Chord Technologies Ltd. October_2001_Solution Exam CMA

The Society of Management Accountants of Canada Page 1

Solution to October 2001

CMA Entrance Examination Part 2

The following sample solution presents only one approach to the case. Readers should note that various other valid approaches and conclusions are possible.

Date: October 18, 2001

To: Jeff Chase and François Garneau, Chord Technologies Ltd.

From: Gerry Parker, Consultant

Subject: Strategic Direction of Chord Technologies Ltd.

Attached is the requested report containing my analysis and recommendations regarding the strategic direction of Chord Technologies Ltd. (hereafter referred to as Chord). The report also provides an implementation plan and highlights some operational issues that require immediate attention. I must emphasize the importance of taking quick action no matter how you decide to proceed. Lack of action, in the short term, can only serve to aggravate the current situation.

Thank you for this opportunity to be of service. I would be more than happy to meet with you, at your convenience, to discuss the report and any matters arising out of it.

Gerry Parker

October 2001 CMA Entrance Examination – Part 2 – Solution

Page 2 The Society of Management Accountants of Canada

A Report to Messrs. Chase and Garneau of Chord Technologies Ltd.

TABLE OF CONTENTS

EXECUTIVE SUMMARY

INTRODUCTION

SITUATION ANALYSIS Strategic Direction

Current Mission Statement Environmental Scan Financial Analysis

IDENTIFICATION AND EVALUATION OF STRATEGIC OPTIONS A. Wind Up or Sell Chord and Pursue Other Employment Opportunities

B. Suspend Chord’s Operations Temporarily C. Continue to Operate Chord at a Reduced Level of Activity D. Diversify Chord’s Line of Services

E. Joint Venture with CCC F. Acquire CDSI

RECOMMENDED STRATEGY

IMPLEMENATION PLAN Revised Mission Statement

Immediate and Strategic Actions Financial Management and Accounting Information Systems Management

Organizational Structure and Human Resources Marketing Financial Accounting

CONCLUSION

APPENDICES Appendix 1 – SWOT Analysis Appendix 2 – Financial Analysis Appendix 3 – Analysis of CCC Joint Venture Proposal Appendix 4 – Analysis of CDSI Proposal Appendix 5 – Proposed Organizational Structure



EXECUTIVE SUMMARY

In its short history, Chord has experienced rapid growth, but has depended mainly on providing a single service to a single large customer. This dependency has caused the situation Chord is now facing: a drastic reduction in business as a result of a downturn in the cable sector of the telecommunications industry. The lack of diversification must now be addressed. Unless new business can be generated, you will soon be forced to lay off all, or most, of your staff, at least until the cable upgrade industry recovers and the survey mapping business improves.

Therefore, the most urgent decision to be made is whether to suspend Chord’s operations, temporarily or permanently, run Chord with a couple of employees while, in the short run, you look to other activities to supplement your incomes and keep current with industry developments, or make some major changes in the nature and operations of Chord for implementation in the near future.

Both of you appear to prefer a solution that will revitalize Chord. One option is to take immediate steps to diversify the line of services offered by Chord, which would utilize the talents of at least your superior employees. At a minimum, you could temporarily reduce staff to Morton and Milan, and select short-term options that will best prepare you to manage Chord when business follows its expected recovery. This would probably require you to offer an ownership interest to Morton and Milan as an encouragement to stay on.

Another option is to purchase CDSI, which offers potential synergies and a number of possible diversification options, but would require a significant injection of your personal financial resources. You could also choose to accept the joint venture proposal from CCC, which would allow you to retain some of your better employees and would provide some additional income for Chord.

To make a sensible short-term decision regarding employee retention, you will have to reach a decision on how you plan to proceed over the longer term. After talking with you and others, and having evaluated all the information available, is recommended that Chord adopt a strategic direction that focuses on diversification in the long term. To help accomplish this, the following is recommended:

1. Continue to operate Chord for purposes of servicing the 70 miles of cable systems mapping per month, and pursue diversification by adding new services to your product line.

2. Immediately accept CCC’s joint venture proposal regarding XPL.

3. Immediately take the necessary steps to acquire CDSI and offer Ella Nehrik the position of director of human resources.

Taking these actions will allow Chord to immediately expand its line of services and its client base, to some extent. Changes will also be required in the areas of human resources, marketing, financial management and information management to enhance Chord’s ability to attract and effectively service new clients, and ensure continued long-term growth and profitability.



INTRODUCTION

Prior to the abrupt decline in prospective business that Chord has recently experienced, Chord has been managed pretty much on a crisis basis. The current serious crisis has indicated the degree to which Chord is vulnerable to changes in the industrial environment and has also brought many underlying concerns to the surface.

