AC3004 2009 May Answers

Question 1 Strategy

(a) Using Porter’s five forces model as a basis, identify the main competitive forces of an organisation you are familiar with and discuss the threat posed by each of these. (16 marks) Michael Porter’s `Five Forces Model’ Threat of New Entrants

Bargaining Power of Suppliers

Competitors in the Industry

Bargaining Power of Customers

Threat of Substitutes
1 mark for diagram Key issues to consider: Threat of new Entrants: Barriers to entry to a particular industry typically include: • High capital investment requirements for new firms and the benefits of economies of scale for established firms; • Setting up distribution channels; • The experience curve - existing firms have the benefit of experience in the industry; • Legislation or government action (e.g. Health and Safety legislation) which may be costly to implement for new firms; • Differentiation of products from the products of existing firms. Power of Buyers - this can force selling prices down. Buyers are powerful when: • There are few buyers and many alternative sources of supply for the product; • Buyers can 'shop around' for the best price; • Buyers can produce the product themselves. Power of Suppliers - this can force costs up. Suppliers are powerful when: • There are few suppliers and the cost of switching to alternative suppliers is high; • Suppliers can produce end product themselves. Threat of Substitutes - this means that customers can choose alternative products with similar properties thus reducing sales volume. The threat of substitutes is high when: • Customers can substitute the product for another; • The product is not adequately differentiated from (is similar to) other products in the market? Competitors in the industry - high competition in the industry forces prices down. Competition is high when: • There are few balanced competitors in mature market; • Industry has high fixed costs and high turnover sought; • Industry has over capacity to be exploited; • Products are similar and there are low levels of differentiation; • Exit barriers (the cost of pulling out) are high. Up to 3.0 marks for each of the 5 competitive forces. An excellent answer will demonstrate understanding and include a relevant example. Total 16 marks

within the segment only and can be a strategy of cost leadership or differentiation. Differentiation – is the exploitation of a product or service to make it unique in the market as a whole. (b) Again using organisation(s) of your choice discuss the possible strategies that this organisation(s) could adopt to gain competitive advantage. Competitive advantage is gained by having lower costs than all competitors. (9 marks) Porter (1985) suggests there are three generic strategies available for an organisation to gain competitive advantage. An excellent answer will demonstrate understanding and include a relevant example iii. A firm must provide something unique that is of value to the purchaser and therefore a higher price can be commanded.Question 1 Strategy cont. 2 . i. ii. Cost focus – specialises in a limited number of products in a selected segment of market.0 marks for each strategy. b. Focus – depends on segmentation and involves pursuing. Cost leadership – to become the lowest cost producer for the market as a whole. Differentiation focus – involves selecting a segment of market and competing on basis of product differentiation. a. Up to 3.

The focus should be on customer needs. 3 . Internal failure costs — costs arising within the organisation of failure to achieve the quality specified. Everyone within the organization should be involved in TQM. External failure costs — costs arising outside the manufacturing organisation of failure to achieve specified quality (after transfer of ownership to customers). should be involved in the process since employees involved in the processes are often the source of the best ideas. ii. distribution and research.5 marks for each category of quality cost up to a maximum of 10 marks. • Administration of quality control • Training in quality control 2. rather than discourage. iv. 1. Prevention costs include: • Quality engineering • Design and development of quality control equipment and inspection equipment. Up to 2. Appropriate training and education should he given so that everyone is aware of the aims of TQM. iii. prevent or reduce defects and failures. Continuous improvement seeks to eliminate non-value activities. This requires a close working relationship between sales. vii. v. b.the cost of any action taken to investigate. a. Simple non-financial measures involving real time reporting should be seen as a vital component of the performance measurement system. The focus should be on continuous improvement. Existing rewards and performance measurements should he reviewed to ensure that they encourage. Senior management should provide the commitment that creates the culture needed to support TQM. quality improvements. An excellent answer will demonstrate understanding of the factor. These include • Failure analysis • Re-inspection costs • Losses from failure of purchased items • Losses due to lower selling prices for sub-quality products • Costs of reviewing product specifications after failures 4. These costs include: • Acceptance testing • Inspection of goods inwards • Inspection costs of in-house processing • Performance testing 3. Total 15 marks. All sections within a company should be seen as a potential customer of a supplying section and a potential supplier of services to other sections. Appraisal costs . rather than just management. All employees. The aim should be to design quality into the product and the production process.Question 2 TQM Total quality management (TQM) is a term that is used to describe a situation where all business functions are involved in a process of continuous quality improvement. Up to 2. This should not just represent the final customer. production. 1 mark The key factors for the implementation of TQM are: i. viii.The costs of assessing quality achieved. produce products and provide services with zero defects and simplify business processes. Senior management should promote the required culture change by promoting a climate for continuous improvement rather than imposing blame for a failure to achieve static targets. Prevention costs . An effective performance measurement system that measures continuous improvement from the customer’s perspective should be introduced. • Maintenance of quality control equipment and maintenance equipment. Such costs include • Administration and costs of customer complaints section • Product liability costs • Costs of repairing products returned from customers • Cost of providing replacement items due to sub-standard products or marketing errors.0 marks for each factor up to a maximum of 7 factors giving 14 marks. vi.

