May 2005 Examinations Strategy Level

Paper P6 - Management Accounting Business Strategy Question Paper 1 Examiner’s Brief Guide to the Paper 11 Examiner’s Answers 12 The answers published here have been written by the Examiner and should provide a helpful guide for both lecturers and students. Published separately on the CIMA website (www.cimaglobal.com/students) from the end of September 2005 is a Post Examination Guide for this paper, which provides much valuable and complementary material including indicative mark information. 2005 The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recorded or otherwise, without the written permission of the publisher.

© The Chartered Institute of Management Accountants 2005

Business Management Pillar

Strategic Level Paper

P6 – Management Accounting – Business Strategy

24 May 2005 - Tuesday Morning Session

Instructions to candidates

You are allowed three hours to answer this question paper.

You are allowed 20 minutes reading time before the examination begins during which you should read the question paper, and if you wish, make annotations on the question paper. However, you will not be allowed, under any circumstances, to open the answer book and start writing or use your calculator during this reading time.

You are strongly advised to carefully read the question requirement before attempting the question concerned. The question requirements are contained in a dotted box.

Answer the ONE compulsory question in Section A on pages 2 and 3.

Answer TWO of the four questions in Section B on pages 4 to 7.

Maths Tables and Formulae are provided on pages 9 and 10.

Write your full examination number, paper number and the examination subject title in the spaces provided on the front of the examination answer book. Also write your contact ID and name in the space provided in the right hand margin and seal to close.

Tick the appropriate boxes on the front of the answer book to indicate which questions you have answered.

P6

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P6 2 May 2005

SECTION A – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER THIS QUESTION

Question One Pipeco, a wholly owned subsidiary of an international chemical company (the parent group), has for the past twenty years manufactured, by an extrusion process, large bore plastic pipe for use in water, sewage and gas piping systems. (Extrusion is a process whereby hot plastic is forced through a die and takes the shape of the die.) Based in Western Europe, Pipeco has been the major supplier to the infrastructure building projects in most surrounding countries. Pipeco has operated from a single site. All projects, which typically last three or four years, are won by competitive tender and Pipeco has had a success rate, for many years, of over 80% of the contracts for which it has bid. Large bore, extruded pipe, is a commodity product sold, by the tonne, on price. Pipeco’s dominant position, in a very competitive industry, has been achieved by its cost effectiveness and the high technical skill of its sales engineers.

In the last three years, revenue and profits have declined as existing building programmes have neared completion and no new projects have become available from current markets.

The directors of Pipeco feel that they cannot maintain the dividend to the parent group at the present levels beyond the current year. The parent group has made available to Pipeco a budget of $2 million for investment and has suggested a hurdle rate of 10% on any project undertaken. Although the parent group takes a strategic, long term view it is currently under pressure from the shareholders to at least increase the overall profitability of the group and maintain the dividend.

The parent group is particularly concerned about profitability over the next five years because of the cost of the expansion plans in other subsidiaries.

There are a number of possibilities which Pipeco wishes to consider including:

Option 1

Pipeco could expand geographically to countries which are beginning to improve their infrastructure. The recent expansion of the European Union is considered to be an opportunity over the coming years.

Preliminary investigations have identified two possible countries to which some of the existing extrusion plant and equipment could be relocated leaving sufficient capacity to finish existing orders.

Country A would involve an initial capital investment of $1·5 million and Country B would involve an initial capital investment of $2.0 million. Sales volumes, in tonnes per year, are as follows; Years Country A Years Country B Tonnes Tonnes 1 to 5 42,000 1 to 8 63,000 6 to 10 64,000 9 to 14 51,000 11 to 15 20,000 Each tonne of product would sell for $90 and there would be variable costs of $85 per tonne.

Option 2

Pipeco could move into other areas of plastics, producing pipework and fittings for use within buildings. The manufacture of fittings would involve moulding, a very different manufacturing process. There are a number of established firms in that industry, although this is considered to be a strong growth industry within Western Europe, particularly at the prestige design end of the business where gross margins of 55% are quite common. Sales within the industry are made to retail outlets or, for larger building projects, by presentation to the architect.

May 2005 3 P6

Pipeco recognises that this is a different business model to that currently used and the approach used by some departments, notably marketing, will need to change. Research has shown that Pipeco could enter the market by investing an initial $1,450,000 in plant and equipment followed by a further $425,000 for plant and equipment payable at the end of the first year of operation. The market entry would be achieved by buying a small, underfunded company from the owner who wishes to retire. The purchase price is included within the total of $1,875,000. This company is based in Pipeco’s current home market.

Research has shown that the project would give the following projected probabilities and cash contributions from sales per year for the next ten years; Year $000 $000 $000 1 - 10 300 435 265 probability 0·5 0·3 0·2 These figures will only be achieved if the investment in plant and equipment outlined above is carried out and do not reflect the level of performance under current ownership. The directors recognise that Pipeco will need to market more proactively and have decided to consider adopting relationship marketing for this option should it be selected. Pipeco realises that the adoption of relationship marketing would represent a significant change to the way the company operates.

Summary

Whichever option is chosen, Pipeco believes that, with the exception of depreciation, which is based on gross capital expenditure, there would be no increase in fixed costs. All capital expenditure is depreciated on a straight line basis over ten years.

Pipeco has a good employment record, with low staff turnover, and would prefer to retrain and possibly relocate (depending on the option selected) staff rather than make them redundant. It believes the staff would welcome this approach.

Required: As the management accountant of Pipeco:

(a) Make reasoned recommendations on the selection of Options 1 and 2.

Note: up to 16 marks will be awarded for calculations (29 marks)

(b) Identify the additional information that would need to be gathered to compare and contrast the suitability of the two countries identified for possible relocation in Option 1.

(6 marks)

(c) (i) Briefly describe relationship marketing and explain how the approach would benefit the company.

(6 marks)

(ii) Advise how the changes associated with the introduction of relationship marketing and the acquisition should be implemented if Option 2 is adopted.

(9 marks)

(Total for Question One = 50 marks)

(Total for Section A = 50 marks)

End of Section A

P6 4 May 2005

SECTION B – 50 MARKS [the indicative time for answering this section is 90 minutes] ANSWER TWO QUESTIONS FROM FOUR Question Two

2XA is an established light engineering manufacturer operating in a single country within the European Union (EU). With 300 employees, the majority of whom are employed in the manufacturing processes, the company is run like a large family business. 2XA supplies components to specialist car manufacturers and manufacturers of light aircraft, all of which are small companies. 2XA has had the same customers for a number of years and there are many personal friendships between the senior management of 2XA and those who own or manage those customer companies.

Since most of 2XA’s sales are a result of repeat business it does not actively market its products. What marketing it currently does consists of an occasional advert in trade magazines and attendance at trade fairs where the Sales Director, and a few office staff, offer light refreshments to their existing customers and anyone who stops at their stand.

