20. Competitiveness (and improving it)

www.a-zbusinesstraining.com

20. Competitiveness (and improving it)

1. Missing words To survive, every firm needs to be competitive, i.e. have enough strengths to be able to

compete effectively with their rivals. A firm’s competitiveness can be based on its low

____________ (allowing the business to cut prices when necessary) or on its ability to add

value through its distinctive market position. Highly competitive firms usually have a

successful combination of clever marketing, well-motivated staff and effective operations

management. Together these factors lead to well-designed, attractive products (or

____________________), good quality production (and ______________________ service)

and therefore a high quality image.

2. Match one cause and one solution to each of the following situations

Situation Possible cause Possible solution

2.1 Sony, which used to have 65% of the games console market, now has only 25%

A. The new Tesco Express, opened nearby, has made people go there for lower-priced everyday items

V. The business needs to re-connect with its customers, to identify the fashions they’re looking for today, and tomorrow

2.2 French Connection stores, once a profit factory, now struggle to break even

B. A new, tougher approach to factory management has led to a sharp decline in staff motivation and morale

W. More delegation may be needed to younger designers and engineers, for sharper future product development

2.3 An independent grocer’s store on a High Street is being squeezed out by competition

C. Tata Motors have started importing their car into the UK (the world’s cheapest, priced at £1,250 in India)

X. Factory managers need training on how to manage staff maturely and effectively

2.4 A dip in its reputation for quality/reliability has hit the sales of a well-known car producer

D. Fashion has turned against the business, making it hard to charge premium prices

Y. There is a need to cut costs in the factory, perhaps by making redundancies

E. A competitor has produced an innovative new product that has captured the imagination of customers.

Z. The owner must change the range of stock (perhaps to more speciality items) in order to avoid the direct competition


3. IDENTIFY TWO FEATURES OF EACH OF THESE BRANDS, THAT MAKE THEM COMPETITIVE

4. Ways to improve competitiveness In May 2008 Land of Leather announced that sales were 32% down compared with the previous year. Furniture rival DFS sales seemed to be holding up quite well. Clearly Land of Leather was uncompetitive. Outline one way in which Land of Leather could improve its competitive position.

_________________________________________________________________________________

_________________________________________________________________________________

Product: Cadbury’s Dairy Milk.Product: Cadbury’s Dairy Milk.Product: Cadbury’s Dairy Milk.Product: Cadbury’s Dairy Milk. Outline two features that make it tough for rivals to compete with: ___________________________________________________

Product: iPod Touch Phone.Product: iPod Touch Phone.Product: iPod Touch Phone.Product: iPod Touch Phone. Outline two features that make it tough for rivals to compete with: ___________________________________________________ ___________________________________________________


20. ANSWERS – Competitiveness

1. costs … services … customer

2.1 E, W

2.2 D,V

2.3 A, Z

2.4 B, X

3.1 Tradition – kids (in Britain) are brought up thinking of Cadbury’s as chocolate; The

branding and advertising keep the product at the front of everyone’s mind.

3.2 Fantastic, innovative design has made the Apple iPod a style leader; the interface

makes it easy to use – making customers reluctant to switch to other MP3s

4. It must find out why people are still going to DFS, and then find a way to beat, not

join, them, i.e. not copy DFS, but find an innovative way to connect with customers.


51. Analysing Balance Sheets

1. Fill in the missing words. A balance sheet is a listing of all a firm’s ______________ and ___________________ at a

point in ___________. It balances because double entry bookkeeping ensures that assets

always equal liabilities. Specifically, assets employed equals _______________ employed.

A balance sheet has three main sections: _______________ assets are the long term assets

such as property and machinery. W_________________ capital shows the short term

assets (minus the short term liabilities). These two sections, added together, comprise

the __________________ employed. This total is balanced by the loans and shareholders’

funds that comprise the firm’s capital employed.

