ACFI 312 Business Strategy MAY EXAMINATIONS 2021

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ACFI 312

MAY EXAMINATIONS 2021

Business Strategy

Online examination

(Duration: 3 hours plus 30 minutes)

Question 1

Ritedoors plc (RD) manufacture garage doors for domestic properties. It sells entirely to retailers on a business-to-business basis.

Company history

RD was established in 1994 and obtained a stock exchange listing in 2010. The directors own 20% of the ordinary share capital, with the other 80% being held by institutional investors.

From incorporation, RD produced reasonable quality, basic garage doors at relatively low cost. It did not aim to be the cheapest, but it did aim to offer best value to customers, selling garage doors at prices towards the lower end of the market. RD established a good reputation with end-consumers, who demand a reliable product at reasonable prices. This helped RD to stand-out from its rivals in an otherwise undifferentiated and crowded market place.

RD sells to retailers located throughout the UK. Around 12% of turnover comes from small shops which buy from RD only when they receive an order from a customer. The remaining turnover comes from two very large national retail chains. They carry high inventories of RD doors to allow immediate delivery to consumers. The two retailers are very cost conscious and demand the best possible prices from their suppliers, as they only achieve a small margin on their sales. The retailers often use the size of their orders as a bargaining tool in negotiations.

A cost reduction policy

In December 2019 a new chief executive, Gayle Rodrigo, was appointed by RD to increase profitability. After briefly reviewing the operations of the business, she decided on a cost reduction exercise, commencing in January 2020. This involved: reducing the quality of the materials used to make the garage doors; reducing staffing levels; replacing some staff at a lower skill level; freezing any unnecessary capital investment in machinery; and reducing maintenance. Strict performance management procedures were introduced to ensure that output volume was maintained, despite the changes.

The changes had a favourable effect on reported profit in the year ended 31 December 2020 (see Exhibit) but by May 2021 some problems were being reported. A board meeting was arranged to discuss these issues.

Board meeting

Gayle, the chief executive, explained the reasoning for her cost reduction plan. 'We have not yet developed a long-term strategy, but the cost reductions were immediately necessary just to make a profit.

We've had some quality problems lately, but the cost of correcting these faults is small in comparison with the cost savings we have made. I realise that the durability of the current products is questionable. Problems will increase after about 18 months of usage of the garage doors, and there may be serious problems after three years of usage. I have made sure, however, that this is not going to be too costly to RD, by reducing the guarantee period to customers from five years to two years. This means that by the time most doors start to develop serious faults after usage, they are out of guarantee and we have no obligation to repair them.

As a result, I have prepared a schedule (see Exhibit) which shows that we expect to make a profit in the year to 31 December 2021, whereas we made a loss in 2019, and the share price is higher now than then. This demonstrates that the strategy is working. This is a competitive market and we need to compete on low prices, so we must keep our costs low.'

The marketing director disagreed: 'This business model is not sustainable. The number of complaints from our customers is growing and our reputation is declining. One of the large retailers has given us a final warning about quality standards and is threatening to stop buying our products when its long-term agreement period with RD is completed. This cost reduction policy is just to improve short-term profits and share price. We should try to keep our customers happy in the longer term, so we must return to our previous policy of best value.'

The chairman joined the discussion: 'We need to balance the cost of rectifying faults with operating cost savings, but it's an increasingly competitive market. Personally, I doubt we can sustain our position as a manufacturer. One possibility is to close down our manufacturing facility and import garage doors from Malaysia at a cost (including transport) that is just below our expected operating cost per door for 2021. In effect, we would become an importer and wholesaler of garage doors. To do this cost effectively, we would need to order in large batches so we can fill a whole shipping container with each order, as there is a high fixed cost for transporting each container. I would like your views on whether we should consider this possibility further.'

An ethical issue

Ritedoors recently received an email from Nailfix Inc (Nailfix), a company located in nearby Eurasia, which is a developing nation. The following is an extract from that email:

'We would like to become your first export customer by placing a major order with RD However, in order to keep the price low, we would require a modification to your garage doors, which is the removal of the safety cut-off sensor system. Unlike the UK, it is not a legal requirement in Eurasia, so it is not necessary for us to have this feature.'

The safety cut-off sensor is a pressure sensing system that stops the closing mechanism of a garage door when an object is detected. This feature was made a legal requirement in the UK following a number of incidents involving both young children and pets in which serious injuries were suffered.

