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Detailed analysis of the N Multi-channel retailer case Pre-seen material Further downloadable Mock Examinations with solutions and selfmarking guides based on the N Multi-channel retailer case Pre-seen material
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The Finance Director of N has asked you, the management accountant, to provide advice and recommendations on the issues facing N. Question 1 part (a) Prepare a report that prioritises, analyses and evaluates the issues facing N and makes appropriate recommendations. (Total marks for question 1a = 90 Marks) Question 1 part (b) In addition to your analysis in your report for part (a) you should prepare a graph which shows the original revenue targets for 2014, 2015, 2016 together the updated revenue targets assuming that all three of the opportunities described are pursued. You should supplement this with no more than 5 bullet points summarising your overall recommendations on these three opportunities. (Total marks for question 1b = 10 Marks)
Note: Marks for calculations, relevant to Question 1 part (b), are awarded within the Assessment Criterion of Application included in Question 1 part (a). Your script will be marked against the T4 Part b Case Study Assessment Criteria shown on the next page
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Analysis of Issues Technical Application Diversity Strategic Choices Focus Prioritisation Judgement Ethics Recommendations Logic Integration Ethics
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Each of these stores is planned to generate cashflows of Z$0.7m in their first year, increasing by 6% each year. (Assume stores opening in year ended 2014 generate full year cash flows.) The new openings in Country YX and Europe include flagship openings similar to the one in City T. The Finance Director of N has confirmed that the net present value of the cost of opening these stores, using Ns cost of capital of 10%, is Z$15m. The proposal is that for each new franchised store, N would receive 9% of the gross sales revenue from each store. In return N would provide full IT and marketing support to all franchisees and give them access to designs, products and suppliers. The IT and marketing support required will, it is estimated, cost N up to Z$2.5m per annum. The franchisees would then negotiate with suppliers to make amendments to products which will reflect local tastes and customs in the relevant markets. The cost of these changes would be borne by the franchisee. GF has stated that its fees for locating franchisees and managing the franchising business for N would be a fee of Z$40,000 for each new store opened, plus a fee of 6% of the franchised revenue for the first year of each store opening. After the first year of each store opening GF would charge a flat fee of 2% of the franchised revenue for the contract period. GF has prepared the following forecast post-tax cash flows for the next 3 years based on its projections of franchised stores opened:
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Zm Franchise income payable to N Share of gross store revenues Franchise fees payable by N to GF Z$40,000 per franchised store Share of first year revenue Share of total revenue
2014 23.4
2015 27.5
2016 30.7
Acquisition opportunity The recession has hit some of Ns competitors very hard, with some retailers going into liquidation and others being put up for sale by administrators and receivers. For some months the Board has been watching the performance of YX, a rival in North America, whose fortunes have fallen dramatically as key management personnel have left and cash for investment has dwindled. YX is privately owned and shareholders are known to be looking for a swift cash only sale but no buyers have yet come forward. A few years ago YXs brand was widely recognised and heavily promoted through sports sponsorship and controversial billboard and magazine advertisements but in recent years its profile has declined due to a lack of investment in innovative designs. It currently has 110 shops across 20 states of North America, 60% of which are owned and the remainder of which are rented under short-term leases. Approximately half the shops are in strong locations in out of town retail parks and city centre sites with parking, but all outlets have suffered from underinvestment and the facilities are tired and outdated. YXs e-commerce capabilities are less advanced than Ns at present. YX has supplied N with summary information of its recent performance as follows, translated into Z$: Year ended Sales revenue Gross profit Distribution costs Administrative expenses Finance costs Taxation Dividend paid Retained profit Other information Total number of employees Gearing ratio (debt/debt + equity) Net assets Cash balance 17,320 73% Z$265m Z$1.7m 17,300 66% Z$277m Z$1.9m June 2013 (unaudited) Z$m 1,760 126 29 36 15 14 20 12 June 2012 (audited) Z$m 1,934 162 27 35 15 26 20 39
YXs projected revenue figures for 2014, 2015 and 2016, converted using the most up to date exchange rate between the US$ and the Z$ are as follows: 2014: Z$1,703m 2015: Z$1,725m 2016: Z$1,780m
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Ns Finance Director has identified two similar retail companies to YX, neither of which are for sale but both of which are quoted on the US stock exchange, and has provided you with the following information again with $ data converted into Z$: Company 1 1,402 11% 4% 5.39 114.5m Company 2 2,201 14% 5% 5.66 175m
Revenue (Z$m) Gross profit % Post-tax profit % Share price (Z$) Number of shares