Here is a summary of the above:

Fixed assets + Working capital = Assets employed

=

Loans + Shareholders’ funds = Capital employed

2. Circle the odd one out along each row.

2.1 Current assets: Creditors Debtors Stock Cash

2.2 Current liabilities: Tax due Overdraft Creditors Old stock

2.3 Capital employed: Reserves 5 year loan Cash Share capital

2.4 Fixed assets: Vehicles Fixtures and fittings Stock Property


3. Insert the 5 missing terms into the following balance sheet:

£000s

________________ Property 140 Vehicles 110

________________ Stock 55 Debtors & Cash 70

________________ Creditors 65 Overdraft 90

Net Current Assets (30) (__________________________)

ASSETS EMPLOYED 220 Loans 105

NET ASSETS 115

Share capital 25 Reserves 90

_________________________115

CAPITAL EMPLOYED 220 4. Anagrams

4.1 The scent of profit RING OF ARMPITS

4.2 A listing of a firm’s wealth THE LACE BEANS

4.3 The net current assets TRIAL, PICK WONGA

4.4 The value of the items held for use and re-use in the short term STRESS CURE, TAN


51. ANSWERS - Analysing Balance Sheets

1. assets, liabilities, time, capital, fixed, working, assets.

2.1 creditors,

2.2 old stock,

2.3 cash,

2.4 stock

3.

£000s

Fixed assets Property 140

Vehicles 110

Current assets Stock 55

Debtors & Cash 70

Current liabilities Creditors 65

Overdraft 90

Net Current Assets (30)

(Working capital)

ASSETS EMPLOYED 220

Loans 105

NET ASSETS 115

Share capital 25

Reserves 90

Shareholders funds 115

CAPITAL EMPLOYED 220

4.1 Profit margins

4.2 Balance sheet

4.3 Working capital

4.4 Current assets


88. Ratios - Profitability

1. Fill in the gaps.

Profitability means measuring profit in relation to a yardstick, e.g. as a percentage of

sales revenue. This helps in comparing the performance of firms of different sizes or to

evaluate a firm’s performance over __________. It may be important to know the

absolute size of a firm’s profit, e.g. £1 million but has that been made from sales of £10

million or £100 million? The key ratios for measuring profitability are profit

______________ (profit as a percentage of sales) and ________________ on

_________________ employed, which measures profit as a percentage of the capital

invested in the business. Missing words: margins, capital, time, return

2. Formulae and Calculations A.

2.1 State the formula for the gross profit margin. _________________________________

2.2 Net profit margin measures net profit as a percentage of sales. If a firm with annual sales of £600,000 has a net profit of £84,000, what is its net profit margin? _______________________________________________

2.3 JC Co has sales of £120,000 and profits of £12,000. Its capital employed is £75,000. Calculate the company’s return on capital. ___________________________________________________

3. Match the explanation to the statement.

Statement Explanation

1 Brital plc has made a return on capital of 16% this year compared with 14% last year

A If margins are too high customers may question the value for money

2 “I’m thrilled that our restaurant has made a gross profit margin of 75% this year”

B Some businesses have low profit margins, but still do well because of very high sales revenues

3 5 years ago, Marks and Spencer’s net profit margin was double that of Tesco

C ROC should be compared with the interest rate, but high-risk businesses should have v. high returns

4 In a year when interest rates were 6%, VB Co had a great year, making an ROC of 12%

D A rise in ROC implies improved financial efficiency and performance of the business

5 BJP Co, wholesalers, has a net margin of just 2%

E Gross margin has relatively little significance, because it ignores fixed overheads


4. True or False?

4.1 If ROC falls below the interest rate, highly geared firms are in very big trouble.

____________

4.2 If the gross margin rises, the net margin and ROC will rise as well.

____________

4.3 Rising margins will lead to rising ROC, if asset turnover is unchanged.

____________

4.4 An ROC of 100% implies that the firm should double in size every year.

____________

5. Formulae and Calculations B.

5.1 If the net margin is 20% and the asset turnover is 2, what’s the ROC?

_______________________________

5.2 ZQ Co has sales of £4.2 million, costs of sales of £2.8m, overheads of £1.3m and corporation tax payments of £60,000. What is the company’s gross margin? ____________________________________________________

5.3 If a firm with £1 million of sales has gross and net profit margins of 16% and 6% respectively, what are the firm’s overhead costs?

