 * 120% = 54,000 units
Bottleneck hours required for B = 54,000 * 0.015 = 810 hours
Bottleneck hours available for A = 3,075 â€“ 810 = 2,265 hours
Output of product A which is possible = 2,265/0.02 = 113,250 units
So the production plan should be to make 54,000 units andprioritise production resources to this product, and then to make113,250 units of A. This is less of product A than is currently sold,but overall profits should be increased.
Profits from new production plan
Other factors to consider
The increase in profits is marginal ($31,500) and it may wellbe that the cost of reorganisation and planning may outweigh this. Itshould be considered whether this is a one-off, short-term problem or alonger-term issue.
It may be that the bottleneck can be removed. Product A makes acontribution per unit of $30 and there is a potential unsatisfieddemand of 30,750 units (maximum demand is 144,000 and only 113,250 willbe produced). So there is a potential gain of almost $1m. If it wouldcost less than this to remove the bottleneck then that strategy shouldbe pursued.
From a strategic point of view the company should consider thelonger term impact on customers, rivals and shareholder returns. It alack of product availability might harm company reputation and providecompetitors with greater economies of scale and a better competitiveposition. It may also be that the products are at different stages oftheir life cycle and that it may be a better strategy to maximiseproduction and sales of A even if it means lower profits in theshort-term (for example, if this product is in decline the company maywant to sell as many as possible before sales completely dry up).
There are many factors to consider in making the productiondecision. But the use of net profit per unit over-simplifies thesituation and could lead to poor decision making.
Question 31 Jays
(a)There are a number of Human Resource Management (HRM) issues that will be impacted upon by the move from retailer to services.
On a fundamental level, when Jays were retailing shoes theyoperated 123 outlets; the move into repairs meant trebling the number ofoutlets to over 300. This expansion will have meant a significantincrease in the number of employees within the outlets. As well as this,the skills required between retailing and repair are different and sodifferent types of employee would have been hired.
In addition, the number of outlets may require an increase inthe management positions at head office analysing the data produced.
Finally, Jays is expecting that more difficult repairs will becarried out at a national centre. Specialist employees to carry out thiswork will need to be recruited.
There are some overlaps between the retailing and repairsbusinesses. Retailing is very much geared towards customer service, anarea that Jays has identified as important within the repairs business.There will obviously be some training involved for the watch repairers.However, it has already been identified that this can be broken downinto ten easy operations. This should make the training progressquicker.
It appears that Jays is already a decentralised organisationsince much of the decision-making is already carried out at eachindividual outlet. Jays will need to ensure that there is consistencybetween outlets particularly over which repairs are passed back to thenational centre.
The culture within the outlets at Jays may cause the managementproblems. As the company concentrated less on shoe retailing and moreon shoe repair, the culture of the craftsman may have appeared. Underthis, knowledge, skill and experience would be respected and passed onto more junior members of staff (almost like apprentices). The watchrepair side, as noted above, has been made extremely simple with theresult that the status of the 'expert' repairer may be diminished.
(b)Motivating the workforce at Jays mayprove more difficult than it initially appears. A number of methods thatmight normally work in companies might prove difficult to implement inJays' situation.
For example, the work at Jays might prove to be monotonous and so jobrotation might be undertaken. The difficulty with this is that thiswould mean training all the staff in the skills of shoe repair whichmight prove costly. Similarly, due to the geographical area beingcovered, moving staff between branches may not be practical.
Another common motivation technique would be to undertake jobenrichment, whereby members of staff add on new skills to their currentones. Again, in the context of Jays' large number of small (tenemployees or fewer) autonomous shops there is a limit to how far thiscan be developed.
One suggestion would be to reward staff on the outcomes oftheir performance. For example, measuring customer feedback (althoughhow useful this might prove is debatable). A broader reward based on thefinancial performance of the shop might be introduced. The difficultywith this is that the nature of the business is reactive, if nobody'sshoes need repairing there is nothing the branch can do about it.
The likelihood is that some kind of competence-based systemwill be introduced. Under this, the employee would be graded by thebranch manager on how well they fulfil certain competencies. These mightinclude technical competencies such as their knowledge and the qualityof their repairs and to service competencies such as how well they dealwith customers.
Question 32 Y
(a)Resistance to change inorganisations can be considered according to whether the resistancecomes from individuals, groups or the organisations themselves.
At the individual level, the following reasons/causes have beennoted as factors involved in resistance: fear of the unknown,well-formed habits, threats to economic interest/status and the threatof inconvenience. In the case of Y, there is much for employees to fear.Several will be afraid that, in the longer term, they may lose theirjobs. Some will fear that they may have to move from one job to anotheror from one department to another. For some, this will be quite anupheaval, although others may welcome the change. Some will fear thatthe change may bring a loss of status in the organisation, especiallythose in middle management whose jobs are to go. Redeployment to anotherjob may include a protected salary, but delayering will inevitablyresult in a loss of status for some employees. Then there are theproblems with learning new skills. Some employees will fear that theymight not make the grade and be reluctant to take on retraining.