As part of your assessment of this proposal you should assess the likely cost of acquiring YX using the earnings based method for valuation. The Finance Director has explained that cash can be made available for this acquisition but only up to a maximum of Z$200m. VP proposal VP is a major white goods manufacturer with factories in Germany and Eastern European countries (white goods are items such as fridges, freezers, washing machines and tumble driers). The goods manufactured by VP are cheap and simply designed and do not come in alternative colours or sizes. One of the ways in which VP keeps its costs down is by using component parts which do not give their products particularly good energy ratings. This is because the goods use a higher than average amount of electricity to run and none of the component parts can be recycled. A further way in which costs are minimised is by offering a 3 month warranty rather than the usual 12 month warranty, a tactic which is consistent with the pricing. Ms. Bilder has had dealings with VP in the past when she worked for a large hypermarket chain in Country Z called B. She enjoyed a very positive relationship with VP and found it easy to deal with and very reliable. At B, when she switched suppliers and introduced VP white goods into Bs stores, the margins on white goods improved dramatically and Bs profits increased sharply. VP has used the advertising slogan German engineering at its finest which, together with the very low prices, has been a very attractive marketing message which successfully attracts high numbers of customers. VP would want to use this slogan in its partnership with N (discussed below). However Ms Bilder is aware that the majority of the goods that VP would be supplying to N would be assembled in Eastern Europe, with 85% of components being purchased from China. The proposal being discussed involves each of the items supplied by VP to N being dual branded so that the two organisations are presented to customers as partners. The items will be sold in all of Ns stores in the Home (Household) department and online. Based on estimates supplied by VP and scrutinised by both the Sales and Marketing Director and Ms. Bilder it is believed this venture, if it is successful, could increase Ns revenues by the following amounts: 2014: Z$303m 2015: Z$525m 2016: Z$780m
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Distribution centre accidents An increasing number of small accidents have occurred in Ns distribution centres in the last six months. These accidents have occurred when goods on pallets are being moved from the forklift trucks onto the shelving where they await despatch to stores. Until March 2013 N provided all distribution centre staff with steel-toed boots and heavy gloves but a cost reduction exercise saw the removal of this policy and now employees are asked to buy their own gloves and boots. Some employees in the distribution centre are turning up for work in training shoes and failing to wear any gloves at all. As a result the number of injuries to toes and fingers from moving pallets has increased and on a couple of occasions people have lost toenails and fingernails, which has resulted in time off work. Marketing expenditure As N has attempted to reduce the widening gap between itself and its main rivals, its expenditure on marketing has increased sharply. Some initiatives have yielded successes in terms of revenue but others have been costly mistakes and there has been very little in the way of coordination across the N group. Some stores have unilaterally gone ahead with knee-jerk marketing initiatives such as discounts, sales, local events involving celebrities and themed fancy dress days for staff. Increasingly, there is a culture of try anything to get sales in both Ns head office and Ns individual stores. Ms Bilder and the Finance Director are not happy with the control being exercised by the Sales and Marketing Director and his management team. They have asked you, as a qualified management accountant, to discuss the ways in which the accounting function can help address this situation, by controlling expenditure and ensuring that the marketing budget is spent on genuinely beneficial initiatives in the future. They are aware that you have recently studied topics such as strategic marketing, performance evaluation and information management and believe that you will be able to make sensible suggestions on how best to control Ns marketing expenditure. End of Unseen Material
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SOLUTION
AND MARKING GRID
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The solution that follows is a comprehensive answer showing the range of points and calculations you could undertake. As the marking grid shows, in the exam you would not need to make all the points in order to be awarded high marks.
ANSWER TO QUESTION 1A
REPORT To: Finance Director
From: Management Accountant Date: July 2013 Contents (1) (2) (3) (4) (5) (6) (7) Introduction Terms of reference Identification and prioritisation of issues Approaches to resolving the main issues Ethical considerations Recommendations Conclusion
Appendices (1) (2) (3) (4) (5) SWOT analysis Mendelows matrix Franchising Acquisition 1b
INTRODUCTION
Despite stabilising its position in the years following its management buy-out in 2004, N is still struggling to find a viable competitive position in its domestic market. Ns sales growth is well below its competitors, and it has weaknesses in on-line sales growth, the integration of its multi-channel sales platform and unfashionable clothes ranges. N needs to create a sustainable competitive position, either in terms of differentiation or cost leadership (Porter) or it will become stuck in the middle. In the challenging economic conditions within Country Z, even well-known companies that are stuck in the middle will struggle to survive. This is illustrated by the failure of many established high street retailers in the UK, such Woolworths, in recent years.