The company has a strong technical competency and a core of capable employees. It is fortunate that it is in a position to survive the current market downturn and has the potential to benefit immeasurably from its experiences to date. At the same time, quick decisions must be made to prevent a serious depletion of resources in the short term.

This report evaluates Chord’s current situation, provides an evaluation of the available strategic alternatives, and makes some recommendations in this respect. Some of the more specific issues are then addressed. The report concludes with an implementation plan.

SITUATION ANALYSIS

At the present time, Chord is experiencing a threat to its profitability and employees. While this has partly arisen through uncontrollable factors, it is also a function of your failure to determine Chord’s strategic direction, take advantage of its existing opportunities, take action in response to existing threats, make more use of its strengths and address its identified weaknesses.

Strategic Direction Up to this time, you have been consumed with the start-up and keep-up aspects of Chord. This preoccupation with operations has prevented you from addressing, in any organized fashion, the important broader issues of long-term strategic direction and vision. These include determining the answers to such questions as, “Why are we in business?” “What are we good at?” “What do we value?” “What do we want to become?” and “What should our future technology-product-customer focus be?” Without a strategic direction, you have allowed Chord to become dependent on a single, large client. As well, you have not been able to foresee the changes in the telecommunications industry and how these might affect Chord in the long run. In light of the recent drop in volume of business from your main client, it is imperative for you to now assess Chord’s strategic direction.

To help you determine your strategic direction, an assessment of your current situation is required, beginning with a determination of your current mission statement and then an evaluation of your external environment, your internal environment and your financial health.

Current Mission Statement In addition to neglecting to determine a strategic vision, you have not yet clearly articulated your mission. A mission statement typically focuses on the current scope of the business, and broadly describes the company’s present capabilities, customer focus, activities and business makeup. From the discussions I have had with you, from other observations I have made, and from information that has been made available to me, your current mission could be stated as follows:



“We are committed to operating a profitable business by offering quick delivery of high quality drafts of survey maps for the cable sector of the telecommunications industry. At the same time, recognizing that our corporate success is largely dependent on our human resources, we are committed to providing as satisfying and rewarding a work environment as is practically achievable in our circumstances.”

Environmental Scan A summary of some of the strengths, weaknesses, opportunities and threats of Chord is provided in Appendix 1. This SWOT analysis identifies many of the environmental issues facing Chord today, which will be further discussed where appropriate in the balance of this report.

Chord has been operating in the communications technology industry over which it has little control. The major players dwarf Chord in all respects and Chord is a minor player. Chord may provide the best support in the industry in its niche, but Chord is easily replaceable. As yet you have not been replaced, but you have felt the impact of an industry-wide cutback over which you have no control. The demand for competent technicians will also go up and down with the industry specific economy.

Key success factors in the industry include superior technical skills, quality production, quick turnaround times, cutting-edge technology, and competitive pricing. In the U.S. market, you have been able to achieve all of these. However, you should recognize that a contributing factor to Chord’s success in the U.S. market has been a competitive price advantage resulting from favourable foreign exchange rates, which is something else Chord cannot control. Should the Canadian dollar strengthen, this price advantage in the U.S. could disappear.

You have indicated to me that you are aware of the risks of depending primarily on one large client and that you have considered diversification as a way to address this situation. I would agree that a general strategic direction which focuses on diversification of both clients and products would certainly help reduce the effects of changing external environmental factors on Chord’s overall health.

In deciding on the specific strategies to adopt with the objective of achieving a long-term strategic direction focused on diversification, you should be significantly influenced by your core competencies. Clearly, your core competencies are your cutting-edge technology, creativity, superior technical skills, and focus on quality and fast turn-around. It is in addressing services and products that are particularly impacted by these core competencies that you will be most successful. Fortunately for Chord, you, collectively, have a wide range of technical competencies, as evidenced by the areas in which you have previous experience. However, to maximize the utilization of your core competencies, you will need to delegate some of the non-core functions to others.

Financial Analysis Overall, Chord is currently in reasonable shape financially and does not have any significant short or long-term debt or commitments. The survey map drafting work is profitable, with a current contribution margin of about $88.92 per mile (see Appendix 2). However, there are some areas of concern:



! Collection of accounts receivable has been a problem, resulting in frequent cash flow problems especially during the past two years. In 2001, this situation has improved, having reduced the receivables from $914,000 at the beginning of 2001 to $300,000 as at October 2001. As well, the main customer has provided assurances that payment of the balance owing would be forthcoming in the near future, which should further improve the cash situation.