In the past two years 2XA has started to lose customers to more aggressive suppliers from neighbouring countries, which have entered 2XA’s home market. The board of directors is concerned at the loss of business and is not really sure why it has happened. It has decided that it is time to become more proactive in its approach to the market and feels the need to know more about both the competitive environment and the competitors themselves.

Required: As the Management Accountant you have been asked to:

(a) Explain what is meant by Industry Analysis using any models you consider

appropriate.

(5 marks)

(b) Describe the information that 2XA might include in such an analysis. (10 marks)

(c) Advise the directors as to the possible sources of the information which 2XA could use

in performing an industry analysis. (10 marks)

(Total for Question Two = 25 marks)

May 2005 5 P6

Question Three The insurance industry is characterised by large organisations producing, packaging and cross-selling a number of different ‘products’ to their client base. Typical products include life insurance, health insurance, house insurance and house contents insurance. Therefore, cost efficiency, repeat business and database manipulation are of significant importance.

BXA is a medium sized insurance company that has grown over the past fifty years by a number of relatively small mergers and acquisitions. Its business is focused on life, automobile and private property insurance. Over the last few years the insurance industry has undergone significant change with increasing consolidation and the squeezing of margins.

The Board of BXA recognises that it is quite old fashioned in its approach to business, particularly in its attitude to information technology. Much of the computing is done on personal computers, many of which are not networked, using a variety of ‘user written’ programs. There are a number of different computer systems in the organisation that have been inherited from the companies that have been acquired in the past. However, these computer systems have not been fully consolidated. It is recognised that this lack of compatibility is causing efficiency problems.

BXA has recently been approached by CXA, an insurance company of a similar size, with a view to a merger. Although BXA has never combined with an organisation of this size before, the Board recognises that this merger could present an opportunity to develop into a company of significant size but that this may also present further problems of system incompatibility.

BXA has decided to proceed with the merger, but the Board recognises that this might only make the situation worse with regards to information management strategy of the resulting combined company.

The Finance Director has asked you, as project accountant, to investigate the potential of outsourcing the information technology function as part of the post-merger consolidation process.

Required:

(a) Discuss the advantages and disadvantages of outsourcing the IT function for the merged organisation at each of the strategic, managerial and tactical levels of the organisation.

(15 marks)

(b) Briefly describe the characteristics of the supplier that BXA will be looking for in the selection of the contractor to take on the outsourcing.

(5 marks)

(c) Identify the factors which should be included in the service level agreement with which the contractor will be expected to comply in achieving the levels of performance that BXA will require.

(5 marks)

(Total for Question Three = 25 marks)

P6 6 May 2005

Question Four D4D is a politically stable, developing country enjoying a temperate climate and a young, educated population, many of whom are educated to graduate level. Those who have studied at this level have tended to do so abroad since there are limited opportunities to do so in D4D.

The economy is mixed, based on agriculture and some light manufacturing but has enjoyed considerable revenue from oil exploration and production which is based offshore in its territorial waters. Some of this revenue is generated by providing services for the oil industry but the majority comes from a tax on every barrel of oil which the foreign oil companies extract.

The Government has used the revenue to keep personal and property taxes low and to support the largely uneconomic local industry. It now recognises that, although politically popular, this decision might not have been in the best long term interests of the country.

The Finance and Trade Minister of D4D is aware that the oil revenue may only last a further ten years. He wishes to build competitive advantage over the neighbouring countries. The Prime Minister is sceptical and has made the observation that “companies have competitive advantages not countries”.

As a management accountant within the Ministry of Finance and Trade you have been asked to produce a number of documents, for both the Prime Minister and the Finance and Trade Minister, considering how competitive advantage could be achieved for D4D and examining the possibilities of attracting inward investment from foreign companies.

Required: (a) Using any models you consider appropriate, explain the factors which lead to

competitive advantage being present in particular countries. (7 marks)

(b) Identify the aims that D4D should try to achieve in attracting appropriate investors into

the country. You should also compare and contrast those aims with the likely aims of any company investing in D4D.

(10 marks)

(c) Explain the steps that D4D should take to make the country more attractive to appropriate inward investment.

(8 marks)

(Total for Question Four = 25 marks)

May 2005 7 P6

Question Five E5E is a charity concerned with heart disease. Its mission statement is;

To fund world class research into the biology and the causes of heart disease. To develop effective treatments and improve the quality of life for patients. To reduce the number of people suffering from heart disease. To provide authoritative information on heart disease. E5E obtains funding from voluntary donations from both private individuals and companies, together with government grants. Much of the work it does, in all departments, could not be achieved without the large number of voluntary workers who give their time to the organisation and who make up approximately 80% of the workforce.

E5E does not employ any scientific researchers directly, but funds research by making grants to individual medical experts employed within universities and hospitals. In addition to providing policy advice to government departments, the charity’s advisors give health educational talks to employers and other groups.

The Board recognises the need to become more professional in the management of the organisation. It feels that this can be best achieved by conducting a benchmarking exercise. However, it recognises that the introduction of this process may make some members of the organisation, particularly the volunteers, unhappy.

Required: As Financial Controller; (a) discuss the advantages and disadvantages of benchmarking for E5E.

(8 marks)

(b) provide advice on the stages in conducting a benchmarking exercise in the context of E5E.

(13 marks)

(c) provide advice on how those implementing the exercise should deal with the concerns of the staff, particularly the volunteers.

(4 marks)

(Total Question Five = 25 marks)

(Total for Section B = 50 marks)

End of Question Paper

Maths Tables and Formulae are on pages 8 and 9

P6 8 May 2005

MATHS TABLES AND FORMULAE

Present value table Present value of $1, that is (1 + r)-n where r = interest rate; n = number of periods until payment or receipt.

Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 6 0.942 0.888 0.837 0.790 0.746 0705 0.666 0.630 0.596 0.564 7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513 8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467 9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424 10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386 11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350 12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319 13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290 14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263 15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239 16 0.853 0.728 0.623 0.534 0.458 0.394 0.339 0.292 0.252 0.218 17 0.844 0.714 0.605 0.513 0.436 0.371 0.317 0.270 0.231 0.198 18 0.836 0.700 0.587 0.494 0.416 0.350 0.296 0.250 0.212 0.180 19 0.828 0.686 0.570 0.475 0.396 0.331 0.277 0.232 0.194 0.164 20 0.820 0.673 0.554 0.456 0.377 0.312 0.258 0.215 0.178 0.149

Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.079 0.065 16 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054 17 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045 18 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038 19 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 20 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026

May 2005 9 P6

Cumulative present value of $1 per annum, Receivable or Payable at the end of each year for n years

rr n−+− )(11

Periods Interest rates (r) (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355 7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868 8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335 9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759 10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145 11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495 12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814 13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103 14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367 15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606 16 14.718 13.578 12.561 11.652 10.838 10.106 9.447 8.851 8.313 7.824 17 15.562 14.292 13.166 12.166 11.274 10.477 9.763 9.122 8.544 8.022 18 16.398 14.992 13.754 12.659 11.690 10.828 10.059 9.372 8.756 8.201 19 17.226 15.679 14.324 13.134 12.085 11.158 10.336 9.604 8.950 8.365 20 18.046 16.351 14.878 13.590 12.462 11.470 10.594 9.818 9.129 8.514 Periods Interest rates (r) (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327 12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 7.793 4.611 4.439 13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 16 7.379 6.974 6.604 6.265 5.954 5.668 5.405 5.162 4.938 4.730 17 7.549 7.120 6.729 6.373 6.047 5.749 5.475 5.222 4.990 4.775 18 7.702 7.250 6.840 6.467 6.128 5.818 5.534 5.273 5.033 4.812 19 7.839 7.366 6.938 6.550 6.198 5.877 5.584 5.316 5.070 4.843 20 7.963 7.469 7.025 6.623 6.259 5.929 5.628 5.353 5.101 4.870

FORMULAE Annuity Present value of an annuity of $1 per annum, receivable or payable for n years, commencing in one year, discounted at r% per annum:

PV =

+− nrr ][1

11

1

Perpetuity Present value of $1 per annum, payable or receivable in perpetuity, commencing in one year, discounted at r% per

annum: r

PV1

=

P6 10 May 2005

The Examiner for Management Accounting – Business Strategy offers to future candidates and to lecturers using this booklet for study purposes, the following background and guidance on the questions included in this examination paper.

Section A – compulsory Question One

Requirement (a) relates to Section C of the syllabus and the learning outcome ‘Evaluate strategic options’. It requires candidates to apply their knowledge of financial evaluation techniques in the context of a strategic investment decision being made by the scenario organisation. Requirement (b) relates to syllabus Section B and the learning outcome ‘Evaluate the impact and influence of the external environment on an organisation and its strategy’. This question is designed to test the candidates’ understanding of the importance of the external environment in strategic decision making. Requirement (c) relates to syllabus Section D and the learning outcome ‘Discuss the role of change management in a strategic context’. This question examines knowledge and application of the change management process required following the decision to acquire an overseas organisation.

Section B – two questions from four Question Two

Requirement (a) relates to syllabus Section A and the learning outcome ‘Evaluate the nature of competitive environments, distinguishing between simple and complicated competitive environments’. This is a straightforward question testing the candidates’ knowledge of the models used to evaluate the competitive environment. Requirement (b) examines syllabus Section A and the learning outcome ‘Evaluate strategies for response to competition’. This question is designed to examine the candidates’ ability to apply the models used in requirement (a) in order to evaluate the information they produce. Requirement (c) examines syllabus Section A and the learning outcome ‘Evaluate strategies for response to competition’ . It tests the candidates’ ability to determine the sources of information when evaluating the competitive environment.

Question Three

Requirement (a) relates to Section D of the syllabus and the learning outcome ‘Identify and evaluate IS/IT systems appropriate to the organisation’s strategic requirements and recommend changes where necessary’. This question tests the candidates’ ability to evaluate the advantages and disadvantages of outsourcing an organisation’s information system. Requirement (b) relates to syllabus Section B and the learning outcome ‘Discuss how suppliers and customers influence the strategy process and recommend how to interact with them’. This is a straightforward question testing knowledge and understanding of the characteristics of an outsourcing supplier. Requirement (c) relates to syllabus Section D and the learning outcome ‘Identify the problems in performance measurement and recommend solutions’. It tests the candidates’ knowledge of supplier agreements.

Question Four

Requirement (a) relates to syllabus Section A and the learning outcome ‘Evaluate the impact of regulation regimes on strategic planning and implementation’. This question examines the candidates’ knowledge of competitive advantage within countries and in particular Porter’s diamond. Requirement (b) relates to syllabus Section B and the learning outcome ‘Recommend proactive and reactive approaches to business and government relations with civil society’. This question examines the candidates’ understanding of the relationship between businesses and the countries in which they invest. Requirement (c) relates to syllabus Section D and the learning outcome ‘Discuss the role of change management in a strategic context’. It tests the candidates’ ability to explain how countries can make the necessary changes to influence investment.

Question Five

Requirement (a) relates to syllabus Section C and the learning outcome ‘Prepare a benchmarking exercise and evaluate the results’. This question examines the candidates’ understanding of the pros and cons of benchmarking. Requirement (b) relates to the same learning outcome as (a) and examines the candidates’ knowledge of the benchmarking process. Requirement (c) relates to syllabus Section D and the learning outcome ‘Discuss the role of change management in a strategic context’. This question examines the candidates’ understanding of the management of change in relation to its impact on the people involved.

May 2005 11 P6

The Examiner's Answers for P6 - Management Accounting – Business Strategy SECTION A Answer to Question One

Requirement (a) Calculations for Option 1 Calculations for country A Cash contribution from sales Years Sales volume Contribution/tonne Annual contribution 1 - 5 42,000 $(90 - 85) = $5 $210,000 6 - 10 64,000 $(90 - 85) = $5 $320,000 11 - 15 20,000 $(90 - 85) = $5 $100,000 Discount factors calculation Cumulative PV

factor PV factor, years 1 - 15 7⋅606 PV factor, years 1 - 10 6⋅145 PV factor, years 11 - 15 1⋅461 PV factor, years 1 - 10 6⋅145 PV factor, years 1 - 5 3⋅791 PV factor, years 6 - 10 2⋅354 NPV for country A Years Cash flow

$ Factor at

10% Present value

0 (1,500,000) 1⋅000 (1,500,000) 1 - 5 210,000 3⋅791 796,110 6 - 10 320,000 2⋅354 753,280 11 - 15 100,000 1⋅461 146,100 NPV 195,490

Profitability index = 13031000,500,1490,695,1

outflows cash of values presentinflows cash of value present

⋅==

P6 12 May 2005

Profit Year 1 2 3 4 5 Cash flow 210,000 210,000 210,000 210,000 210,000 depreciation 150,000 150,000 150,000 150,000 150,000 profit 60,000 60,000 60,000 60,000 60,000 Calculations for country B Cash contribution from sales years Sales

volume Contribution/tonne

Annual contribution

1 - 8 63,000 $(90 – 85) = $5 $315,000 9 - 14 51,000 $(90 – 85) = $5 $255,000 Discount factors calculation Cumulative PV

factor PV factor, years 1 - 14 7⋅367 PV factor, years 1 - 8 5⋅335 PV factor, years 9 - 14 2⋅032 NPV for country B Years

