CIMA Learning

TOPCIMA Workshop

How is TOPCIMA marked?

An Example

Friday 9 March 2007

Script 1 Page 1 of 16
 SCRIPT 1

To: Kadgee Board

From: External Consultant
Subject: Report that priorities, analyses and evaluates the issues facing
Kadgee, and makes appropriate recommendations.
Date: 23rd November 2006

Script 1 Page 2 of 16
Contents

1. Introduction
2. Terms of Reference
3. Key Issues facing Kadgee
4. Discussion of these Key Issues and possible courses of Action
5. Ethics
6. Recommendations
7. Conclusions
8. Appendices

Script 1 Page 3 of 16
1. Introduction

Kadgee is a European Clothing manufactures producing ready to wear

clothing at the upper end of the market. It pride’s itself of producing goods that
are not only fashionable but of high quality.

It has recently suffered turbulent trading times due increasing downwards

pressure on prices by its customer and increased competition from cheap
imports from the Asia.

To combat this Kadgee has recently appointed a new Managing Director,

Birgit Ziem, who has had previous experience in turning around other clothing
manufacturers.

Kadgee now faces the difficult choice of whether to move its base of
operations as well as dealing with the ongoing aftermath of the loss of the
Forum Contract.

2. Terms of References

Following on from the November 2006 Board Meeting I have been appointed
as an External Consultant to advise on the issues facing Kadgee and make
recommendations.

3. Key Issues facing Kadgee

Appendix 1 contains a SWOT analysis of Kadgee, based on this I have

prioritised the issues that are facing Kadgee which need to be dealt with by
the Board.

Priority One: Ensure Continuing Operations, Deal with Potential Strike

The SWOT Analysis shows that Kadgee is still very much at risk of losing
another customer and still has serious cash-flow issues. The potential for staff
to strike could lead to another customer giving Kadgee just six weeks notice
of termination of their Contract. While a strategic move to China is very
important, production will not be able start for at least 6 months. During this
period Kadgee could breach its overdraft facility if it fails to maintain
customers and the Bank has said that they will withdraw the facility if it is
breached. For this reason dealing with the potential strike of employees has
been given the top priority as failure to deal with this issue could lead to the
loss of customer’s and financial difficulties before a move to China is possible.

Priority Two: Evaluate Xina

Script 1 Page 4 of 16
The new MD has stated that the only way that Kadgee can continue business
is to undergo transformational change. Strategically Kadgee needs to reduce
its cost base (which is currently a big weakness) so that it is better able to
compete in the market place. A move to China would achieve this. This has
been ranked as the second priority as it would ensure Kadgee’s long term
survival.

Priority Three: Factory Closure

If the Board were to accept the proposed relocation to China then it would
need to consider its plan for winding down European operations. As this issue
is dependent on the Board accepting a move to China it has been ranked as
the third priority.

Priority Four: Investment in IT

An investment in IT could allow Kadgee to continue its operations in Europe. It

would allow Kadgee to pursue a differentiation strategy (Porter’s Generic
Strategies) and provide Kadgee customers to have a closure link in the supply
chain. This project is costly and would require Kadgee to maximise its loan
facility. To date there is not enough interest in this project to cover the costs
and this would therefore be a very risky investment. Because of this it has
been ranked below the China’s opportunity as it does not clearly provide
Kadgee with a definite solution to its long term strategic problems and could in
fact result in Kadgee being forced out of business sooner.

4. Discussion of these Key Issues and possible courses of Action

Priority One: Ensure Continuing Operations, Deal with Potential Strike

and Quality Issues

The dismissal of an Employee Rita Scree has lead to the remaining

employees of Kadgee threatening strike action. They are also suffering from
low morale which is causing quality to fall. If a strike were to occur then
Kadgee would face the potential wrath of its customers whose orders would
not be met promptly. This could lead to customers withholding payment of
invoices and even cancelling their contracts. There could be the possibility of
the customers pursuing legal action against Kadgee for failure to fulfil contract
obligations.