780 10·83d 235.000 12·00 216.400 95.292 x 0·368421052 = £91. could calculate the variable cost in year one and hold for the four years.040 Investment 100. Gross profit is then simply sales revenue less variable costs.000 to this net profit means that £83. given that variable costs are said to be constant over the four years.476 2012 (40 – 5 – 4·75)/(100(0·95)(0·95)) = 33·5180055% Total gross profit = £235.000 75.400 VC per unit = £7·20 So year two gross profit will be: £237. Variable costs in 2005: £216.600 2011 21.750 of gross profit is needed.000 2010 19. At a price of £10·83 this suggests sales volume of 23.040 Overheads 70.000 –3·8% Marks 3 2 1 1 1 1 Total 9 marks (b) In order for a bonus to be paid in 2012 an ROI of 15% is needed.000 x VC = £86.877 79. Total gross profit = £237.000 – 18.292 91.061 Alternatively. 1 mark 1 1 1 Total4 marks (c) Performance statistics 2005 2006 ROI 13% 17·5% Bonus paid? No Yes Sales Growth – 0% Gross margin 40% 35% Overheads £67.Question 3 ROI & Galaxy (a) The forecast for Guildford depot is as follows: 2009 (£) 2010 (£) Sales W1 216.600 x 0·4 = £95. This implies a net profit of £25.000 4·7% .072 units.750.780b 11·40c 248.476 50.040 2011 (40 – 5)/100(0·95) = 36·8421052% Total gross profit = £248. Total gross profit = £216.83 W2 Gross Profit 2009 40% (given).040 2009 18.000 Net profit % on Sales 6·5% 7% The performance of Liverpool can be assessed in various ways: 4 2007 16·7% Yes –10% 35% £53.000 x 15% = £3.000 x 0·4 = £86.000 11.000 70.000 (1·1) = 19.476 80.00 (0·95) = 11.877 x 0·335180055 = £79.000 Net Profit 16.000 22·95% 2012 (£) 235.000 £56.40 (0·95) = 10.000 ROI 16·4% 33·39% W1 Sales Volume (units) Sales Price (£) Revenue (£) (Volume x Price) a: 18.877 2011 (£) 248.600 – 19.292 2012 21.800 x 7·2 = £95.400 2010 40% (given).866.000 5·6% 2008 20% Yes –5·6% 30% £43.061 80.600 Gross Profit W2 86.800 (1·1) = 21.780 c: 12.800 b: 19.000 (939) 25.800a 12·00 237. At a gross profit % of 33·518% this implies sales of £249.40 d: 11. Adding overheads of £80.000 237.400 25.