Cash flow $

Factor at 10%

Present value

0 (2,000,000) 1⋅000 (2,000,000)1 - 8 315,000 5⋅335 1,680,525 9 - 14 255,000 2⋅032 518,160 NPV 198,685

Profitability index = 09931000,000,2685,198,2

outflows cash of values presentinflows cash of value present

⋅==

Profit Year 1 2 3 4 5 cash flow 315,000 315,000 315,000 315,000 315,000 depreciation 200,000 200,000 200,000 200,000 200,000 profit 115,000 115,000 115,000 115,000 115,000 Calculations for Option 2 Cash inflows year cumulative

discount factor cash flow

PV cash flow

PV cash flow

PV

$000 $000 $000 1 – 10 6⋅145 300 1843⋅5 435 2673⋅075 265 1628⋅425 probability 0⋅5 0⋅3 0⋅2 weighted PV

921⋅75 801⋅923 325⋅685

total 2049⋅358 Cash outflows year disc factor cash flow

$000PV

0 1 1,450 1,4501 0⋅909 425 386⋅325NPV 1,836⋅325 NPV for Option 2

213⋅033

May 2005 13 P6

Probability weighted outcome

Profitability index = 11601325,836,1358,049,2

outflows cash of values presentinflows cash of value present

⋅==

Probability weighted cash flow Year 1 2 3 4 5 0⋅5 150,000 150,000 150,000 150,000 150,000 0⋅3 130,500 130,500 130,500 130,500 130,500 0⋅2 53,000 53,000 53,000 53,000 53,000 Weighted total 333,500 333,500 333,500 333,500 333,500 Probability weighted profit Year 1 2 3 4 5 cash flow 333,500 333,500 333,500 333,500 333,500 depreciation 145,000 187,500 187,500 187,500 187,500 profit 188,500 146,000 146,000 146,000 146,000 Examiner’s Note: A more comprehensive answer would include calculation of the potential profit under each outcome as follows: 50% weighted outcome

Profitability index = 00391325,836,1500,843,1

outflows cash of values presentinflows cash of value present

⋅==

Year 1 2 3 4 5 cash flow 300,000 300,000 300,000 300,000 300,000 depreciation 145,000 187,500 187,500 187,500 187,500 profit 155,000 112,500 112,500 112,500 112,500 30% weighted outcome

Profitability index = 45571325,836,1075,673,2

outflows cash of values presentinflows cash of value present

⋅==

Year 1 2 3 4 5 cash flow 435,000 435,000 435,000 435,000 435,000 depreciation 145,000 187,500 187,500 187,500 187,500 profit 290,000 247,500 247,500 247,500 247,500 20% weighted outcome

Profitability index = 88680325,836,1425,628,1

outflows cash of values presentinflows cash of value present

⋅==

Year 1 2 3 4 5 Cash flow 265,000 265,000 265,000 265,000 265,000 Depreciation 145,000 187,500 187,500 187,500 187,500 profit 120,000 77,500 77,500 77,500 77,500

P6 14 May 2005

Reasoned recommendations The criteria that the company must satisfy are to: 1. Provide an ongoing business 2. Satisfy the parent groups long term view 3. Satisfy the parent groups investment criteria 4. Help the parent group satisfy the shareholders desire for increased profitability 5. Maintain the dividend There are effectively four options: 1. Do nothing 2. Option 1 investing in Country A 3. Option 1 investing in Country B 4. Option 2 investing in new product 1. Do nothing This option can be dismissed immediately since the Board has already said that the dividend cannot be maintained without some action and the business will come to an end shortly. 2. Option 1 investing in Country A This project involves the investment of $1⋅5 million, will offer a net present value of $195,490, has a profitability index of 1.1303 and would contribute $60,000 per year to the profits of the company. On purely financial grounds, Option 1 Country A is viable. It is essentially the same business that the company operates now, but relocated to another country, with the risks that this might involve. Although the staff and the company are recognised as being highly skilled in this area, the business is acknowledged as a commodity business and, as such, is sensitive to price wars, increases in variable costs and changes in demand. By definition, the business must have a finite life; until infrastructure building in the country is complete. 3. Option 1 investing in Country B This project involves the investment of $2 million, will offer a net present value of $198,685, has a profitability index of 1⋅0993 and would contribute $115,000 per year to the profits of the company. Again, it is the same business that the company currently operates in and the same comments can be made. The Board has been informed that there is a capital investment budget of $2 million available and, although this project has a lower profitability index, it will contribute nearly twice as much profit to the group as Country A. Since the parent group is under pressure to maintain the dividend for the shareholders, it would appear that subject to the country and competitor analysis elsewhere, investment in Country B would be a better option than investment in Country A. 4. Option 2 investing in new product On first consideration Option 2 has a positive NPV and would appear to be a viable project. The profitability index of the probability outcome is 1⋅1160 and, as can be seen, would afford good profit figures over the five year period in question. year 1 2 3 4 5 $ profit 188,500 146,000 146,000 146,000 146,000 This makes this project potentially more attractive than Option 1 with Country B on purely financial grounds. However, taking the three cash flow projections separately there is only a 30% chance of a significantly positive NPV at $836,750 (2,673,075 – 1,836,325). There is a 50% chance of a small positive NPV at $7,175 (1,843,500 – 1,836,325) and only a 20% chance of a significantly negative NPV at <$207,900> (1,628,425 – 1,836,325). Note: A more comprehensive answer would also include the calculation of the probability weighted cash flows for this option shown in the workings and would enable the following comments to be made:

May 2005 15 P6

Similarly, if the probable cash flows are considered separately it can be seen that there is, in fact, only a 30% chance of a significant profit. In terms of the profitability index for this option, there is 20% probability that this will be lower than 1. Year 1 2 3 4 5 50% chance 155,000 112,500 112,500 112,500 112,500 30% chance 290,000 247,500 247,500 247,500 247,500 20% chance 120,000 77,500 77,500 77,500 77,500 As can be seen from the table, profit levels at all probabilities are positive but vary between $120,000 and $290,000 for the first year. The variation in the second year is between $77,500 and $247,500 year when the depreciation increases to $187,500. With the exception of the first year there is a 70% chance that the project will provide an inferior profit to Option 1 with Country B in the first five years of the project. There is however, a 30% chance that the contribution to the profit of the group will be more than twice that of Country B. Non-financial aspects Some of the non-financial aspects of this option relating to relationship marketing and change have been considered in requirement (c). Additional non-financial aspects of the venture, which need to be considered are inherently more risky due to the unfamiliar production process and the differentiated nature of the product. While the company will continue to operate in its home market, it will have to embrace not only a new technology but also a new market, significantly different from the one in which it currently operates. While success in the pipe business is based on cost efficiency, the proposed business involves a differentiated product and, consequently, a different approach to marketing. This may present a steep learning curve for Pipeco. It could be argued that this product has a potentially longer life than that of large bore pipe since the latter is based on infrastructure building which has a finite life. The forecasts suggest that the market has a strong future, and could be a successful venture for the company. In general the profit margins available in differentiated markets are higher than those for commodity products. There are also, usually, higher margins of safety in terms of break even because of the higher contribution to sales ratio. It must also be considered that this option involves an acquisition and there is no evidence of the Board of Pipeco having any past experience of this type of project – this represents a significant risk. The significance of the change programme (discussed in 1(c)) should not be underestimated. Not only is there an acquisition to be dealt with but the company is also contemplating a change in approach to marketing which will represent a considerable difference to the way it currently operates. If the Board feels that these potential problems can be surmounted then it should choose to exercise Option 2. In informing the parent group of the analysis that has been made, the Board should offer the two options: Option 1 with Country B Option 2

