Week 6-7 Suggested Solutions to Class Questions

8/12/2019 Week 6-7 Suggested Solutions to Class Questions

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Week 7

Problem 16-8 (45 minutes)

1. Financial Analysis- The return on opportunity cost of capital has increased from 9.4% to 10%. This improving

return is not huge, but is probably satisfactory given the absolute level of net profits for WilliamWordsworth, who owns 100% of the share capital.

- Turnover is up 5.3%. This is not very high, but is likely to be higher than inflation, indicatingreal growth. This is encouraging, and a sign of a growing business.

- The net profit margin has increased from 19.8% to 20.0%, suggesting cost control is adequate,with price levels being increased in line with inflation.

- The ratio of current assets to current liabilities has improved from 2.5 times to 4.3 times,indicating good management of net current assets, with no apparent concerns regardingliquidity.

Overall, the business looks in very good shape from a financial perspective.

2.Financial performance figures are often referred to as lagging indicators. They tend to reflectthe extent of past successes, without being a reliable indicator of future financial performance.Some non-financial measures are regarded as better indicators of future performance(determinants in Fitzgerald et alsResults and Determinants Framework).

Kaplan and Norton posit a causal link between improved capabilities, effective businessprocesses, and measures of customer satisfaction; leading to improved financial performancethrough more custom, higher prices and cost efficiencies.

Heskett et al.take the cause-and effect relationship still further, suggesting there is a servicevalue chain in service industries, where satisfied and well-motivated employees provide a highquality service to customers who, in turn, respond with loyalty and positive referrals.

These ideas are reflected in the design of Kaplan and Nortons balanced scorecard, whichforms the basis for the data presented in the appendices. The learning and growth perspectiveaddresses issues such as staff training and service innovation, which should improve businessprocesses, both of which contribute to customer satisfaction and loyalty. Good performance inthese areas (measures used in appendix 2) should be reflected in good financial performance inthe future, whereas the financial data in appendix 1 reflects the past. Numbers of hotel clientsmay fall due to poor performance in the non-financial areas, and costs may escalate, turning

past profits into losses in a very short space of time.


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3.The non-financial data presented in appendix 2 provides much more insight into the RoyalHotels activities than appendix 1 alone, and it paints a much bleaker picture for the future.

The number of clients appears to have fallen dramatically, with the room occupancy rate downfrom 65% to 55%. This is quite alarming, and indicates a high level of customer dissatisfaction,

as reinforced by the customer satisfaction and returning customer ratings. Clearly clients areeither not happy with the service provided, or think they are no longer getting value for money.

The overall increase in turnover appears due to a very large increase in average prices, ratherthan extra clients. In the previous year, occupancy was 300 days x 50 rooms x 65% = 9750room-nights. So average revenue was 950,000 / 9750 = 97 per room-night. Whereas in thecurrent year occupancy was 300 days x 50 rooms x 55% = 8250 room-nights. So averagerevenue has increase to 1,000,000 / 825 = 121 per room-night, a whopping 24.7% increase!This alone could explain the loss of clients, but there seems to be other reasons as well, asindicated by other elements of Appendix 2.

There appears a major problem with employee satisfaction, as indicated by the high and

increasing levels of staff turnover. It is true that levels of staff turnover are generally high in thehotel industry, with its preponderance of temporary staff. But if Heskett et al.are to be believed,well trained and satisfied employees are essential in service industries, because they tend bemore responsive to clients, and give them high levels of service; resulting in customersatisfaction and, ultimately, improved profitability. It is difficult to understand from the case whythere is employee dissatisfaction. The reasons may be relatively low pay, a reduction in staffnumbers and/or employment a fewer qualified staff. But whatever the reasons, they need to bequickly identified and rectified so as to improve the percentage of procedures done according tospecification, and the customer ratings. The high staff turnover may also be a factor contributingto the difficulty of recruiting staff with qualifications in hotel and catering. If not arrested, thisspiral of decline will lead to poor profitability.

A major strategic issue is revealed in the learning and growth perspective where we see thataverage percentage of revenue from sources other than accommodation and restaurants ismuch higher for hotels in general in Keswick than for the Royal Hotel, which is entirely reliant onthose sources. This suggests unexplored opportunities for the Royal Hotel, which shouldinvestigate the viability of such things as bar sales, health club, business conference facilities, abusiness centre etc.

Overall, the data in appendix 2 appear to paint a bleak picture for Pam Ayres. However, theyshould not necessarily discourage her from becoming a partner. The source of the problemsregarding employee satisfaction and the consequent decline in customer satisfaction mighteasily be identified and addressed. Strategic issues such as pricing and the lack of serviceinnovation may present opportunities for significant growth in the future. It is difficult to be

prescriptive for Pam Ayres because we do not know the financial terms of her partnership andsubsequent control of the hotel, nor do we know the nature of her working relationship withWilliam Wordsworth. But we can conclude that the hotel appears on a sound financial footing, iswell maintained, and the difficulties identified in Appendix 2 may provide opportunities forsubstantial future turnaround and growth.


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Problem 17-2

1This question develops the BSC model introduced in chapter 16 by applying it to the RoyalBotanical Gardens (RBG), a public sector/not-for profit organization The balanced scorecardcan be used by public sector/not-for profit organisations to demonstrate to external stakeholdersthat their objectives are being met in order to improve accountability.

Generally a scorecard should incorporate the 4 perspectives/questions:

1 Financial perspectivehow should we appear to our shareholders?

2 Customer perspectivehow should we appear to our customers?

3 Internal perspectiveTo satisfy our shareholders and customers, what business processesmust we excel at?

4 Future the innovation and learning perspective. how will we sustain our ability to changeand improve?

For each perspective, a number of objectives, appropriate measures and target levels ofperformance together with initiatives for their achievement, would be defined.