_________________________________________________________________________


88. ANSWERS: Ratios – Profitability

1. time … margins … return … capital

2.1 d

2.2 e

2.3 a

2.4 c

2.5 b

3.1 Gross profit/sales revenue x 100

3.2 14%

3.3 16%

4.1 T

4.2 F

4.3 T

4.4 T

5.1 40%

5.2 33.33%

5.3 £100,000 (10% of sales revenue)


Can General Motors Survive the Crunch?

With over 250,000 employees around the world, General Motors is a true business giant. For more than 70 years it was the world’s number 1 carmaker. In recent years Toyota and Honda have given it a torrid time. Now it may not be able to survive. The problems are more obvious in its accounts than anywhere else. With the banking crisis of 2008, unless the US government comes to the rescue, bankruptcy may loom.

The figures below enable you to compare General Motors with the Japanese giant, Toyota. Profit & Loss Account for year ending (all figs in $millions)

GENERAL MOTORS (year to Dec 31st)

TOYOTA (year to Mar 31st)

2007 2006 2008 2007

Sales turnover 178000 171000 262000 203000

Cost of sales 166000 164000 215000 163000

Gross profit 12000 7000 47000 40000

Administrative overheads

16000 18000 25000 21000

Operating profit (4000) (11000) 22000 19000

Finance, tax and one-offs

(35000) 9000 (5000) (5000)

Net profit (39000) (2000) 17000 14000

Balance sheet as at … (all figures in $millions)

GENERAL MOTORS (as at Dec 31st)

TOYOTA (as at March 31st)

2007 2006 2008 2007

Fixed assets 89000 121000 203000 176000

Stock 15000 14000 18000 15000

Debtors & Cash 45000 51000 103000 85000

Current liabilities 70000 67000 119000 100000

Net current assets (10000) (2000) 2000 0

ASSETS EMPLOYED 79000 119000 205000 176000

Long term loans 114000 124000 80000 71000

Share capital 18000 17000 15500 13000

Reserves (53000) (22000) 109500 92000

CAPITAL EMPLOYED 79000 119000 205000 176000

Questions (30 marks; 40 minutes) 1a) Calculate the operating profit margins and the return on capital for General Motors and Toyota for the most recent year available. (4)

1b) Comment on the differences between the two companies’ performance. (7)

2. Analysis each firm’s liquidity and gearing in order to evaluate their financial health. (9)

3. Since Dec31st 2007 US car sales have fallen sharply, adding to the pressures on General Motors. During 2008, cash has been draining out of the business at a rate of $1billion per month. Discuss the ways in which the company might act to avoid bankruptcy. (10)


Mark Scheme - Can General Motors Survive the Crunch?

1a) Calculate the operating profit margins and the return on capital for General Motors and Toyota for 2006. (4) One mark for each ratio:

FORMULA G.M TOYOTA

Operating margin Op profit/Turnover * 100 -2.2% 8.4%

Return on capital Op profit/cap employed * 100 -5.1% 10.7%

1b) Comment on the differences between the two companies’ profitability. (7)

3 4

CONTENT APPLICATION

3 4-3

Good understanding shown of the ratios

Relevant issues applied in detail to the data and business context

2-1 2-1

Some understanding of the relevant terms

Relevant issues applied to the data or the business context

Possible answers include:

• Toyota’s is sound but looks quite unexciting (though in fact it’s very high for the car industry)

• More significant is that of G.M., which had operating losses in 2006 and again in 2007; they reduced the operating losses (good) but seem to have suffered a major one-off loss (of $35 billion!) in 2007; the real problem for G.M. is that profits usually bring cash into a business but losses drain the cash away; with the credit crunch kicking in during 2008, this underlying position becomes very serious


2. Analysis each firm’s liquidity and gearing in order to evaluate their financial health. (9) General Motors’ position

FORMULA G.M. 2007 G.M. 2006

Acid test ratio Debtors & cash/current liabilities

0.64 0.76

Gearing ratio Loans/Capital employed * 100 145% 104%

Toyota position

FORMULA TOYOTA 2008 TOYOTA 2007

Acid test ratio Debtors & cash/current liabilities

0.87 0.85

Gearing ratio Loans/Capital employed * 100 39% 40%

MARKING GRID (Out of 9)