Further explanation should involve discussion of the risk return profile of each investment and the changes that will need to be made to the business depending on which option is selected. While Option 1 with Country B has a lower potential return, it also has a lower risk profile, the opposite being true of Option 2.

P6 16 May 2005

Requirement (b) Should Option 1 be selected, then before any decision is made concerning the most appropriate country in which to establish the business, a fuller country analysis should be conducted. In terms of non-financial information which might influence the decision, the following are examples of issues and questions which need to be addressed: Country intelligence (including analysis of the countries current competitive environments) Is there any difference in the countries in terms of political stability?

Is infrastructure building likely to be handled at local or national government level?

How sophisticated are their buying processes at the government level that handles infrastructure building?

Are decisions likely to be by competitive tender or by preferred supplier lists?

Will it be government policy to favour local manufacturers?

Will there be a requirement for a local partner in the process?

If so, do suitable local partners exist?

The possibility of other companies entering the market in each country. Do any of the existing competitors have relationships with the government or other organisations within either country.

Do any other companies intend to enter the market?

Are there local companies which have any expertise in the area of plastics fabrication, particularly the extrusion process which might develop as competitors?

Are there local companies which have expertise in plastics that could be persuaded to enter a joint venture with Pipeco or one of its existing competitors?

Requirement (c) (i) Relationship marketing The basic concept of relationship marketing is that resources are dedicated to maintaining the existing customer base as well as to attracting new customers. It has been suggested that there is a broader perspective for relationship marketing in that the six markets model has been developed. This implies that there is a marketing relationship with all the stakeholders, both internal and external, of the organisation. Not only customers but suppliers, recruitment markets and those that can influence the purchase decision are to be considered. There is also a need to consider the relationships between departments within the organisation as their smooth interaction will have an effect upon the final customer. Should Pipeco decide to introduce a relationship marketing approach, the potential benefits are: A possible increased spend per customer. The longer a customer stays with a particular

supplier the better knowledge and understanding the supplier will have about that customer. Therefore, they will be able to develop the product range in order to cater for more of the customer’s needs, which is appropriate to the type of business they are intending to enter.

There is the possibility of reduced marketing costs since finding new customers is invariably more expensive. A differentiated business, such as Option 2, usually has a more heavy promotional spend than a commodity business so any cost efficiency saving would be welcome.

If relationship marketing is successfully implemented it can result in free word-of-mouth recommendations adding to the intangible value of the product. Bearing in mind the

May 2005 17 P6

target markets are retail, or architects and designers who specify suppliers this would be an appropriate approach.

There can be effects on employee motivation and satisfaction since they feel happier in a long term relationship. The company already enjoys good working relationships with its staff, and this can only improve them or at least help them in a time of change. The impact of the approach may well help in the integration of the new members of staff working for the company to be acquired.

Requirement (c) (ii) Dealing with changes If Pipeco adopts Option 2 it will involve an acquisition and there is a possibility that relationship marketing will be introduced at the same time. Either event will involve change but if the two are to be introduced together this will involve significant change in systems, procedures and patterns of behaviour. For change to be successfully implemented, there is a need for a clear shared vision effectively communicated to all staff by an obviously committed senior management group. There must be high levels of trust between all concerned together with appropriate levels of authority, accountability and empowerment. Reward systems should reflect the importance of what is being undertaken. Where possible, management should identify opportunities for “quick wins” which are consolidated to give a base for further improvements and boost morale. The organisational capacity to learn and adapt will be tested. Having said that, there is no one recipe for success in change programs. The issues that the company will face include: 1. Absorption of the acquired company

2. Establishing a marketing department within the consolidated firm

3. Identifying those current members of staff who can be trained to take some of the new roles within the new venture and establishing a market driven attitude amongst all of the staff

4. Additionally, Pipeco will be faced with developing a business model within the company appropriate to the new venture.

Although changing the culture of an organisation is a slow process, there will be a fairly short timescale for most of these necessary steps. 1. Absorption of the acquired company The acquisition represents a change of direction for Pipeco and it needs to learn the characteristics of the new firm as soon as possible. It is assumed that the only real problem with the business is underfunding but this should be established before the acquisition is made. As it is an unfamiliar business, staff retention will be important and, post-acquisition, it is vital to communicate with the existing staff to allay any fears or uncertainties that they may have as soon as possible. Ideally, the present owner should be persuaded to remain associated with the company for a finite period of time to allow transition. As this is an agreed sale rather than a contested takeover this should be feasible. A clear vision of the future should be communicated as soon as possible together with a willingness to learn and open mindedness. However, financial control should be established within the first few weeks. 2. Establishing a marketing department within the consolidated firm There may be an existing marketing department within the target company but whether this has adopted a relationship marketing approach is unknown. As a first step Pipeco need to determine current nature of the marketing process within the target company. Those currently responsible for marketing should be involved from the outset and the current Pipeco staff who are to be retrained must also be identified. Presentations should be made to the combined

P6 18 May 2005

group explaining what is intended and how it is to be implemented. This will involve an analysis of the current customer base, and identification of market areas where expansion is possible. 3. Identifying those current members of staff who can be trained to take some of the new roles within the new venture and establishing a market driven attitude amongst all of the staff As Pipeco has been successful in its existing business there must have been a good working relationship with the clients served. With the new business the nature of the clients will have changed and the nature of their buying decision will have changed. Whereas the existing customers will be driven by performance and cost effectiveness there will, within the new market, be a greater focus on the aesthetic appeal of the product. Pipeco has said that it would prefer to retrain people rather than make them redundant. As a first stage management should ask staff who wishes to retrain for the coming opportunity, while making the point that the existing customers still need to be serviced. The concept of relationship marketing should be presented to all staff – everyone at Pipeco needs to be aware of the markets that they serve and the fact that they are all customer facing and that it is just the definition of “customer” that has changed. Over and above the basic training given to all staff, those who are to transfer should be given more in-depth training about relationship marketing. 4. Developing a new business model As regards developing a business model within the company appropriate to the new venture, the operating characteristics of the acquired company should be determined as soon as possible and the systems and procedures mapped. Once it is established how the company operates it should be established how the company should operate. Summary It is important that, if this acquisition goes ahead, the management of Pipeco recognise the magnitude of the change process that is being embarked upon. There will need to be clear commitment to change from senior management and this will need to be clearly communicated to all staff. A shared vision must be communicated to the staff of both companies, and their concerns and doubts discussed at the earliest opportunity with a view to establishing a consensus of the way forward. The necessary changes can be brought about by changes in systems, processes and, quite possibly, reward packages.