2)A BSC team should be cross-organisational, contain representatives of all functional groupswithin the Gardens and have senior management representation. The main tasks of a team areto:

identify strategic themes;

define perspectives and desired outcomes;

create a strategy map; define performance measures and targets;

develop strategic initiatives to achieve targets.

The mission statement should recognise the special nature of the RBG objectives and its varietyof stakeholders. The team should establish critical success factors and performance measuresfor organisational sub-groups and individuals that help to operationalise the RBG mission.


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Problem 16-2 (30 minutes)

The answers below are not the only possible answers. Ingenious people can figure out manydifferent ways of making performance look better even though it really isnt. This is one of thereasons for a balancedscorecard. By having a number of different measures that ultimately are

linked to overall financial goals, there will be less opportunity to gamethe system.

1. Speed-to-market can be improved by taking on less ambitious projects. Instead of

working on major product innovations that require a great deal of time and effort, R&D may

choose to work on small, incremental improvements in existing products. There is also a danger

that in the rush to push products out the door, the products will be inadequately tested anddeveloped.

2. Performance measures that are ratios or percentages present special dangers. Aratio can be increased either by increasing the numerator or by decreasing the denominator.

Usually, the intention is to increase the numerator in the ratio, but a manager may react by

decreasing the denominator instead. In this case (which actually happened), the managers pulledtelephones out of the high-crime areas. This eliminated the problem for the managers, but was

not what the CEO or the city officials had intended. They wanted the phones fixed, not

eliminated.

3. In real life, the production manager simply added several weeks to the delivery

cycle time. In other words, instead of promising to deliver an order in four weeks, the manager

promised to deliver in six weeks. This increase in delivery cycle time did not, of course, pleasecustomers and drove some business away, but it dramatically improved the percentage of orders

delivered on time.

4. As stated above, ratios can be improved by changing either the numerator or thedenominator. Managers who are under pressure to increase the revenue per employee may find it

easier to eliminate employees than to increase revenues. Of course, eliminating employees may

reduce total revenues and total profits, but the revenue per employee will increase as long as the

percentage decline in revenues is less than the percentage cut in number of employees. Suppose,for example, that a manager is responsible for business units with a total of 1,000 employees,

120 million in revenues, and profits of 2 million. Further suppose that a manager can eliminate

one of these business units that has 200 employees, revenues of 10 million, and profits of 1.2million.

Before eliminating the

business unit

After eliminating the

business unitTotal revenue 120,000,000 110,000,000

Total employees 1,000 800

Revenue per employee 120,000 137,500Total profits 2,000,000 800,000

As these examples illustrate, performance measures should be selected with a great deal of careand managers should avoid placing too much emphasis on any one performance measure.


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Case 17-7Origins of the budgeting problems in the local schools in Metroshire

1. Incrementalism system of budgeting - the government seemed to have increased the

schools existing budgets by a small amount without investigating if the underlying

educational services that they are financing are still being catered for in the mosteffective way.

2. The government was not in touch with the real financial needs of the local schools in the

area. Despite the extra resources that the government thought that the schools had

received, the schools were in reality operating on a tight budget in order to meet the

basic financial needs of the schools and have had to make huge cutbacks on their

spending. The government and the local authority just allocate what they consider to be

adequate funds without knowing what the cost drivers for the schools are.

3. The 20% increase in allocation for spending in education seems to have been swallowed

up by the increase in the schools costs such as national insurance payments and the

financial cost of retaining staff. As such, even though there is a 20% increase in

spending in the eyes of the government, the increment is only on paper as it does not

tally with the reality.

4. The government does not seem to be aware that Metroshire is an expensive place and

does not seem to be making allowances for that when allocating resources to schools in

the area.

5. There also seems to be lack of communication between the schools, local authoritiesand the government. The local authority which is supposed to advocate for the schools

does not seem to acknowledge that the schools are in dire straits. As a result, the local

authority just accepts whatever is allocated to the schools without presenting the

schools cases to the government and negotiating for a higher budget.

6. The schools are just left to their own devices since they have been given the freedom to

manage their own budgets with no proper follow-up system in place regarding the

management of financial resources.

7. There appears to be a lack of accountability regarding spending in the schools.

8. The head teachers are being given too much autonomy regarding the schools budgets.

9. The government and the local authorities seem to be in denial about the schools

financial woes. Noone seems to be taking responsibility and taking an initiative to

address the schools financial problems and seek solutions as Toni Cherry who was

representing the government was accusing the local authority of not passing on the extra

funding to the schools. The local authority officials in turn blamed the schools for not


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managing their financial resources well without making any investigations. As a result,

the schools financial predicament remains unsolved and appears to be the least of the

governments priorities as was seen by the way Toni Cherry quickly dismissed the issue.

10. The government states that improving schools in Metroshire is a central part of the

governments agenda but it is not clear what measures are going to be taken as thegovernment does not seem ready to address the schools financial problems. The

government seems to be doing nothing more than paying lip service to the schools.

Overall budgeting practices could be improved if the local authority was involved in the schoolsbudgeting to avoid misuse of funds by the head teachers. Even though head teachers should have

a certain level of autonomy over their budgets they should not have complete autonomy and

should not make decisions that could compromise the quality of education that they offer without

the involvement of the local authority. They could end up prioritizing issues that wouldotherwise not have been prioritised. Proper public policies should thus be implemented and

managed in order to ensure that appropriate strategies and public services are delivered. Aperformance measurement system that combines performance management with financialmanagement should also be put in place for the schools and the local authority. There should be

clear non-financial performance indicators that are employed in conjunction with financial

measures to ensure that schools and the local authority work towards a system of responsibility

accounting.

Week 6-7 Suggested Solutions to Class Questions

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