At group level there will be collections of individuals who seetheir position threatened and who will combine to resist any threats totheir position. The middle management groups in Y in particular willfeel threatened and will be looking to their trade union to protecttheir interests. There may well be calls for industrial action toattempt to prevent delayering from taking place, or at least to win forthe managers affected the highest possible severance pay or redeploymentterms.
Even where individuals are not members of a trade union, it ispossible for groups of employees, including managers, to colludeinformally to resist change. This may be achieved by such measures aswithholding information or by not being wholly co-operative with thoseseeking to implement change.
At the level of the organisation, a number of factors willoperate to make the change process difficult. These included theexisting structure and culture of the organisation, the existinginvestment in resources, and past contracts and agreements with variousstakeholders within the organisation. For example, many state industriesthat have been privatised in recent years have required flatter, moreorganic, organisational structures; it is hard to change from a 'role'culture to a 'task' culture to cope with competition in the open marketand hard to renegotiate the terms of the contracts with stakeholders,such as the trade unions.
(b)A useful way of looking at the problemof resistance to change is via the simple framework formulated byAmerican social psychologist, Lewin.
Lewin's framework suggests that change, or lack of it, is the resultof disequilibrium or equilibrium between two sets of opposing forces.One set he refers to as 'driving' forces, because they act to encourageand facilitate change, and the other as 'restraining forces' becausethey act in the opposite direction and seek to maintain the status quo.
Any attempt to bring about change, therefore, requires ways andmeans of overcoming resistance to change. This may be achieved in avariety of ways, but it is apparent that what is required is either afurther strengthening of the forces for change or a reduction in thepower of restraining forces.
Using this framework we can see that the major driving forcefor change is the increasing competition brought about by changes in theindustry environment. There is little that Y can do about this exceptto respond to it by becoming leaner and more effective. The reduction inmanagement levels should help to cut costs, and the strengthening ofthe telephone banking division should help the bank's competitiveness,as should the investment in IT and training.
The spur to change is the threat of the new competition, andmanagement should seek to communicate the message to managers and otheremployees more effectively. We cannot tell from the scenario just whatattempts have been made to communicate to the workforce either theseriousness of the bank's situation, or the rationale behind seniormanagement's plans to combat this situation. To the extent that the needfor the planned action has not been properly communicated it followsthat this must be an early priority for the senior management team.Communication, along with other means such as education, participation,consultation, manipulation and coercion are part of typology of methodsadvocated by theorists such as Kotter and Schlesinger for assisting inthe management of change process.
It may be that communication is not sufficient and that aprocess of education is required. In this day and age the seniormanagers should tread carefully. Bank employees generally have a highlevel of education and it would not help the case for change ifmanagement underestimated this. Nevertheless, in trying to persuadeemployees that the plans management have drawn up are in the bestinterests of all, there may be a place for the education of some staffmembers to management's point of view.
A method associated with communication and education is that offacilitation and support. Y management may be able to alleviate fearsof some individuals by the use of counselling and group discussion.
Another way of reducing resistance to change is that ofinvolving all employees from the start of the change process. By puttingthe problem the bank is facing to employees in a series of face-to-facemeetings, and offering the possibility of participation in thedecision-making and planning process, it may be possible to get moreemployees to buy into the planned changes. The problem in the case of Yis that senior management may already have made decisions withoutconsultation. This kind of participation exercise is alsotime-consuming.
Given that the decisions have been made and that resistance hasalready been encountered it may well be that the best way forward nowis through a process of negotiation with representatives of theworkforce. In the case of Y it is probable that trade union officialswill represent the employees' side. Through a process of negotiation andbargaining it may be that the union can gain sufficient concessionsfrom management, in terms of built-in safeguards and appropriatecompensation for its members. The bank could then be allowed to proceedwithout further hindrance.
An alternative approach is the less ethically based use ofmanipulation and co-optation. Manipulation involves seeking to persuadepeople by the use of partial and misleading information whileco-optation involves 'buying people off' by the promise of some kind ofreward for going along with the proposed changes. Through these methodsare used, they are not the kinds of methods that professional peoplewould involve themselves with.
If all else fails, however; senior management may find that theuse of explicit and implicit coercion is the only way forward. This mayinvolve mass redundancies without right of appeal. This method would beone of last resort since the image of the bank would suffer and themorale of the remaining workforce would be badly affected.
Question 33 BHH Clothing
(a) The strategic context
The key environmental issues are as follows:
- High customer power
- The threat from low cost competitors
Both of these threats are likely to increase rather than decrease.