2 2 2 3

CONTENT APPLICATION ANALYSIS EVALUATION

2 2 2 3

Good understanding of relevant terms

Relevant issues applied in some detail to the case

Analysis of question set, using relevant theory

Judgement shown in discussing the issues raised, reaching a balanced conclusion

1 1 1 2-1


Relevant issues applied to the case

An attempt at building an argument, but weakly

Some judgement shown in text or conclusions

Possible themes might include:

• Toyota’s position shows reasonable liquidity and very sound gearing; better still, both the acid test and gearing ratios show an improved trend between 2007 and 2008 (if only slightly); liquidity is improving and gearing is falling

• General Motors’ position looks impossible; on the face of it a business with a gearing level of more than 100% should put itself into liquidation (as the shareholders have nothing left of value); presumably its creditors have been sustainedly generous; now, with the gearing worsening rapidly and the liquidity worsening (up until the balance sheet date, but also by $1 billion a month since December) survival looks very difficult, even without a credit crunch


3. Since Dec31st 2007 US car sales have fallen sharply, adding to the pressures on General Motors. During 2008 cash has been draining out of the business at a rate of $1billion per month. Discuss the ways in which the company might act to avoid bankruptcy. (10)


2 2 3 3


2 2 3 3

Good understanding of relevant terms




1 1 2-1 2-1





Possible themes might include:

• It started 2008 with an acid test ratio of 0.64; with every $billion drained from the balance sheet the acid test will fall further; eventually it will be unable to find the cash to pay the bills, as borrowing more is not an option (as gearing is so high)

• It must try to cut stocks in order to boost its cash position, though its stock level doesn’t look high in relation to Toyota

• Alternatively it could try to squeeze more credit from its suppliers, though it is hard to think that the suppliers would want to take on any more risks, especially in times of credit crunch

• Raising more money from share capital also seems unlikely for now; perhaps the government might be game for some equity investment; are banks more deserving than G.M.?


Halfords plc

You are Britain’s Number 1 bike retailer with 33% of the market. The market is booming – especially in London (up 80% in the past 5 years). These must be good times. The figures below show the performance of Halfords plc in its latest accounts. Halfords plc has more than 400 stores and nearly 10,000 staff. It specializes in car parts and accessories and also in bicycles. After many changes in ownership, Halfords was bought by a finance house in 2002, then returned to the London stock market in 2004. It is now a fully independent public limited company. All figures in £millions

Profit & Loss Account (yr to March 31) Balance Sheet (as at March 31st)

2007 2006 2007 2006

Revenue 750 680 Fixed assets 370 360

Cost of sales 370 335 Stock 140 130

Gross profit 380 345 Debtors 30 30

Overheads 289 256 Cash 30 2

Interest charges 10 12 Current liabilities 145 182

Operating profit 81 77 Net current assets 55 (20)

Corporation Tax 24 23 Assets employed 425 340

Net profit 57 54 Long term loans 220 140

Dividends 30 28 Share capital 135 135

Retained profit 27 26 Reserves 70 65

Capital employed 425 340

Questions (45 marks; 50 minutes)

1a) Analyse the financial health of Halfords plc in 2006 and 2007. (10) 1b) Discuss whether the company’s financial position threatens its financial survival. (10) 2a) Calculate the stock turnover ratio for Halfords in 2006 and 2007. (5) 2b) Comment on the figures. (5) 3a) Calculate the Return on Capital figures for the business in 2006 and 2007. (5) 3b) Use all the information available to discuss whether the management should be congratulated on the company’s best-ever profit in 2007. (10)


Halfords PLC Mark Scheme

1a) Analyse the financial health of Halfords plc in 2006 and 2007. (10)

3 3 4

CONTENT APPLICATION ANALYSIS

3 3 4-3

Good understanding shown of relevant formulae

Relevant formulae applied accurately to the data provided


2-1 2-1 2-1

Some understanding of the relevant formulae


One or two points applied in a limited way to analyse the Q.