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SECTION B Answer to Question Two Requirement (a) An industry analysis should contain both a structural analysis and a description of the characteristics and participants. The analysis is conducted with the intention of determining those factors, which can affect profitability or any other measure of success in the industry. Its purpose is to help the company overcome any of those factors which can have a detrimental effect on the performance of the firm and to help it to capitalise on those factors which can contribute to superior performance. Industry analysis should include both PEST (that is political, economic, societal and technological factors) analysis as an indicator of threats and opportunities, and a discussion of Porter’s five forces model as a guide to the competitive forces impacting upon the industry in which the firm operates. Although PEST analysis is possibly the most well know acronym for this component of an industry analysis there are others. It can also be referred to as PESTEL (the additional factors are ecological and legal) or even STEEP (the legal has been dropped). It is often suggested that the analysis is better conducted on a thematic basis since it is difficult to identify purely political, economic, societal or even technological factors. In developing the five forces model Porter made the observation that the essence of strategy formulation is not just coping with competition, but also requires that a company competes with both suppliers and customers for negotiating power. Companies must understand the five forces on which the nature of competition depends and which determine the industry’s potential for profit. Where there are weak forces there is the possibility for superior profits but where the forces are strong there is more likely to be perfect competition and poor profits. The five forces are: The bargaining power of supplier groups;

The bargaining power of buyers;

The threat of new entrants;

The threat of substitution;

The degree of competitive rivalry within the industry. Requirement (b) 2XA supplies engineering components to other industries and, as such, it enjoys derived demand. The demand for its customers’ products will be an important issue for 2XA. Knowledge of the volume of that demand, and the nature of any changes which its customers are having to react to will make it better able to negotiate with its customers and to serve their changing needs. For instance, for 2XA, many of the technological developments in the area of light aircraft will have been inherited from investment in military aircraft. The development of military aircraft has both technological and political elements in its success, and it is difficult, if not impossible, to separate the individual strands. Knowledge of the changes in military aircraft technology should give 2XA an early warning of its own customers’ future requirements.

P6 20 May 2005

By having an understanding of the political and economic circumstances in adjacent countries, it will be better able to foresee attempts by foreign competitors to enter its home market. It may even find that its own government is likely, in the future, to want to encourage exports and may be intending to provide assistance in some form to companies like 2XA so that it may compete in foreign markets. An awareness of socio political factors will give it foresight into the labour market, and help it to ensure that it recruits the appropriately trained workforce that it needs in the future or that its current workforce becomes appropriately trained. 2XA is aware that the competitive rivalry within the industry is increasing and this has, to some extent, been due to new entrants from other countries. By performing this kind of analysis it might be possible to anticipate this threat and build barriers to prevent new entrants. This can often be done by building better working relationships with both customers and suppliers based not on personalities, but on process and performance benefits. Joint development of components will lock in both customers and suppliers to 2XA’s value chain and make it difficult for a competitor to offer competing products and services. With particular reference to the buyers, the company should determine the degree of dependency it has on 2XA. Since it is currently losing customers it should investigate ways to increase that dependence. In addition to the factors described above, other issues that will make the customers more dependent and therefore less powerful could include: The degree of fragmentation of the buyers’ industry- how many players are there in the

industry?

The importance of the components supplied to the buyer. What proportion of their cost structure is represented by the component they get from 2XA?

Has the buyer standardised on the component supplied by 2XA?

If substitutes for the component exist how close are they? Requirement (c) Possible sources of information which 2XA could use: Securities Analysts specialising in manufacturing industry. Most brokerages will have analysts who specialise in particular industries and they will produce quite detailed reports on industry trends and specific companies within an industry. 2XA should seek information not only on its own industry but also those of its suppliers and customers. Engineering regulatory and professional bodies Regulations are set within most industries by professional bodies but on some occasions there are other organisations who will act in this way. 2XA should establish good contacts with them, so that it can gather information and forecasts on environmental factors and trends within the industry. Engineering standard setters Most organisations which set standards also provide information to interested parties on the future of their industry. 2XA should consider having some of its senior staff involved in the various committees that operate within the appropriate body. Press – particularly engineering trade press & the local press at competition sites. As well as monitoring the appropriate press for information about the industry and the factors that may affect it, senior management within 2XA should develop relationships with the journalists and specialists that write for the relevant media. Additionally, monitoring the local press in the area in which competitors are based will occasionally provide information about their plans in relation to staff. Government – departmental & local. The government departments responsible for trade, science and education can often provide information about both competition and opportunities for export. 2XA could usefully develop a

May 2005 21 P6

relationship with civil servants or even the minister responsible for the areas in which it is interested. Suppliers of plant and equipment to themselves and competitors Suppliers are often happy to talk about new plant and equipment, its capabilities and where they have installed it. They may also have good profiles of competitors of 2XA where they would like to install their equipment. 2XA could gather useful information about their competitors in adjacent countries by building a relationship with their existing, or potential suppliers. Additional sources could include: Watchdog groups. Engineering trade associations. Consultants Answer to Question Three Requirement (a) The merger of BXA and CXA offers an opportunity to cure a number of the existing problems with IT provision that currently exist within BXA. If the merger proceeds without significant change to the IT provision, it is likely that the current problem of legacy systems and incompatible “user-written” programs will worsen. Even without the merger this is a problem which, it is recognised, needs addressing. The fact that the insurance industry is currently consolidating means that cost efficiencies should be sought at every opportunity and if the combined company wishes to survive and prosper then it must act like a large company. BXA has a history of growing by acquisition. Outsourcing would offer the following advantages: At the strategic level: BXA could take advantage of the supplier’s economies of scale gaining cost advantage;

BXA could take advantage of the supplier’s core competencies;

Some of the risks of the IT provision and the merger will be transferred to the supplier;

BXA can capitalise on the innovative skills of the supplier;

Of particular importance in this and subsequent mergers will be the ability to bring about transformational change within both BXA and the target companies;

BXA can take the opportunity to have a “world class system” developed by the supplier and act like a large firm.