TERMS OF REFERENCE
This report identifies and evaluates the issues facing N and offers appropriate recommendations.
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McDonalds has become a brand known worldwide thanks to successful franchising. Despite the difference in market, this model proves franchising can lead to market dominance, a position N used to hold. Options 1. 2. 3. 4. Decline GFs offer. N may feel it can move forward alone. Approach other franchising companies with a view to a similar deal, but without the prohibition on N opening new stores. N may accept the offer and the terms of GF unequivocally. Alternatively, N can enter into negotiations with GF to alter the deal, especially the cap on total number of stores.
4.2 Acquisition of YX
Suitability This opportunity is also suitable as it offers scope for international growth. The stores currently owned / leased by YX are spread across 20 states of North America, allowing N greater market access across a large swathe of the country. N is also hampered by its governments policy of preventing takeovers that may reduce competition. Looking to take over a business abroad is a move which circumvents this issue. A significant problem surrounding the acquisition however is that YX currently has less advanced ecommerce capabilities than N. Acquiring YX will not help N meet increasing trends towards online purchasing. Acceptability Appendix 4 shows an approximate value of YX. This would potentially utilise all of Ns available cash resources, as YXs shareholders want a cash sale. This would result in no cash left to fund other activities, or for shareholder dividends. It is unlikely this purchase would be acceptable to shareholders. There is also the risk of taking on a company with a high gearing ratio (which has increased since the previous year) and a history of decreasing sales revenue and decreasing gross profit. If debt has increased and revenue and profit decreased, there is a serious risk that in the future YX will no longer be viable. The value of YX company has been reached using the average of two proxies P/E ratio, scaled down as YX is a private company. This is risky because there is no assurance the PE ratio used will be right it should also have been adjusted to take account of YXs debt level, which is likely to be different to those of the proxies and to reflect YXs poor growth prospects. There is no guarantee the value of YX calculated is accurate, and this should be of concern to the Board, particularly the Finance Director. Feasibility Financially this would be likely to increase Ns debt levels. With the upcoming negotiations around the loan finance position, now may not be the best time to request further loans. A final thing to consider is that YX is in North America and therefore fluctuations in exchange rates need to be taken into account. The projected revenue figures could turn out to be lower in Z$ terms if the US$ devalues. Options 1. 2. Press ahead with attempts to acquire YX. Because YXs shareholders are looking to sell, YX may be available at a cheaper price than anticipated. Stop monitoring YX and do not purchase. This will not reflect badly on N because no offer has been made.
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3. 4.
Look at alternatives for acquisition. With funding available and expansion planned, there are alternatives for N to consider. Make an offer for certain stores only. This would be financially more viable, and less of a strain on other resources.
4.3 VP Proposal
Suitability The Sales & Marketing Director has noted that competitors are successfully following a strategy similar to this, so on that basis the proposal would have some strategic logic. However the proposal from VP is not consistent with Ns current strategy as a differentiator priding itself on offering quality products and excellent customer service. To take up the proposal from VP would result in N becoming stuck in the middle, as Michael Porter phrased, as the cheap products offered by VP would clash with Ns current strategy. Other businesses found guilty of being stuck in the middle, such as Woolworths and JJB. Both of these have now folded. Stocking such products is unlikely to assist with Ns plan to become once again a leading force in the market. There will be a clash of brands and image. The dual branding proposal could mean negative publicity that may adversely impact sales of other products. Acceptability Ms Bilder would be quite happy to deal with VP, since she has worked with it before and had no issues, finding it to be quite reliable. The margins on the products and proposed revenues are likely to be appealing to the investors, although there is no profit figure stated. The estimates have been supplied by VP. There is no guarantee of accuracy even after scrutiny. The 3 month warranty period should be a serious consideration. Whilst the Sales & Marketing Director is pushing for increases in own brands, these must still fit with overall company image. The fact the products do not come in alternative sizes or colours is also a downside in Argos for example there are many versions of such products, coming in a variety of different colours and sizes. Shoppers are far more likely to use competitors such as Argos for these items. Feasibility There is no initial financial outlay mentioned, therefore this would not seem to be an issue. Sales training will be required in VPs products. Floor space is also an issue. To sell these items N would have to either rearrange stores, or potentially stop selling other product ranges. All of this could damage reputation and the customer experience. Options 1. 2. 3. Agree to the deal and begin stocking and selling the items. Negotiate the terms of the deal to avoid the dual branding issue in order to protect N. Reject the proposal.