Kadgee’s bank PGB have indicated that they will not extend Kadgee’s
overdraft indefinitely and that is will be capped at €2.5 million. This currently
leaves Kadgee with operating cash of just under €1 million. Finance and
operating costs are approximately €5.9 million per month ((72580-
1965)/12+520/12) as per 2005 financial statements. While staff costs are
unlikely to be paid during a period of industrial action, it Kadgee’s customers
chose not to settle debts during the period of upheaval then Kadgee would
run out of cash very quickly.

Script 1 Page 5 of 16
Lars Veel should take immediate action in order to try and defuse the situation
with the staff. Mendelow’s stakeholder matrix normally classifies staff of the
organisation in the low power/high interest category however if staff choose to
act a group they quickly gain more power over the organisation. Birgit Zeim is
right to take a hard line on staff behaviour as Kadgee are facing very difficult
trading times, however staff welfare and fair treatment is a key issues and this
will be discussed further in the ethics section of this report.

Priority Two: Evaluate Xina

In appendix 3 I have prepared an evaluation of the Xina opportunity based on

the information given including the initial investment of €8 million. The
headline is that the project produces an expected net present value of nearly
€17.5 million over the 5 year investment period. This compares very
favourably with the present value of Kadgee’s current operating profit over the
next five years which could be estimated as €3.2 million (€924*3.433),
assuming no growth.

Without a change in strategy it is very likely that Kadgee will not longer be
able to operate as it currently stands as it will be in danger of breaching it
overdraft and could very well lose further customers in the next round of
Contract negotiations.

There are a number of other issues that the Board needs to consider if it
wishes to transfer all operations to China. These have been analysed in a
PEST framework provide in Appendix 2.

Kadgee will be sharing the risk of the venture with Xina this should help
Kadgee to manage some of the political risks since Xina is a company based
in China, they are unlikely to have restrictions placed on them that could be
placed on foreign investors. Kadgee also need to consider what impact any
reintroduction of quotas will have on their production. In 2005 “Bra Wars”
meant that Chinese goods were left at sea when quotas were exceeded.

The economic risks of currency fluctuations could be hedged against by

Kadgee starting to sell some of its goods to the emerging Chinese middle
classes. This would create a real hedge and provide Kadgee some
protections against adverse movements in exchange rates. In any event the
NPV of the project is still €6.5 Million even when the low cash-flows are
reduced by 15%. Kadgee will also be able to take advantage of the low
employment costs that are present in china.

Kadgee also needs to consider technological risk. Firstly, moving to China will
increase the time to make as shipping could take up to 8 weeks. This move is
against the more recent trends displayed by high street stores such as Zara
and New Look where speed to market has been ranked a higher priority than
a low cost base of operations and they have their operations to European
countries with closer proximity to the market. There is also an increasing trend
for clothes to be low cost and fashionable. Consumers wish to emulate the
latest catwalk and celebrity trends as soon as possible, meaning retailers

Script 1 Page 6 of 16
want very short lead times. Zara can start a new line in as little as 14 days.
Another aspect that needs to be considered when locating to China is that the
time difference will mean that staff will need to be very flexible. A problem at
noon in a Chinese factory will have occurred in the early hours of the morning
in Europe. This could lead to problems taking longer to solve.

The issues surrounding labour rights in China will be discussed in the Ethics
section.

The Kadgee Board also need to consider how they will finance this operation
as it requires an investment of at least €8 million. The bank have indicated
that they will only be prepared to lend another €2 million and Kadgee do not
have any accumulated cash in order to finance this mover. However as
discussed in the next issue if Kadgee closes it’s European operations down
then it will receive the proceeds from the sales of some of its factories. This
cash should be sufficient for the venture. However, Kadgee will be at risk if
any further investment is required as they will not be able to fund it without
additional borrowings from the banks. In any event as the loan is currently
fixed on some of Kadgee’s assets permission must be sought before
disposing of the assets, unless Kadgee is able to pay of all the loans, in which
case there will not be enough cash left to finance the joint venture.