If inventory in 2005 could be overstated this would have the effect of increasing 2005 profits at the expense 2006 profits. Gross Margin The gross margins have also shrunk. Clearly Liverpool is under performing. or one could say it reflects flexible management. The invoice itself would not have to be sent to the customer. An excellent answer will demonstrate understanding of the manipulation 5 . Overhead Control The one area that is impressive is the apparent ability of the business to reduce overheads as sales and margin have shrunk. It is possible that reducing these overheads could have contributed to the poor sales performance. Understate a provision or accrual in 2005: This has the effect of moving cost from 2005 to 2006 (assuming that by the end of 2006 the provision is correctly stated). This is hard to justify. The ROI will tend to increase as assets get older and this will distort the financial performance picture. Performance calculations and discussion ROI discussion up to 5 marks up to 3 marks Total marks 8 (d) The unethical manager would have needed to move profits out of 2006 and in to 2005. perhaps on the receipt of an order and before actual delivery. Suppliers might have increased prices or labour could have got more expensive. Net profit levels have fallen overall and yet ROI has increased. One immediate problem here is having the information in good time to respond. In a period of falling sales and weaker margins the manager of W has been awarded bonuses in three out of four years.0 marks for each manipulation. The level of margin has only reached the normal level once in the last four years. primarily due to falling gross margins as overheads have reduced. The manager need only move £2. This could be poor volumes or poor prices achieved. Delay the recording of 2005 cost: A supplier’s invoice could be left unrecorded at the end of 2005.000 of profit from 2006 to 2005 to achieve a 15% return in both years. if (for example) quality has been affected. including it in 2006 expenses instead. It is hard to argue that the ROI figures properly reflect the performance of the centre. It is possible that Liverpool is subject to higher than normal levels of competition. Reducing margins can result from sales price pressure or increases in the cost of sales levels being incurred. Clearly a disappointing performance. He could. It is likely that such a manager would have to gamble at the end of 2005 and make an adjustment in the hope of a better year in 2006. Up to 2. Possible methods of adjustment include: Accelerate revenue: Sales made early in 2006 could be wrongly included in 2005. ROI The ROI has improved in most years and has exceeded the 15% target in all but one year (year 1). Manipulate accounting policy: Inventory values (for example) are easy targets for the unethical manager. then a reducing sales price is likely.Sales Growth Sales revenue growth is most unimpressive. Given the reducing gross margin (see below). for example. This is often difficult to do. This is simply due to the reducing asset base as the stores assets have gradually been depreciated. Net Margin The net margin has also fallen. We are told that the market in which GALAXY operates is steadily growing and yet the centre has shrunk in terms of sales over the last four years. merely filed until the second year had begun and delivery made. The manager would have to be able to anticipate the 2005 poor result and the improvement in 2006. raise an invoice before is normal.

Total marks 4 6 .

Taxation has been ignored but the company will have to account for it assuming it will make profits. thus not a long way ahead yet the cost of oil has been very volatile over the last twelve months. The two methods are either change the value of a variable to achieve a NPV of £nil or change all assumptions one at a time by the same percentage and observe the effect on the NPV of the project. Does the proposed investment have the support of the senior management team? Is the acquisition in line with the company's strategy? Here we are looking for a sensible discussion of any relevant aspect of the business for 5 marks. Supply based approach including cost plus in all its forms. Here we are looking for a sensible discussion of investment appraisal for 5 marks.5 marks for each pricing strategy.Question 4 a) see spreadsheet Question 4 b) Discuss the merits of your appraisal in part (a). Another method of allowing for uncertainty is the three point estimate and then to calculate the expected value. Up to 2. Here only forecasting the next three years. Demand based including target costing. Question 5 a) and b) see spreadsheet Question 5 c) Discuss the pricing strategies that should be considered when pricing new products (10 marks) Market based including skimming and penetration pricing. (5 marks) The non-financial factors are often more important than the numbers. • • • (5 marks) • • Draws on forecast data as does all investment appraisal. An excellent answer will demonstrate understanding and include a relevant example 7 . One way of allowing for uncertainty about the future is to carry out some sensitivity analysis using either method. Question 4 c) Discuss any non-financial factors that should be considered by TP plc when taking such a decision. Here as always it is important to obtain the estimates from the expert manager for that particular aspect of the business.