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By setting marketing budgets for each store or product line, N will have greater control over spend as it will identify which areas are over or under spending against their budgets. The finance team can then highlight areas needing to curb expenditure. This process will also (if done properly) allow for specific levels of marketing at various different times. For example, if a new flagship store was to open, in the run up to opening the marketing spend would be expected to increase. 2. Benchmarking By benchmarking Ns activity against rivals it will be possible to see how N does in comparison to its direct competition. This can involve comparison of overall activity, activity directly in certain markets, or marketing activity in direct relation to certain products. The results of such benchmarking analysis will highlight areas N outperforms the competition, and areas where N is not performing adequately. These areas, which might well include on-line marketing and marketing to smartphones, can then be looked at in more detail and resources allocated more effectively. This could be based upon benchmarking regions, stores, product lines, and then comparing sales performance and revenues.3. Authorisation controls By implementing a system where only certain managers within the business are allowed to sanction levels of expenditure, N will be able to identify poorly-controlled expenditure areas. This may also have the effect of making staff more aware of how and what they are spending. Waste may then be avoided.4. Yield analysis This process would involve comparing sales and contribution against the money spent on marketing. This will identify how much additional revenue comes from each additional dollar spent on marketing. Better performing items can be identified and marketed further. Highlighting items which are unprofitable could mean that those products are removed from stores, this freeing up space for more profitable products.
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ETHICAL ISSUES
5.1 Suggestion to not stick to GFs proposed terms
Why is this an ethical issue This is part of the deal stipulated by GF around the franchise offer. Entering the deal without intending to honour it is dishonest and a breach of integrity. Recommendation for this ethical issue N should either stick to the terms stipulated by GF, or renegotiate to more favourable terms. N does not want to gain a reputation as an untrustworthy business partner.
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RECOMMENDATIONS
6.1 Franchise offer from GF
Recommendation N should take up the offer from GF, but negotiate over opening new stores Justification This option represents the least risky method of global expansion for N. The franchisees are already in place with specifically tailored products. Franchising will give N greater media coverage and advertising far quicker than could be achieved otherwise. It is also a quicker way of generating sales than opening up new stores. By allowing the franchise N will enjoy revenues, and allow its management to consider other potential routes of expansion, without the distraction of having to worry about the franchised stores, as GF will be tasked with supervising them,. However the blanket prohibition on Ns organic growth is too broad and restrictive. Actions to be taken 1. 2. Contact should be made with GF immediately indicating a willingness to agree a deal if certain agreements can be reached. GFs proposed franchisee stores are within specific countries. N should suggest no more stores be opened only in those particular countries until the franchises have built up a reasonable base. This should not include Country Z where N should continue its modest store opening program. A proportion of the Z$15m, which was set aside for the opening up of new stores in countries where franchises will operate, should now be used in other areas of the business. This could be used to fund further development of the online platform. Regular meetings should be set up between GF and N to monitor franchisee performance.
3.
6.2 Acquisition of YX
Recommendation N should not consider YX as a potential acquisition and focus on growth through franchising. Justification The acquisition of YX is too risky. N needs to look to move to online retail, as that is the current shopping trend, and YX has inadequate e-commerce capabilities. N could make an offer for only certain stores within YX, but it is most likely that YXs shareholders will look to sell the company as a whole. Buying a limited number of stores may well be more trouble than it is worth, as there may be problems of integration and the North American market does not currently offer many opportunities for growth. Companies like Carrefour have found that spreading resources over a wide range of geographical markets does not work well. Carrefour has recently started to retrench to focus on a number of targeted overseas markets. Ns target growth markets are in the Middle East and Asia and it would presumably concentrate on these if it decided to narrow its focus..
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Actions to be taken 1. 2. Focus on identifying other acquisition targets, profiling companies either with good online retailing competences and / or companies in the Middle East /Asia.. Keep an eye on what happens with YX as this may provide strategic insight into the situation abroad.
6.3 VP Proposal
Recommendation N should cease discussions with VP regarding this proposal, and communicate that there will not be a partnership. Justification VPs products do not fit with Ns brand image. N is a differentiator, and VPs products are more of a cost leaders products. N is trying to enhance its competitive position, and to do so there must be a clear strategy with every aspect of the company focussed and pulling together. Partnership with VP is likely to cause more problems than potential benefits, mainly through damage to Ns image. Actions to be taken 1. 2. 3. The situation should be explained politely to VP and discussions aborted. It is recommended that N looks to implement an electrical home goods line, as this is a product line sold successfully by many of Ns competitors, such as M&S and Tesco. N should research other suppliers of white goods and make contact with appropriate suppliers with a view to supplying products.
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CONCLUSION
This report has identified and evaluated the issues facing N and has offered appropriate recommendations.