! With the major cancellation of most of the survey mapping work, future revenues will not be sufficient to sustain the current level of payroll (see Appendix 2). Employees will either have to be let go or be re-deployed, and shareholder salaries may have to be withheld or substantially reduced.

! Assuming a reduced payroll and the collection of current overdue receivables, it is estimated that Chord’s current line of credit will be sufficient to cover operating cash requirements for the rest of 2001. Otherwise, you may be required to continue advancing funds to finance operations.

! Chord’s cash situation is such that a major investment could only be undertaken if you find an external source of funds or if you advance some personal funds. However, provided that the outstanding accounts are, in fact, collected and costs are effectively minimized, this should only be a short-term issue.

! With the decrease in business and more than three years left on the lease, Chord will have expensive excess space. If necessary, you can sub-lease some or all of the space to the adjacent tenant.

IDENTIFICATION AND EVALUATION OF STRATEGIC OPTIONS

While it appears that Chord’s long-term strategic direction should focus on diversification, you first need to be concerned with its short-term survival. It is evident from the previous analysis that you cannot continue Chord’s operations as is with the same level of employees. There are a variety of options open to you (as follows), which should be evaluated in terms of compatibility with your core competencies and your personal desires, as well as their feasibility and their effects on your personal wealth:

A. Wind up or sell Chord and pursue other employment opportunities.

B. Suspend Chord’s operations temporarily.

C. Continue to operate Chord at a reduced level of activity.

D. Diversify Chord’s line of services.

E. Enter into a joint venture with CCC.

F. Acquire CDSI.

A. Wind Up or Sell Chord and Pursue Other Employment Opportunities Both of you have expressed a preference for pursuing your economic future in cooperation with each other and through the vehicle of Chord Technologies Ltd., if at all practical. Therefore, this



option should only be considered if there is no feasible way to continue operating Chord profitably.

B. Suspend Chord’s Operations Temporarily This option is not as drastic as winding up Chord altogether and it recognizes the reality of the market conditions in the cable upgrade industry. It would enable you to accept consulting positions or other employment that would provide you with the opportunity to develop contacts in the Canadian cable industry and/or contacts in other industries. Eventually, when the cable upgrade industry begins to recover, you could start Chord’s operations again and use the newly developed contacts to solicit new business for Chord, thereby achieving diversification. On the downside, all of Chord’s employees would have to be immediately laid off and there could be difficulties finding competent staff later when you need them. As well, you would have to do something about your lease – either find a way to terminate it early, or find someone to sublease the space, such as the adjacent tenant. Another argument against this option is that Chord would be abandoning its current main client, which might decide to use another company’s services once the cable upgrade industry recovers. Chord could be in the position of having to find all new clients.

In terms of your core competencies and your personal preferences, this option would likely satisfy both in the long run, but not in the short run, since you would not be working together for the time being. You would almost have to start your business from scratch, which is not much better than the option of winding up Chord. You should only seriously entertain this option if you discover that your main client does not intend to pay you the $300,000 in overdue receivables, in which case you would likely not wish to deal with them again in the future.

C. Continue to Operate Chord at a Reduced Level of Activity It should be clear that there is no feasible status quo option available, as you would only have approximately 300 hours of work per month (i.e., 70 x 4 = 280 hours of drafting and about 20 hours of quality control), resulting in many idle employee hours. The closest you could come to a status quo position is to lay off all of your employees and do the 70 miles per month of drafting yourselves. This would provide you with a position similar to when you started business, and it is a possibility. The calculations in Appendix 2 indicate that this option should provide you with salaries and income of $1,964 + $6,376 = $8,340 per month or $4,170 each. This could easily be increased by $2,500 (or $1,250 each) if you could sublet your leased space.

In terms of your personal preferences and wealth, you would still be working together under this option and making a reasonable living, for the time being. This option would allow you to continue to provide your client with a quality product on a timely basis and Chord would remain functional and poised to take advantage of any upturn in the operations of your client. However, this option by itself does not provide any diversification and you would be exposed to the same risks as before. As well, you would be letting go some very skilled employees who may not be available or willing to come back later when the cable upgrade industry improves.

Appendix 2 also indicates that, instead, you could employ two full-time CAD jockeys to do the work and still earn between $1,700 and $5,200 (i.e., $1,700 + $1,000 + $2,500), depending on whether you did your own administration and were able to sublet all or some of your space.