probably a result of reducing turnaround times to improve delivery on time percentages. A good performance here is very likely to lead to more custom in the future. Interestingly these measures can indicate current cost efficiency as much as any future result. – Average cash balances are up 5% – indicating improved 8 marks. (b) Financial performance indicators will generally only give a measure of the past success of a business. Internal business processes are a measure of internal efficiency. Measuring performance by way of non-financial means is much more likely to give an indication of the future success of a business. Customer knowledge measures how well the business is dealing with its external customers. Clients may leave and costs may escalate turning past profits to losses in what can be a very short time period. c) Internal business processes Error rates Error rates for jobs done are up from 10% to 16%. This is encouraging and a sign of a growing business. This is critical as users expect their treatments to be successful. The only possible concern may be that they are being particularly aggressive in chasing up outstanding debts. . Non financial measures are often termed “indicators of future performance”. New products would be reflected here along with indicators of staff retention. with a possible concern about margins and low growth. The extra non-financial information gives much greater insight into key operational issues within the business and paints a bleaker picture for the future.Question 6 Answer (a) Financial analysis There are various financial observations that can be made from the data. There is no guarantee that a good past financial performance will lead to a good future financial performance. Good results in these measures can lead to a good financial performance. – Profit is up 3. Specifically the non-financial information relates to the non-financial measures within the balanced scorecard. Here we are looking for a reasonable discussion f non-financial 5 marks. Britewite could be sued if clients’ teeth are damaged by mistakes. 8 . – Turnover is up 5% – this is not very high but is at least higher than the rate of inflation indicating real growth. – The main weakness identified in the financial results is that the net profit margin has fallen from 20% to 19. Again this is much more focused on the future than the present. In absolute terms profits are impressive given that Simon is sole owner of the business. – Average debtors days are down by 3 days – indicating improved efficiency in chasing up outstanding debts. Innovation and learning measures the way the business develops. Positive cash balances are always welcome in a business. For example if a business delivers good quality to its customers then this could lead to more custom at higher prices in the future. the business looks in good shape and would appear to have a healthy future Here we are looking for a reasonable commentary on the financial performance .9%.8% suggesting that cost control may be getting worse or fee levels are being competed away. Overall. It is noticeable that Britewite’s days are lower than the industry average indicating strong working capital management.

The industry average revenue from non-core work has increased from 25% to 30% but Britewite’s figures have dropped from 5% to 4%. Up to 3. Continuity of staff at a client is important to ensure a quality product. an increase of 29%! This could explain the loss of clients in itself. Conservative clients may resent meeting a variety of different people each year. An excellent answer will demonstrate understanding and include a supporting example.Customer Knowledge Client retention The number of clients has fallen dramatically – this is alarming and indicates a high level of customer dissatisfaction. Looking at revenue figures one can estimate the size of the market as having grown from £4. The firm should be doing much better and looks to being left behind by competitors. Also staff may realise that the lack of range of services offered by the firm will limit their own experience and career paths Conclusion In conclusion. In a specialist business like this one would normally expect a high level of repeat work.5m to £6. Staff turnover is possibly a result of extra pressure to complete jobs more quickly without the satisfaction of a job well done. At present it is being left behind by a changing industry and changing competition. Learning and Growth Non-core services The main weakness of the firm seems to be is its lack of non-core services offered. Employee retention Employee turnover is up indicating that the staff are dissatisfied. The firm has fundamental weaknesses that need to be addressed if it is to grow into the future. Clearly existing clients are not happy with the service provided. Total marks 12 9 .0 marks for each aspect discussed. an increase of 50%. Average fees It would appear that the increase in revenue is thus due to a large increase in average fees rather than extra clients – average fee is up from £600 to £775. the financial results do not show the full picture. Compared to this. however there could be other reasons. Market share The result of the above two factors is a fall in market share from 20% to 14%. Britewite’s figures are particularly worrying. It is vital that Britewite reassesses its attitude and ensures that the firm has a better fit with its business environment.75m. It would appear that most clients are looking for a wider range of products but Britewite is ignoring this trend. In particular they should seek to develop complementary services and reduce errors on existing work.

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