Against this must be set the potential disadvantages of the possible loss of control of a critical part of the business and the problems of project over-run. Much will depend upon the quality of the contractor chosen. At the managerial level: BXA can reduce the risk and expense of consolidating legacy systems;

There will possibly be gains from flexibility;

Management of BXA will be able to focus on other aspects of the business, developing other areas of distinctiveness;

BXA should enjoy improved business continuity provision;

Management of BXA should gain from the reduction in the complexity of the business;

There will be an improved ability to respond to future change especially in the event of further acquisitions;

P6 22 May 2005

It may gain access to specialist IT skills and advanced technology with the prospect of transferring them to its own staff.

There are however, a number of possible disadvantages: The supplier may not be able to deliver on promised service levels, particularly at the

beginning of the consolidation period;

The management of BXA may not be able to manage the revised “virtual” value chain;

BXA management may fail to recognise the cost of managing outsourcing properly;

The company may be more vulnerable during the transition period; they will already be vulnerable by virtue of the merger;

BXA may suffer morale problems if the transfer of BXA staff to the contractor is not handled in a sensitive manner.

At the tactical level: The main advantages to be expected are that there should be an improvement in the cost effectiveness of supply with the possibility of improved quality and service levels as long as these are written into the heads of agreement. Additionally, BXA should expect to see a reduction in capital costs. However, there are the avoidable disadvantages that the supplier may attempt to exploit BXA’s subsequent dependency by increasing charges and may try to “cut corners” and deliver below specification. Requirement (b) The supplier selection can be considered in two parts: General supplier characteristics First, there is a need to ensure its general financial stability and also its capacity to handle the volume of work proposed and envisioned in the future. The usual measures of financial stability can be applied by the credit controllers of BXA to determine the suitability of the company. Its client list should be used to give an indication of size and capacity. Secondly, it is necessary to consider criteria specific to the project being considered. Specific supplier characteristics There will be a need to examine its record on similar work particularly focusing on cost and timeliness of completion - suppliers should be prepared to arrange discussions with previous clients to facilitate this, and there will almost certainly be a file of testimonials. BXA is undergoing a merger, is likely to make further acquisitions and wish to perform like a “large” company if it is to be successful in the insurance industry. The ability of the potential supplier to offer innovative solutions, in partnership with BXA, will be important. Evidence of it having done so for others should be sought. Since BXA is merging with CXA there will be quite a lot of uncertainty and doubt amongst the staff of both companies. A number of members of staff will be transferred to the outsourcing company as part of the project. BXA should investigate the track record of the outsourcing company in terms of staff retention and its attitude to them. Ideally staff, once moved to the outsourcing company should be rotated and enjoy staff development with career opportunities. Similarly the cultural compatibility of the existing staff working for the contractor and those of BXA (and CXA) should be considered. BXA must check that those involved from the contractor’s side in the negotiation phase are to be involved in all subsequent stages and in the management of the ongoing relationship. Finally, much can be judged about the supplier during the due diligence phase of the project, bearing in mind the partnership nature of the venture its openness should be monitored closely.

May 2005 23 P6

Requirement (c) Negotiation of the service level agreement (SLA) must recognise that it is a partnership for mutual benefit. As such the SLA will be bespoke and not “off the shelf”. Amongst the points which should be included are: Clear description of benefits expected, with a focus on management information systems

not just data;

An accurate definition of the service and required performance together with clear demarcation of duties;

Charges and service credits procedure;

Compliance with key obligations;

Management information and reporting procedure;

Open book charging and right to audit;

Continuous improvement plans;

Problem management and customer satisfaction surveys;

Benchmarking process to be used;

Transition or termination (for fault and/or convenience) arrangements;

Finally there should be a clear definition of the expected and predicted business transformation to be achieved in the merged company.

Answer to Question Four Requirement (a) The sources of competitive advantage of nations are described by Michael Porter in his model known as Porter’s Diamond. Within the model the point is made that countries produce successful firms because of four main reasons: 1. Firm strategy, structure and rivalry – fierce, capable national firms. Distinctive business

focuses can be created by ownership structure, attitudes and investment horizons of capital markets, the extent of competitive rivalry and the openness of the market to outside competition.

2. Demand conditions – sophisticated and demanding with international outlook. These are important for three reasons: (i) Substantial demand will allow economies of scale.

(ii) The experience gained in supplying a strong and varied domestic base will give an information advantage as long as purchasers are critical, innovative in their purchasing behaviour and susceptible to segmentation.

(iii) Reaching the maturity stage of the product life cycle quickly will give an incentive to export.

3. Related and supporting industries – home based suppliers and related industries that are

internationally competitive.The presence of world class suppliers of components and technology will have a knock on effect on a manufacturer and often contribute to a pool of skilled people.

P6 24 May 2005

4. Factor conditions – advanced, specialised, and with good technical know-how. The factor endowments described in economic theory as basic factors; raw materials, unskilled and semi-skilled labour are largely natural, but advanced factors such as infrastructure, levels of training, skill and R&D experience are policy matters.

The role of government in terms of subsidies, legislation and education can impact upon all of the other four elements as can the effect of chance events such as civil unrest and wars. National competitive advantage often arises because the successful firms are clustered, having linkages between them. This facilitates the transfer of expertise, concentration of advanced factors and better supplier – customer relations within the value chain. Porter concludes that entire countries do not have particular competitive advantages but that specific industries, or firms within them, do seem able to use their national backgrounds to their advantage. Requirement (b) The aims of D4D and potential investing companies can be summarised as:

D4D Investing company Good PR from company’s presence Stable economy and government

Attractive industry, that is clean and growth

Business oriented government

Likely attractor for other companies Skilled and well educated workforce

Good employer for local population Attractive base for overseas posting for their own staff

Likely to invest in infrastructure, particularly higher education

Good infrastructure particularly transport and communication

Reputable firms – good record on corporate governance

Good relationship with neighbouring markets for use as an export base

International focus Business oriented planning laws

Similar companies already present or intending to go there

From the two lists above it can be seen that, in general, the objectives of the State and any potential investors will be in line. D4D will want companies that are good attractors for other companies, which will suit investing companies which would prefer the establishment of industry clusters. While the Government will be looking for investment in educational infrastructure and good employment prospects for its population, investing firms will want good working relationships with educators to supply suitably qualified staff and will know that universities are one of the most cost effective sources of R&D. Good public relations are important to both the Government and investing firms. Similarly, both parties will want good infrastructure links both within and without the country. Both parties will want D4D to be a pleasant place to live. The only area of potential differences between the objectives of the Government and the investing company will be the level of financial support that the company want from the Government. The Government has been used to a situation where it has enjoyed a steady stream of revenue from the oil companies for little effort. However, potential investing companies will expect somewhat more for their investment.