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Appendix 3: Franchise
Year end 2014 2015 New stores to be opened in each year Middle East Asia Europe North America Country Z Total Cumulative total 0.7 foregone rising at 6% 4 2 0 0 2 8 8 5.6 4 3 1 2 2 12 20 14.8 Year end 2015 27.5 6 3 4 2 2 17 37 29.1 2016
2014 Franchise income payable to N Share of gross revenues per store Franchise fees payable by N to GF Z$40,000 per franchised store Share of first year revenue Share of total revenue Support costs 23.4
2016 30.7
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Alternative solution Z$m 2014 revenue IT etc GF costs per store 1st yr rev total rev 23.4 -2.5 -3.4 -2.6 -1.1 Z$m 2015 27.5 -2.5 -5.7 -4.1 -1.3 Z$m 2016 30.7 -2.5 -6.1 -4.6 -1.8
opportunity cost (lost cashflows from stores that would have been opened) 2014 store openings -5.6 -5.9 -6.3 growing at 6% pa after 1st year 2015 store openings -8.4 -8.9 growing at 6% pa after 1st year 2016 store openings -11.9 see workings net 8.2 -0.4 -11.4
df 10%
0.909
0.826
PV 7.5 -0.4 nb $15m of costs are saved this changes the NPV to
Workings stores opened in 2014 stores opened in 2015 stores opened in 2016
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Appendix 4: Acquisition
Company 1 Share price Earnings Shares EPS P/E Z's PAT Scaled down P/E (10*0.6) Value of Z using proxy Pes 5.39 56.08 114.5 0.49 11 32 6 192 Company 2 5.66 110.05 175 0.63 9
Appendix 5: Graph
The franchise opportunity should be pursued but only if the conditions over store openings can be restricted to the countries in which GF intends to have operations. This will result in an NPV of approximately Z$11.6m. The acquisition should not be pursued the benefits to be gained do not fully justify the risks and the costs in this case The opportunity with VP should not be pursued as the business models employed by each company are too different N needs to stick to its core competencies and seek growth with the minimal amount of uncontrolled risk
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Workings Z$m Revenue per original forecast Additional revenues Franchise YX VP Revised revenues 23.4 1,703.0 303.0 4,110.0 27.5 1,725.0 525.0 4,410.1 30.7 1,780.0 780.0 4,776.6 2014 2,080.6 2015 2,132.6 2016 2,185.9
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1 each max 5
Max = 5
Application
13 12 Max 5 for application of theory 17 14 16 1 mark each example used on merit Max = 5
Max = 15
Calculations: Franchise Acquisition Total marks available (but max = 15) Diversity Display of sound business awareness and relevant real life examples related to case Major issues to be discussed:
Focus
(only award if issue is in the main report)
Franchise Acquisition VP Marketing Distribution centre Total marks available award 5 marks for 4 issues (but max = 5) Prioritisation 5 marks if 4 issues are prioritised and the rationale for ranking is good AND the top 2 issues are ranked in the correct order 34 marks if top 2 priorities are in top 3 but ranking rationale is weak 2 marks maximum (marginal fail) if EITHER of the top 2 issues are not in top 3 priorities, irrespective of quality of rationale for ranking of other priorities
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Criteria Judgement
Issues to be discussed 4 key and 1 minor issue available for detailed analysis in this case: Marks on merit based on depth of analysis and commercially realistic comments Franchise needs a full evaluation of the financial and non-financial factors with a focus on risk Acquisition - needs a full evaluation of the financial and non-financial factors with a focus on risk VP another opportunity less on numbers here but still must consider risk v benefits Marketing MUST provide imaginative ideas here from a management accounting perspective Accidents small commercial impact which requires some ideas to address Total marks available (but max = 20)
Marks
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Logic
Recommendations: (Marks on merit. Max 1 mark if only an unjustified recommendation is given) Franchise this is a difficult one to turn down so look for strong arguments Acquisition overlap with franchise (wouldnt do both in reality) VP Look for a no here argued on the basis of brand clash and generic strategies Marketing marks on merit Accidents buy equipment ? Total marks available (but max = 20) 07 06 Max = 30 Q1 (a) 20 05 05 02 25 Q1 (b) 10
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Criteria QUESTION 1b
Issues to be discussed 1 mark for each valid bullet point. 4 for graph, 1 for referring to the numbers. Total marks available Judge script holistically and whether recommendations follow on logically from analysis of the issues and refers to data in appendices. How well written is the report: professional language? Ethical issues in case include:
Integration
Max = 5
Ethics
GF VP Accidents
Up to 5 for identification and discussion of issues Up to 5 for recommendations on how to address those issues Max = 10
Total
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