Priority Three: Factory Closure

If Kadgee were to relocate to China then it would need to close down all its
European operations. There are a number of things that Kadgee needs to
consider. Appendix 4 provides an analysis of the expected receipts from the
sales of the factories. This ranges from €6.5 to €8.7 million depending of
whether Kadgee pays more than the required redundancy payments and it
they clean up the factory sites post relocation.

Kadgee needs to consider how it will continue to meet its operational

requirements during this transition period. If Kadgee wishes to keep its
existing loyal customers then it must keep operations running until at least
June 2007 when the new factory will be ready to start production. This would
mean that Kadgee would need to borrow the investment required for the joint
venture as the proceeds from the closure of the factories would not be
available to finance this.

Throughout the transition period Kadgee will need to consider the fair
treatment of its staff and also need to consider its responsibility to clean up
the factory sites post closure. These issues are discussed further in the ethics
section of this report.

Priority Four: Investment in IT

An investment in IT could potentially allow Kadgee to continue is production in

Europe and not have to close any of it factories. However this idea is very
much unproven and there are no committed customers to this project though

Script 1 Page 7 of 16
BBZ has shown an interest. The Board should also note the BBZ says that
they wish to be free to procure from other manufacturers globally who have
implemented this type of IT Strategy. This highlights one of the risks of this
strategy. Kadgee would be investing in IT so that it could differentiate it
product from others in the market place. The rationale behind this is that
customers would be prepared to pay the extra from this production. However
one of the risks of a differentiation strategy is that it will be copied by
competitors thus reducing the company’s competitive advantage.

The scale of investment required in this project is €2.1 million in the first two
years and a return of €0.6 million. At present Kadgee would have difficultly
financing this option and would have to seek the maximum borrowing
possible. This project would also not produce a positive net present value at
present.

Other Issues

Birgit Ziem proposed two alternative strategies in order to move Kadgee’s to a

cheaper operating base in Asia. The first was to set up in China on its own.
This has not been seen as a viable solution as it is very undeveloped at the
moment. Kadgee do not have any idea of the costs involved. Also setting up
in China without a Chinese partner would be very problematic and Kadgee
would end up fighting a lot of bureaucracy and red tap, if they were indeed
allowed to setup on their own at all.

In Appendix 3 I have evaluation the other Asian opportunities. These would

have the same risk as the Xina venture; however, Kadgee would not have to
take on a partner. The expected net present values calculated for investments
are a lot lower than the joint venture which is why I have not given them
greater priority in this report.

5. Ethics

Staff Issues – Low Morale and Rita Scree

Currently staff morale is very low and the staff feel that have not been treated
fairly in a number of instances. This has lead to a fall in quality that if left
unchecked could lead to Kadgee customers cancelling contracts. However
this not yet a major issues, as some sub-standard production is to be
expected in all manufacturing organisations.

While I am sure that Kadgee will have followed the letter of the law, therefore
the likelihood of successfully legal action again Kadgee for unfair dismissal
etc. is slim, Kadgee do need to consider its ethical and morale obligations to
its staff during the period of transition.

Firstly Kadgee needs to keeps its staff informed throughout the transitional
arrangements. This could be achieved by regular consultations with staff

Script 1 Page 8 of 16
elected representatives. The management should seek to avoid any strike
action at all costs for the reasons mentioned above.

Because of the danger of a strike the management may wish to reconsider

how it has dealt with Rita Scree. However, Birgit Ziem stance on this matter
should be respected. While is a minor issue it does have big implications to
Kadgee’s ongoing business.

I recommend that management should communicate with the staff to explain

why she has been dismissed and how she failed to comply with the company
absence procedure. They should also show sympathy to Rita situation and
potentially consider a goodwill payment in lieu of notice, though this is very
much at the discretion of the management.

Health and Safety

Their have been a number accidents in the work place which have been the
result of poor training and Health and Safety. Kadgee should immediately
review the training of staff and ensure that’s its Health and Safety Policy is
known to all employees and is complied with. As well as Kadgee’s morale
responsibility to provide a safe working environment, this is also a legal
requirement in most European countries.