Exhibit

Years to 31 December	2019	2020	2021 (expected)
Revenue	£32m	£32m	£30m
Selling price to retailer per door	£400	£400	£400
Fixed operating costs	£15m	£14m	£14m
Operating profit/(loss)	£(1m)	£3m	£2m
Number of doors repaired under guarantee	8	24	96
Price per share	£2.10 at 31 Dec 2019	£4.50 at 31 Dec 2020	£3.20 at 31 May 2021

Requirements

(a) On the basis of the information in the Exhibit, determine:

(i) The expected variable cost per garage door for 2021; and

(ii) The break-even level of sales by volume for RD in the years ended 31 December 2019 and 31 December 2020.

Comment on the usefulness and implications of these calculations for the business. (11 marks)

(b) In the context of Porter’s Five Forces discuss the Power of Customers for Ritedoors. (7 marks)

(c) Evaluate the benefits and problems of each of the three strategies for RD that were discussed at the board meeting:

· Return to the original strategy of producing in the UK at low cost and selling at best value, as suggested by the marketing director;

· Continue with the cost reduction programme introduced by the chief executive; or

· Cease manufacturing and import garage doors from Malaysia, as suggested by the chairman. (15 marks)

(d) Discuss the ethical issues that arise for Ritedoors from Nailfix’s request to modify its garage doors, and outline how Ritedoors should respond. (7 marks)

Total for the question 40 marks

Question 2

Applejacks Limited was formed in 2009 by two university friends, Maddie Thomason and Jack Green. The pair had earned money during their spare time at University selling their uniquely blended spiced apple juice from a retro van at local events and markets.

Following this early success and the hugely positive reaction from customers, upon graduating, they set up a small permanent stall at a local food market selling their unique drinks. This proved very successful.

To cope with the level of trade they rented a unit on a local trading estate where they set up a small-scale production facility. Here the apples were juiced before the unique mix of spices were carefully measured and gently whisked into the juice to maximise the flavour. The finished juice was then bottled in distinctively shaped, green, glass bottles, sourced locally from a small bottle producer.

Industry background

Although Applejacks apple juice is spiced it is still classified as an apple juice drink. The apple juice market in the UK was worth £550 million (by sales revenue) in 2020 and is dominated by two large international brands, Applicious and Juice King. They sell their products in all major supermarkets and chain restaurants throughout the UK. Both brands price their juices competitively with a view to achieving a high volume of sales and gaining market share from each other. The products are both of a similar quality and come in standard sized plastic bottles as detailed in exhibit 1.

The other major market player are supermarket own-brand apple juices. These are sold in larger volumes plastic containers with a focus on value for money. The reminder of the market consists of smaller artisan produces typically focused on localised geographical markets.

Growth

Over the following decade the business growth really accelerated, Maddie and Jack tapped into the growth in social media. They employed a marketing specialist and invested in some high-tech software to optimise Applejacks social media reach. Attracted by the Applejacks brand they managed to secure contracts with some influential celebrity influencers before they became too expensive for the business to afford. The product essentially went viral and for a period the company was unable to keep up with demand.

Through this growth, additional investment was injected into the business to set up a purpose-built manufacturing facility. New state-of-the-art production technology was purchased which increased the juice yield from each apple by as much as 8%. It was also almost completely automated allowing for higher quality and consistency, increased productivity and reduced labour costs.

Despite this automation the unique mixing process is still maintained, which along with the mix of spices is a carefully guarded secret. The distinctive green glass bottles have become a unique feature of the brand and whilst significantly more expensive than standard bottles, they are a key to the product identity.

Due to the growth in the business, Maddie and Jack have formalised the business structure, recruiting several more marketing staff as well as a procurement specialist, a small customer services team and some office and admin staff to deal with accounts and paperwork. The business pays above market rates and offers generous working conditions but is very selective to ensure the highest calibre staff are recruited. Any none essential tasks such as IT, HR and payroll are typically outsourced to third party providers to allow management to focus on key activities. Maddie and Jack keep the structure as lean and as flat as possible to keep in touch with the operations and allow for fast responsive decision making.

One such decision was to opt to use only organic, fair-trade ingredients, with the word “organic” and the fair-trade logo both being added to the product’s labelling. Only the highest quality apples and spices are sourced. The procurement manager has helped to formalise close links with the primary apple growers used by the company. Applejacks pay a high price for their apples but the growers in return must deliver the apples on a just-in-time basis, using specially designed crates which go straight onto the Applejacks production equipment, this helps to ensures the freshness of the finished juice.