The options available to BHH include the following:
(1) The mainadvantages of the current plan are that they should reduce cost withoutcompromising quality. Furthermore BHH keeps the higher-skilledvalue-added finishing aspects in-house. This should help BHH manage thethreat from low-cost competitors but does not address the problem ofhigh customer power.
(2) Keep manufacturing in Europebut focus on improving production efficiency to reduce costs. This couldinvolve implementing TQM, better use of IT, improved throughput,eliminating processes that do not add value and improving employeemotivation and output. This could be planned as part of a BPR projectbut is likely to be just a short term fix. In the longer term the threatfrom lower-cost Chinese manufacturers will still need to be addressed.
(3) BHH could shift bothmanufacturing and finishing overseas, focussing mainly on the customerrelationship and design aspects. This should reduce costs further butwould lose the differentiating factor that comes from high qualityfinishing.
(4) BHH could seek to sell goodsunder its own brand name to reduce customer power. However, this willrequire substantial investment to develop the BHH brand in the market.
(5) BHH could seek to verticallyintegrate forwards and open its own retail outlets. Again, the problemfor BHH would be the major investment required.
(6) BHH could manufacture highervolume garments overseas but seek to make and deliver small batches ofmore exclusive lines with shorter lead times. This would allow BHH to bemore responsive to market trends, thus reducing the risk of "fashionmiss" (i.e. producing items that consumers do not want). The offer ofreduced lead times may be difficult for Chinese firms to match and sowould enhance BHH's strategy of differentiation. This would also reducethe scale of redundancies facing BHH.
Given its lack of brand strength, BHH has to move at least someof its manufacturing overseas to respond to the serious environmentalthreats it faces. Major change is thus unavoidable. However, thedirectors may wish to consider option 6 above as a way of reducing theimpact of the change process.
(b) Contextual features
The key contextual features are as follows:
- Time â€“ Given the recent loss of Forum and the threat from other retailers, BHH has to act quickly to develop a response. The time context is close to being a crisis rather than allowing an incremental approach. Time must thus be viewed as a strong driver of change but as a negative aspect in terms of how easy that change will be.
- Scope â€“ A significant proportion of manufacturing must be outsourced but design and finishing should continue as before without major changes. On balance the scope aspect is best described as realignment rather than transformational.
- Preservation â€“ It is vital that design, customer service and finishing skills are retained, despite other production staff (presumably) being made redundant. A major threat is that current employee unrest will result in key staff looking for new jobs elsewhere. The existing culture may need to be refocused firmly on high quality and customer responsiveness.
- Diversity â€“ While there is likely to be a difference in sub-culture between production and design, only the latter will really be impacted by the change. Furthermore, there is likely to be a strong sense of unity within BHH due to them all being based in the same location and the length of time many employees have worked together. Given that the change will primarily impact production workers, diversity is unlikely to be a problem. (Note: were BHH to switch to short lead-time, small-batch production, then the change would be more widespread, in which case diversity would be a more major consideration).
- Capability â€“ Given that management have so far resisted the industry trend to outsource production, it is likely that BHH does not have staff who are experienced in change and change management.
- Capacity â€“ Given falling margins it is probable that BHH does not have significant funds to invest in the change process. However, the move to outsourcing will not require significant funds. Instead there will be pressure on management time to locate and screen potential suppliers. There is insufficient information available to determine whether or not this will be a problem.
- Readiness â€“ A major problem facing management is that staff have discovered some aspects of the change without being properly informed. The negative implications have thus been blown out of proportion, resulting in threatened strike action. Staff are thus likely to oppose any changes rather than support them.
- Power â€“ there is insufficient information to determine how much authority and respect change agents have to implement proposed changes. It is clear however, that employee representatives are key players in the change process.
(c) Design choices
Key recommendations are as follows:
- Change path â€“ The most pressing problem is to avoid strike action and to reassure staff about the actual changes proposed. Only then can management look to address the details of how, when and where production should be outsourced.
- Change start point â€“ the crisis nature of the problem necessitates a top-down approach initially where senior management need to regain control of event.
- Change style â€“ once the immediate problem of staff unrest is addressed, management should adopt a participative approach to involve employee representatives in deciding how and where redundancies should be made, whether some staff could be retrained and what support will be offered to staff who lose their jobs.
- Change interventions â€“ Initially the key mechanism is likely to be communication and education to convince employees that only production staff involved in making the basic garments might lose jobs. As stated above participation will be key to successful change management.
- Change roles â€“ Given the lack of experience of change, BHH may wish to employ the services of external consultants. Either way it is vital that change action teams are set up, including designers, finishers and production staff. BHH could also consider including representatives from key customers to improve BHH's chances of keeping their accounts. Certainly consultants should be used to investigate potential Chinese suppliers.
Created at 5/24/2012 1:01 PM by System Account
(GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
Last modified at 5/25/2012 12:55 PM by System Account
(GMT) Greenwich Mean Time : Dublin, Edinburgh, Lisbon, London
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