I recommend that Peter Colette and Lars Veel review employee training
records and ensure they are up to date. A major accident could result in the
company being found legally liability and being forced to pay damages.

Dealing with Redundancies

Relocation to China will lead to nearly the entire European workforce being
made redundant. If the decision is made then the staff should be informed as
soon as possible. Kadgee should seek to treat staff as compassionately as
possible. Waving the normal notice terms could mean that employees are
able to leave on short notice as an when a new job materialises. This could
also reduce the burden of redundancy payments. Key members of staff may
need to be given retention payments in order to ensure the smooth running of
Kadgee in the transition periods, it is noted that some key staff have already
left.

While it is not a legal obligation Kadgee may wish to consider paying

redundancy to it’s part time staff members as failure to do so would portray
Kadgee in a very negative light and could damage some of the relationships
with its clients.

Factory Closures

As with redundancy issues if Kadgee fails to clean up it’s factory sites after
leaving this could be seem as Kadgee failing its morale obligations and bad
publicity could result.

Script 1 Page 9 of 16
Chinese Labour Laws

A major issue in the press that has tarnished companies that have moved
there production to the Asia is the use of Child Labour. Recently Tesco have
been accused of having child labourers working in one of their factories. The
resulting bad PR from this could lead to loss of customers and they would not
wish to risk their own reputation.

Kadgee needs to be wary of its Chinese partners. Some Chinese companies

have got into the habit of keeping two sets of accounts in order to hid child
labour issues.

6. Recommendations

Ensure Continuing Operations, Deal with Potential Strike

I recommend that urgent action is taken to diffuse the situation with the staff. I
understand the Birgit Zeim is not prepared to reconsider her position with Rita
Scree therefore action must be taken to prevent the strike. This should involve
communication and consultation with staff and confirmation that they will be
treated fairly and inline with Best Practice and the terms and conditions of
their employment. In case a strike is inevitable, plans should be put in place to
minimise the impact that this will have on the suppliers. Kadgee should try
and maintain orders to customers at all costs, to prevent the risk of Kadgee
breaching its overdraft.

Xina

I recommend that Kadgee go ahead with the proposed move to China in the
form of a Joint Venture with Xina. A present this seems to be the only viable
option to ensure the long term stability of Kadgee. The board will need to
prepare reports for presentation to the bank in order that they can secure the
funding required for this and transitions arrangements.

Factory Closures

If the Board chooses to relocate then it will need to close the factories I
recommend that the Board pay full redundancy costs and clean up the old
factory sites as failure to do this will result in bad PR and potential legal action
against Kadgee. Providing there are not additional costs to the joint venture
then the €6.5 million from the sale of the factories and the additional €2 million
loan will cover the setup costs of €8 million.

Investment in IT

I recommend that the investment in IT is rejected at present as the benefits of

this project are unclear and it is very likely at present that the initial investment
would not be recovered in increased sales. However, Kadgee should continue

Script 1 Page 10 of 16
to investigate this solution as it could help speed up the supply chain if the
Company were to relocate to China and help bridge the distance in between
Kadgee and the supplier. Jan Berzin and Sam Skala should continue to
canvass clients and potential clients and keep the Board updated.

7. Conclusions

In conclusion Kadgee is facing a time of change and needs to look in a

different strategic direction to survive. If the Board have any further queries
please do not hesitate to contact me.