The main staff at the production facility are involved in quality control, the business invests significant sums to ensure they are highly trained and have the latest equipment. Raw materials received are thoroughly checked for imperfections as one bad apple can destroy a batch. Additionally, each finished batch is quality checked before bottling.

Distribution & sales

The product is sold through carefully selected retailers with the main customer now being an up-market grocery store with over 35 retail outlets in the UK. The bottles are carefully packaged, ready to go straight on the shelves and a premium refrigerated logistics company takes care of the distribution. Applejacks regularly perform spot-checks on the paperwork from the distribution company as well as surveying the retailers to ensure the deliveries are on-time and in the perfect condition.

Although the end consumer is not Applejacks direct customer, the company prides itself on high level and friendly customer service. The company pledges to send two free bottles of Applejacks to any customer who, for any reason, feels that their product does not meet the expected quality levels.

Exhibit 1

	Applicious	Juice King	Applejacks	Supermarket own brand
UK sales revenue 2020	£198 million	£208 million	£16 million	£87 million
Average bottle size	500 ml	500 ml	300 ml	1,000 ml
Average retail price per bottle	£1.80	£1.70	£2.20	£1.50

Requirements

(a) Use the data in Exhibit 1, and the other information provided, to discuss how the competitive positioning of Applejacks would be defined according to Porter’s Generic Strategies. (9 marks)

(b) Use Porter’s Value Chain to identify and discuss how Applejacks supports its competitive position. Your discussion should consider:

· Primary activities

· Support activities

· Any linkages between primary and support activities (21 marks)

Total for the question 30 marks

Question 3

Home Domestics World plc (HDW) is a company listed on an international stock exchange. It manufactures electrical kitchen appliances and sells in the low to medium price sector of the market.

Company profile
HDW manufactures three different types of electrical appliances: cookers, washing machines and fridges.

The company currently has four manufacturing sites located in Malaysia, Russia, England and the United States. Each of the factories currently manufactures all three products and, in general, sells them in the region of the world in which that factory is located.

While sales are internationally diversified, market research has shown that different geographical regions require different designs and features. As a result, each factory has developed each of the products (cookers, washing machines and fridges) separately with different features and capabilities which are appropriate to the market in its own geographical region.

Cost competitiveness and cost reduction
Each of the factories is a separate profit centre. Profitability has declined in all four of the factories in recent years and thus profitability for the company as a whole has fallen steeply.

The central board has attempted to improve matters by reviewing costs, engaging in internal benchmarking exercises and applying a series of cost reduction programmes. Each of these cost reduction programmes focused on one factory at a time and were relatively short-term, lasting up to a year. At a board meeting to discuss the results of the latest cost review exercise the finance director summarised the results.

'It is clear that some of our factories can produce at a lower cost than others, but the results are not consistent. Take, for example, the Malaysian factory. It produces fridges and cookers cheaper than any of our other factories, but it is the highest cost producer of washing machines.

Another concern is that we have repeatedly engaged in cost reduction programmes by: selective redundancies, shifting production, changing reporting structures, reducing capacity and outsourcing functions, to name but a few. These tend to give a short-term local boost to profitability which is soon lost, and do not consider the overall group strategy. Despite all this, there has been no permanent cost reduction of any significance.

Also, there has recently been an unexpected major new entrant into the industry from South East Asia, which has low costs and low prices. If we are to compete we will have to reduce costs much more significantly than we have able to do in the past.'

Global production
In response to the concerns of the finance director a proposal was put forward to globalise production.

The key features of the proposal are as follows:

· Each of the three products would be made in only one basic design, and all of the world production of each product would be made at a single factory.

· As a result, only three factories would be needed in future; one for washing machines, one for fridges and one for cookers with the other factory therefore closing.

· Each factory would be a cost centre and marketing would be centralised worldwide. It would therefore be outside the responsibility of the factory managers in future.

· The change would be pushed through urgently with the aim of completion of the change programme within six months.

· It is intended that larger scale specialist production would significantly reduce production costs, but the situation would be reviewed in two years' time given the uncertainties involved in such a major change.

Requirements

(a) Compare the previous change programme engaged in by HDW which focused on cost reduction, to the current proposal to globalise production. Your discussion should consider:

· The scope of change

· The type of change (8 marks)

(b) Using Mendelow’s matrix:

· Identify some of the main stakeholders of HDW and discuss how the globalisation change programme will impact them.

· Consider how HDW should manage and communicate with the various stakeholders identified. (15 marks)

(c) Give examples of barriers to change that may arise and which may cause resistance to the implementation of the globalisation change programme in HDW. (7 marks)

Total for the question 30 marks