Appropriate ratios include:

� Acid test ratio: 2006 = 0.18; 2007 = 0.41. Both figures are far short of the 1:1 ‘ideal’, yet the dramatic improvement in 2007 is very encouraging

� Gearing: 2006 = 41%; 2007 = 52%. This worsening position implies increasing levels of risk. Although the management is perhaps gearing itself up to take advantage of growth opportunities, the risks are clear (especially when the weak liquidity is taken into account)

� ROC would also be understandable (which falls in 2007)

1b) Discuss whether the company’s financial position threatens its financial survival. (10)


2 3 3 4


2 3 3 4-3

Understanding of

relevant

terms/issues

Relevant issues

applied in some

detail to the case

Analysis of question

set, using relevant

theory

Judgement shown in

discussing the issues

raised, reaching a

balanced conclusion

1 2-1 2-1 2-1

Some understanding

of the relevant

terms

Relevant issues

applied to the case

An attempt at

building an

argument, but

weakly

Some judgement shown

in text or conclusions

Reasons to go ahead include:

� Probably not, as even though it looks stretched financially, it’s a profitable business

and has quite large shareholders’ funds

� If the market stays as it is, the business should be fine. The risk is that if interest rates

rise, or if the market for bicycles goes into reverse, it will be much harder to cope with

this balance sheet

� Within the improved liquidity position, the leap in cash from £2m to £30m gives rise to

plenty of hope about the future.


2a) Calculate the stock turnover ratio for Halfords in 2006 and 2007. (5) Formula (1 mark): Sales (at cost) Stock 2006: 2.58 (2 marks) 2007: 2.64 (2 marks) 2b) Comment on the figures. (5)

2 3

CONTENT APPLICATION

2 3

Good understanding shown of relevant terms

Relevant issues applied in detail to the case

1 2-1




• Seems very low for a bike shop; average piece of stock is lying around for about 5 months

• Very hard to judge, though, when there’s no comparable data, e.g. from other retailers

• All we do know is that 2007 is slightly better than 2006

3a) Calculate the Return on Capital figures for the business in 2006 and 2007. (5) Formula (1 mark): Operating profit x 100 Capital employed 2006: 22.6% (2 marks) 2007: 19.1% (2 marks) 3b) Use all the information available to discuss whether the management should be congratulated on the company’s best-ever profit in 2007. (10)


2 2 3 3


2 2 3 3

Understanding of relevant terms/issues




1 1 2-1 2-1







• It can be hard to cope well when the business is growing (diseconomies of scale etc) so the business has done well to make a record profit

• But if the managers had been able to keep the ROC constant at 22.6%, there would have been a profit of £425m x 22.5% = £95.5m. In other words the business has lost out on nearly £15 million of profit.

• It is easy to see what has been wrong: overheads rose more sharply than revenue (overheads up by 13% when sales were only up by 10%)

• The company has allowed its asset turnover to fall dramatically, from 2 in 2006 to 1.76 in 2007.

Overall, there seems to be rather little reason to support the argument for congratulating the government.


Strategic Goals

It’s everybody’s dream – to make serious money doing what you love. For Keith Rogers, it all fell into place when playing 5-side football. Every week was a struggle organising matches; if only there was an organised league – with decent pitches – and changing rooms – and a bar to have a drink afterwards. At the age of 25, Keith started up ‘Pitz’, which was later renamed ‘Goals’. The standard Pitz/Goals location has 10 – 14 outdoor 5-a-side football pitches. All are floodlit and have artificial grass. Each team pays £40 to play in 40 minute slots, which potentially brings in £120 per hour. The referees need to be paid £10, leaving a decent income. The key is to generate high utilisation. To that end, various league and cup competitions are run. Today, aged 45, Keith has made his millions twice over. In 1999 he sold Goals for £28 million. Then he was invited to get involved in a management buy-out, just 18 months later. In 2004 the company floated on the stock market that targets smaller businesses (AIM). Shares that were floated then for 62p are now trading at 315p. Keith Rogers has 5 million of them. Goals is highly profitable and fast-growing. It has 22 sites, from Southampton to Glasgow. It looks for sites with easy access and an urban population of at least 150,000. It has a dedicated team to identify, negotiate and build new sites. These specialists are able to get a new venue up and running in 5 months, at an average capital cost of £1.85 million. They are convinced there are enough opportunities to allow for at least 10 years of further growth. The only substantial competitor is ‘Powerleague’, which has more venues (34) and generates more income. Overall, though, Goals seems to be growing more rapidly. This is partly because their expansion plans are more aggressive, and partly because their like-for-like sales rose 5% in 2006, compared with 3% for Powerleague. Full details of the recent financial performance of the two rivals are shown below. Now the directors of Goals are considering their first overseas expansion. Moving into Germany would require £15 million of finance, and must be considered a high risk. The directors are very keen, though, to make an overseas move before Powerleague.