Script 1 Page 11 of 16
8. Appendices
Appendix 1:
This appendix contains as position audit (SWOT) for Kadgee and the
environment in which it is currently operating and a PEST Analysis for a
proposed relocation to the Asia
SWOT
Strengths
• Kadgee has a reputation of quality
in its production and this is
appreciated by its suppliers.
• Kadgee uses CAD techniques in
order to facilitate quicker
production and alignment with the
wishes of the clients.
• Speed to market is greater than
some of Kadgee’s competitors
who are based in the Asia.
• Kadgee has recently appointed a
new MD with a good reputation
within the fashion industry.
Opportunities
• There is an opportunity for a Joint
Venture in China.
• Relocation of operations to
another part of the Asia
• Use IT Solutions in order to
engage in an interactive sales
system.
Script 1
Weaknesses
• Kadgee relies on a few customers
for the majority of its orders. The
loss of Forum resulted in a
reduction of revenue by almost a
quarter, Kadgee is still very much
at risk of losing further customers.
• Poor working capital management
and limited borrowing capacity.
• The quality of Kadgee’s products
is falling and there are
increasingly a number of issues
with the machinery.
• The staff is currently suffering
from low morale.
• Kadgee has a high cost base and
very slim operating margins of
around 2.5%. Price cuts required
by customers could lead to
Kadgee incurring losses.
Threats
• The staff are currently threatening
industrial action over the dismissal
of a fellow employee.
• Kadgee risks losing further
customers as quality declines and
prices uncompetitive.
• The threat of cheap Chinese
imports still remains high.
Page 12 of 16
PEST
Political
• In most Asiaern Countries as Joint
Venture is required in-order to set
up business.
• Government could change Tax
regimes which could increase
liability and restrict the movement
of profits out of the country.
• Political unrest could disrupt
production.
• Quota’s could be reintroduced on
imports from the Asia. There is the
possibility of a trade war with US.
Social
• Labour rights are not developed in
the Asia.
• Kadgee could be unknowingly
using child labour in its factories.
• Look behind the label campaigns
could mean that some of
Kadgee’s customers would not
wish to use them if the good were
produced in China or the Asia.
Script 1
Economic
• Loss wage rates lead to reduced
costs for production.
• Fluctuations in the foreign
currency could lead to goods
produced in the Asia becoming
less competitive.
• The Yuan (Chinese Currency) is
currently considered to be
overvalued.
• Costs of operations could increase
as standards of living improve and
a middle class starts to develop.
Technological
• Transport times from the Asia will
increase the lead time on
Kadgee’s orders as shipping could
take up to 8 weeks.
• Asiaern Countries do not have as
well developed infrastructure as
European Countries.
• Time differences of over 8 hours
will make communication
problematic and less timely.
Page 13 of 16
 Appendix 2: Evaluation of the Xina Opportunity

Option 1 High Cashflows: Probability 70%

Year 0 1 2 3 4 5
Cashflow -8,000 2,000 8,000 10,000 12,000 14,000
Discount Rate 1 0.877193 0.769468 0.674972 0.59208 0.519369
Present Value -8,000 1,754 6,156 6,750 7,105 7,271

NPV 21,036

Option 2 Low Cashflows: Probability 30%

Year 0 1 2 3 4 5
Cashflow -8,000 1,000 5,000 6,000 7,000 8,000
Discount Rate 1 0.877193 0.769468 0.674972 0.59208 0.519369
Present Value -8,000 877 3,847 4,050 4,145 4,155

NPV 9,074

Expected NPV 17,447

Options 3: Worst Case Low cashflows reduced by 15% to account for

adverse movements in exchange rates

Year 0 1 2 3 4 5
Cashflow -8,000 850 4,250 5,100 5,950 6,800
Discount Rate 1 0.877193 0.769468 0.674972 0.59208 0.519369
Present Value -8,000 746 3,270 3,442 3,523 3,532

NPV 6,513

Script 1 Page 14 of 16
 Appendix 3: Evaluation of other Asia Opportunities

NPV of
Location 1

Expected NPV 7,950

NPV of
Location 2

Expected NPV 7,950

Script 1 Page 15 of 16
Evaluation of Closure Costs for Kadgee's Factories

Maximum
Minimum Value Value

Sale of Factories to Land

Developer 12,000 12,000

Site Closure
Costs 1,500 300
Redundancy
Costs 4,000 3,000

Total income from

Closure 6,500 8,700

The Minimum scenario assumes that Kadgee will clean up the sites and pay full redundancy costs
to all employees

The Maximum Scenario assumes that Kadgee will do the bear minimum and will only make
payments that it is legally obliged to.

Script 1 Page 16 of 16