May 2005 25 P6

Requirement (c) The Government of D4D should focus on improving the advanced factor conditions within the country and promoting the fact that such attractive conditions exist. Possible ways of doing this include: Strengthening the productivity and competitiveness of local firms by providing

encouraging business conditions for investment and training. This should be done particularly for service industries or other industries that it feels its target investors will require.

Developing a robust capital market within the country. Intended to benefit not only the incoming companies but also the local population in terms of a good environment for savings and investment.

Recognising the advance of the information age and investing in infrastructure, particularly digital communications. This will offer potential benefits to the companies it wishes to attract and to the population who will gain from a more open society.

Investing in transport facilities, both within the country and to facilitate export.

Investing in the universities to encourage a strong research and development base, particularly in “modern” technologies. Providing the opportunity for incoming companies to develop R&D partnerships with local universities. This will also broaden the access to higher education currently being served by overseas institutions.

Developing a strong pre-university education system to provide a suitable skilled workforce for any investing company. Additionally, this will contribute to the attractiveness of the area for the families of expatriate staff.

Working towards an investment friendly tax and incentive regime. Recognising that companies will have an objective of maximising their profits and will be attracted by a business friendly political and economic environment.

Building, or maintaining, good trading relationships with neighbouring countries. This will attract companies which will wish to serve a market in the whole geographical region beyond the borders of D4D.

Answer to Question Five Requirement (a) Benchmarking – the advantages and disadvantages The purpose of benchmarking is to assist management in understanding how well the organisation is carrying out its key activities and how its performance compares to competitors and to other organisations which carry out similar processes. Advantages It helps to improve organisational performance through:

increased client satisfaction; reduced waste and costs of poor quality; reduced overhead through business simplification; transmission of best practice between divisions and departments.

It can assist in overcoming complacency and drive organisational change;

It provides a way to monitor the conduct of competitive strategy;

It provides advanced warning of deteriorating competitive position;

It improves management understanding of the value adding processes of the business.

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All of these points are particularly important for a not for profit organisation such as E5E, where there are likely to be budgetary constraints (compared with the amount they want to achieve). Additionally, the stakeholder groups such as government funders and corporate donors would welcome clear evidence that the organisation is being run as efficiently and as effectively as possible. Disadvantages It increases the diversity of information which the management must monitor, increasing

the potential for information overload;

It may reduce managerial motivation if the organisation is compared unfavourably wit a better resourced rival;

There is a danger that the confidentiality of data will be compromised;

It encourages management to focus on increasing the efficiency of their existing business instead of developing new lines of business;

Successful benchmarking organisations may find that they are later overloaded with requests for information from much less able organisations from whom they can learn little;

The measures and not the processes being measured become the focus of management attention.

For the management of E5E, the principal concerns must be that the time commitment necessary for the exercise is a potential drain and distraction for management and may potentially alienate the volunteers. Both of these concerns can be dealt with by careful planning and implementation. Requirement (b) The stages in a benchmarking exercise can be described as: Stage 1 Gain senior management commitment to the project. (This should not be a problem since the Board has suggested it. However, it should be seen to do so publicly.) Stage 2 Decide the processes and activities to be benchmarked. From the mission statement the exercise could focus on: Identification and funding of suitable researchers; Fund-raising; Treatment development; Provision of services to improve quality of life for patients; The quality of E5E as a source of information regarding heart disease and could also

include education services.

(For the purposes of this answer we shall concentrate our examples on educational services, but other topics from the above list could be chosen and discussed in the same level of detail.) Stage 3 Understand the processes and develop appropriate measures. Within the educational aspects of work this would require: Discussion with key stakeholders. These will include those who find the clients, prepare

the material, make the presentations and, at another level, offer policy advice to the government.

Observation of the process. Process mapping of what occurs, often shadowing the people concerned, will help.

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Experimental approaches involving adjustments to the processes and measuring the effects, for better or worse, of those temporary changes. This may not be possible and is often the hardest thing to “sell” to the stakeholders. If carried out, this should lead to a sensible set of Key Performance Indicators (KPIs). These will hopefully be revealed by discussion with the stakeholders but, in the case of preparation of material, may revolve around the amount of customisation necessary to make the material applicable for use with a differing client base.

Stage 4 Monitor the process measurement system The measures need to be proved to be reliable as does the data gathering process. They will also need time to settle down. Bearing in mind the service nature of the organisation, there may be a need for staff to use detailed time sheets. This may meet some resistance amongst staff, unless sold carefully. Stage 5 Choose appropriate organisations against which to benchmark. These could be: Internal benchmarks. This may not be possible for the education process within the

charity. Competitive benchmarks. There are other charities which perform an educational and

policy role. There may be a central clearing house for the charity industry that already gathers information which, when made anonymous, is made available to members. If this ideal situation is not available then there may be a need for E5E to start a benchmarking club.

Activity or process benchmarks. For the education processes E5E could benchmark against firms that make presentations as part of their business. Consultancies, training firms, even universities are possible options.

Generic benchmarks. Here, taking the broader context of education and policy work as the dissemination of information, E5E could compare themselves to any firm in the media business.

Stage 6 Obtain and analyse data. Stage 7 Discuss results with process management and staff. Bearing in mind the concerns of some of the stakeholders, it is essential that there is early discussion of results with them. It must be emphasised that this is about the processes not the individuals. Care must be taken to ensure that factor differences, environmental differences and any other considerations which might make the comparisons unfair or perceived to be unfair are eliminated. For instance, when comparing with a competing charity, considerations of size and resource and their effect on performance must be made. Stage 8 Develop and implement improvement programmes. These may well involve: Visits to best in class to observe their methods; Process improvement programmes; Capital investment in information processes, that is an enhanced database system for the

educational material and client base; Management and staff training; Restructuring, particularly looking at the work of adjacent departments to see if the

“boundary” is in the correct place in the process. Stage 9 Monitor results It must be recognised that this is not a one off process but one of continuous improvement. This should be used to maintain the continued involvement and motivation of the staff,

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particularly the volunteers, by encouraging them to look for ways to enhance the process they operate. Requirement (c) Addressing the concerns of the staff. Throughout the stages above, emphasis has been placed on consultation and involvement of staff within the departments being benchmarked. They must be involved from the beginning . Senior management’s commitment must be real and obvious. They should work with those who map and define the processes which are to be benchmarked. They should also have significant involvement in the development of the KPI’s to be employed in the measurement. The emphasis throughout should be on improvement of the service provided to clients by better working practices developed by a process of continuous improvement rather than measurement and criticism of individual staff. It should be remembered that, before they chose to give their time to E5E, some of the volunteers may have had careers that involved similar processes, which could provide useful information for this exercise. The staff are an important information resource and must feel that they are valued and involved throughout the process.