Profit & Loss Account for year ending June 30th 2006 (all figs in £000s)

GOALS PLC POWERLEAGUE PLC

2006 % change since 2005


Sales turnover 13,115 +34.2% 20,488 +17.2%

Cost of sales 1,741 +27.8% 3,640 +13.3%

Gross profit 11,374 +35.2% 16,848 +18.1%

Administrative expenses (overheads)

6,777 +24.1% 12,114 +32.8%

Operating profit 4,597 +56.0% 4,734 -8.1%

Balance sheet as at June 30th 2006 (all figures in £000)

GOALS PLC POWERLEAGUE PLC



Fixed assets 39,773 +40.3% 67,069 +12.9%

Stock 157 174

Debtors 497 1,042

Cash 438 +31.1% 766 +1.5%

Current liabilities 3,300 +33.6% 7,892 +12.4%

Net current assets (2,208) (5,910)

ASSETS EMPLOYED 37,565 +41.5% 61,159 +12.9%

Long term loans 21,595 18,235

Share capital 12,783 15,469

Reserves 3,187 27,455

CAPITAL EMPLOYED 37,565 +41.5% 61,159 +12.9%

Questions (40 marks ; 50 minutes)

1. The text says that ‘the key’ to successful operation is ‘high utilisation’. Explain why that would be important, and identify any evidence that it is being achieved. (10) 2. Use the data in the Profit & Loss Account table to analyse why operating profit for Goals shot ahead while Powerleague slipped backwards. (8) 3. Consider the financial health of Goals’ plc, as shown in its accounts. (8) 4. Discuss whether the directors of Goals plc would be right to move into the German market in the near future. (14)


Goals – Mark Scheme

1. The text says that ‘the key’ to successful operation is ‘high utilisation’. Explain why that would be important, and identify any evidence that it is being achieved. (10)

3 3 4


3 3 4-3

Good understanding shown of

relevant terms

Relevant issues applied in detail to

the case

Analysis of the reasons why

2-1 2-1 2-1

Some understanding of the

relevant terms

Relevant issues applied to the case One or two points applied in a

limited way to analyse the Q.

After defining ‘high utilisation’, possible approaches include:

• The importance is because the business is based on fixed costs, not variable costs; this is

clear in the tiny P&L Account cost of sales (variable costs) …

• … in other words, the high fixed costs of the site itself dominates the total operating costs

of the business; idle pitches = £0 revenue, yet the fixed costs don’t go away (rent, rates,

salaries etc)

• High utilization is the only way to keep costs per customer low, and profits high; the

evidence that Goals achieves this is in the P&L, and probably explains why Goals’ operating

profits are booming while Powerleague is struggling

2. Use the data in the Profit & Loss Account table to analyse why operating profit for Goals shot ahead while Powerleague slipped backwards. (8)

2 2 4


2 2 4-3


relevant terms


the case


1 1 2-1


relevant terms




• Both firms managed to keep the % rise in cost of sales below the % rise in sales – which is

excellent cost control and inevitably leads to higher gross margins

• Goals beat Powerleague in 2 vital areas, though: first was the greater rise in sales

turnover, which came partly from internal (like-for-like) growth, and partly from new sites

• Most important of all was the admin overheads; Goals kept their growth below the growth

in sales, allowing operating profits to jump by more than a half; Powerleague failed in this,

with its admin costs outstripping sales and outstripping gross profit. The result was a profit

collapse


3. Consider the financial health of Goals’ plc, as shown in its accounts. (8)

2 2 4


2 2 4-3


relevant terms


the case


1 1 2-1


relevant terms




• Short term financial health = liquidity, which can be measured by the acid test ratio; it is

£935,000/£3,300,000 = 0.28; this is distinctly low, though the fact that Powerleague’s is

0.23 is very reassuring; even more important is that the business is very profitable, so the

cash flow is regularly being topped up by the operating profits

• Long term financial health is measured by the gearing; at 57% this is high, though not too

much so; the high profits will tend to bring the gearing down, while at the same time push

liquidity up

• Overall verdict, the balance sheet is a little weak, though the booming profits keep one

confident that the business is fine

4. Discuss whether the directors of Goals plc would be right to move into the German market in the near future. (14)


2 3 3 6


6-5

Judgement shown in the

text and in a well-supported

conclusion

2 3 3 4-3

Understanding of

relevant terms/issues

Relevant issues applied

in some detail to the

case

Analysis of question

set, using relevant

theory

Judgement shown in

discussing the issues raised,

within the text or in a

balanced conclusion

1 2-1 2-1 2-1

Some understanding of

the relevant terms

Relevant issues applied

to the case

An attempt at building

an argument, but

weakly

Some judgement shown in

text or conclusions


• The very low acid teat (liquidity) and slightly high gearing make any big expansion look

quite risky; the business is used to growing in £1.85m chunks, not £15 million.

• Furthermore, the ‘at least 10 years of further growth’ in Britain makes the move to

Germany look premature.

• Yet there is a case for saying that it’s better to move early than too late; if they wait until

Britain is saturated, perhaps others will have captured the market (we don’t know whether

Germany already has something like Goals/Powerleague)

• The P&L account information shows that costs are wonderfully under control while revenue

surges ahead; while the current management is on fire it is perhaps the time to take

another step forward.

• On balance I’d recommend sending out a small team to study the German market for 3

months and report back; if the market is untapped and research shows there’s real

potential, get going; first, though, find sources of capital that provide share as well as loan

capital, so that the gearing doesn’t get too high


The Real Story of the Woolworth Collapse

1. The November Collapse The November 26th collapse of Woolworth was a shock to many. With its 815 stores and 25,000 staff, customers thought it was too big to fail. The immediate causes of the company’s failure were related to the credit crunch. Yet the underlying reasons go back further. They relate largely to the company’s sources of finance. Therefore they are useful for Unit 1 (AS) and Unit 4 (A2) exams. In the first half of 2008 Woolworths made an operating loss of nearly £100 million. Its sales had fallen by 3.2% compared with the previous year. Neither figure was too alarming for a business that has always made its profits at Christmas. More surprising was that the new Chief Executive (appointed on September 1st) publicly criticised managers for many shocking practices. It had too much stock (50% was held in store rooms), yet customers often complained of availability problems (bare shelves). Most modern retailers moved a long time ago to ‘just-in-time’ deliveries that go straight onto the shopfloor, i.e. straight in front of customers. The new chief also criticised its buying policies, observing that Woolworth stocked 54 types of pencil case, but did not sell women’s tights. In September this year, the most alarming fact about Woolworth plc was that it had debts of £385 million. Then came two factors that twisted the knife. First, on October 6th, the financial business ‘Coface’ stopped providing credit insurance to suppliers dealing with Woolworth. This showed publicly that a major financial provider no longer trusted Woolworth’s ability to survive. From that time onwards, if a supplier provided goods to Woolworth on credit, it risked losses if Woolies couldn’t pay its bills. Therefore bigger suppliers such as Cadbury started demanding to be paid in advance of delivery. This brought forward cash outflows, making Woolworth’s cash flow position much worse. The second shock to the business was the sudden collapse in High Street sales that started in September, as shoppers took alarm at the impact of the credit crunch. Even a strong retailer such as John Lewis started suffering sales declines as high as 15-20%. For Woolworths the fall in cash inflows was a serious matter. The combination of higher cash outflows and falling cash inflows persuaded its bankers to pull the plug. When the administrators were called in, the small confectionery company Zetar announced that it was owed £1 million by Woolworth plc. Along with hundreds of other suppliers, it will almost certainly lose every penny of that. Inevitably, some smaller, weaker suppliers will collapse as a result of their Woolworth losses.


2. Sale & Leaseback - The Underlying Cause of Woolworth’s Collapse In 2001 Woolworth’s was ‘demerged’ from its parent company Kingfisher plc (B&Q). In effect, the Woolworth business was sold off. The terms of this demerger included the 2001 equivalent of toxic debt. 182 of Woolworth’s prime stores were sold in a sale-and-leaseback deal that raised more than £600 million of cash for the Kingfisher shareholders. The Financial Times has reported that: ‘ In return for the princely price tag, Woolworths was saddled with onerous leases that guaranteed the landlords a rising income stream … the rent bill rose from £70 million a year to £160 million today.’

(Financial Times November 29th ‘08) What is more, turning freehold property into rent obligations made it impossible for Woolworth’s new chief executive to find the cash (by selling stores) to fund the shake-up of the dying business. In effect the 25,000 employees of Woolworth will pay a high price for the cash taken by Kingfisher shareholders in 2001. Of course, the failure of Woolworth’s was hastened by poor management: poor decisions about stock ranges, poor store layout, design and organisation and many other examples of poor retailing. But if a business is weighed down by unnecessarily high annual fixed costs, its cash and its profits are sucked out, leaving it struggling to afford to make changes and struggling to afford to hire bright managers. Short-sighted use of sale and leaseback hammered some early nails into the Woolworth’s coffin.

Questions (40 marks; 50 minutes) 1. Explain the implication of a ‘combination of higher cash outflows and falling cash inflows’. (5) 2. Analyse two reasons why most modern retailers would avoid having stockpiles of goods held in store-rooms. (8) 3a) What is meant by the term ‘sale and leaseback’? (2) 3b) Briefly outline one advantage to a business of using sale and leaseback as a source of finance. (2) 3c) Examine why sale and leaseback ‘hammered some early nails into the Woolworth’s coffin’. (8) 4. From the text and from your own knowledge of Woolworth’s, discuss whether the stores could have been saved from collapse this year. (15)


Mark Scheme - Woolworths

1. Explain the implication of a ‘combination of higher cash outflows and falling cash inflows’. (5)

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CONTENT APPLICATION

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• Higher cash outflows will inevitably hit the short-term net cash flow position • Falling cash inflows also hit short-term net cash flow • The combination of both factors could switch a business from positive cash flow to a serious negative cash position

2. Analyse two reasons why most modern retailers would avoid having stockpiles of goods held in store-rooms. (8)

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• Stock ties up cash, so firms prefer to minimise their stock-holding, i.e. new supplies should be placed in front of customers as soon as possible, to try to turn them into cash before the supplier needs paying; in Woolworth’s situation it’s even more vital to generate cash as quickly as possible. Stock in a stockroom is widely regarded as ‘dead money’

• Although it can be hard to organise, a real just-in-time system can force a business to think hard about exactly what customers want (and will want in the coming weeks). It also enables the shop to respond quickly to changing customer needs, e.g. Tesco in August 2008 launching a new range of discounted brands in response to the gloomy economic position

3a) What is meant by the term ‘sale and leaseback’? (2) - selling freehold property for cash, simultaneously signing up to a long-term lease to rent the property 3b) Briefly outline one advantage to a business of using sale and leaseback as a source of finance. (2) • Brings cash in immediately – as long as it’s used profitably, this can boost profitability • Avoids the need to get finance from a bank


3c) Examine why sale and leaseback ‘hammered some early nails into the Woolworth’s coffin’. (8)

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• It hung a weight of ever-rising fixed costs around the neck of the business; if it had higher fixed costs per store than competitors, this would always make it difficult to offer good prices; it also may have made it ever-harder for Woolworths to find the funds to revamp and improve their shops

• The big problem is that sale-and-leaseback means a business is stuck with fixed costs for a long period of time. With ever-upward property prices – and with Woolworth’s in a difficult position for many years – it is hard to believe that the originators of this deal weren’t aware of its toxic nature; so the statement is valid

4. From the text and from your own knowledge of Woolworth’s, discuss whether the stores could have been saved from collapse this year. (15)



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Understanding of relevant terms/issues




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• Plenty of evidence of scope for improvement, e.g. better product ranges, better stock management – the new chief executive (appointed on Sept 1st) simply didn’t have time to sort things out; perhaps if he’d been appointed earlier in the year there may have been a chance

• A famous brand name should be a help to any business – and Woolworth is a big one – and should have provided a basis for some kind of re-launch, especially as many of the stores are in terrific High Street positions

• However, the text makes it clear that there were underlying financial problems that may have made it impossible to find the funds to rebuild the business; it needed far better management some years ago to make it possible to rebuild the business.

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