Under this scenario, you could basically have Chord run itself while each of you devoted yourself to generating income from any of the variety of options available to you. It should be pointed out that income will be maximized when the two of you can be fully productive at the top end of your charge-out scale, say $100+ per hour, while using other architectural technicians to do the basic CAD jockey work at a cost to you of $21.12 per hour (i.e., $16 x 1.1 x 1.2.). This would also allow you to develop new contacts and achieve some diversification.

D. Diversify Chord’s Line of Services From the situation analysis, it appears that Chord’s main weakness is its dependence on only one service being provided to one main client. Although Chord has a superior AutoCAD program that gives you a competitive advantage in the survey map drafting market, your have had little success in obtaining significant contracts from cable companies other than your main client. One reason for this is that Chord does not offer turnkey services. You certainly have the talent to provide the surveying and design services as well as drafting survey maps, so you could consider offering these services to your current and potential cable clients. If they also require you to provide construction, you could investigate the possibility of contracting out the construction service, perhaps to CCC Ltd.

There are a number of other services that you could add to your product line, some of which only the two of you are currently qualified to do and some only Chase would be able to do (e.g., architectural, industrial and/or web-site design, and CAD software customization, installation and/or training). These services have high charge-out rates and would be a very profitable use of your time. On the other hand, in some cases this could result in only a short-term gain. Customization of CAD software, CAD training and consulting on CAD installations could result in your clients eventually becoming your competitors for CAD application jobs, which could erode your competitive advantage in the long run.

Some new services could be done by the CAD jockeys (e.g., aerial photography survey map drafting, drafting support for architects and industrial design production drawings). This would allow you to keep at least some of your best employees and provide them with some variety in their jobs, which could help keep them motivated. You could also put some of the superior employees through training programs to develop the skills to perform some of the services that are at the higher end of the charge-out scale.

This option is not without its challenges, however. It may take time to find sufficient clients and work to keep your employees busy. In the meantime, you would either have to lay off these employees who you many not be able to hire back when you need them, incur idle employee costs, and/or incur employee training costs. As well, you would have to delegate Chord’s administrative functions to others.

Consideration also has to be given to the fact that this option might not succeed without developing an effective marketing strategy to help you obtain new clients.

Overall, this option would be compatible with your core competencies and would result in you doing what you do (and hopefully enjoy) best. It may also be the only way you will be able to ensure the long-term growth and profitability of Chord by minimizing the risks of significant decreases in business as a result of specific market downturns.



E. Joint Venture with CCC This proposal is analyzed in Appendix 3. The calculations presented use very conservative numbers based on the minimum volume of work guaranteed by CCC. These calculations indicate a probable loss for XPL. However, both the management fee and rental charges would flow directly to Chord, resulting in a contribution of $20.91 per mile for Chord. Therefore, there would be little risk for Chord since any XPL losses would be shared equally with CCC, while Chord would still benefit from the management fee and rent paid by XPL.

In general, the positive aspects of this proposal are much stronger than the negative ones. This proposal helps Chord to resolve some of its overcapacity problems by keeping at least a couple of its CAD jockeys employed and utilizing idle space and equipment. While the venture stands to be marginally unprofitable at minimum revenue levels, it has considerable potential and opens up the Canadian market.

The most important of the negative points is that Chord will be required to give XPL priority treatment. In the expected better days to come, this may have a negative impact on Chord’s ability to supply its regular customers on a timely basis.

While this proposal caters to Chord’s core competency of leading edge technical ability in the use of computer-aided design and application, it does little to resolve the need for diversification of its services. It would, however, serve to broaden the market niche available to Chord.

F. Acquire CDSI Some preliminary analysis of this proposal can be found in Appendix 4.

Quantitative Considerations: The schedule in Appendix 4 breaks out the determination of net income, by its pieces, using the formula $434,000 - x - .4($434,000 - x) = $120,000, where x = owners’ salaries. According to industry information, management salaries would typically be $90,000 each, totalling $270,000, which is greater that the salaries that had been paid to the owners in the past three years. This indicates that either the past net income for CDSI has been overstated, or that one or more of the owners is not performing a function that would justify a salary of $90,000 per year. A third possibility is that they have a preference to split their remuneration between salaries and dividends in a certain way. If Chord purchases CDSI and hires the three current owners, the expected net income using the 2000 gross revenue would be $98,000.

The asking price can be paid over a three-year period. This, in effect, reduces the purchase cost by the discounted value arising from the payment deferrals. A precise calculation of this value is not possible without making significant assumptions, but the applicable discount rate would fall between the after-tax cost of debt of about 4% (i.e., .6 x 7%) and the minimum expected return of about 12.5% (i.e., $98,000/$852,000). There are good arguments for the appropriateness of the higher number, in the circumstances, since it represents the expected return on the investment.

At 4%, using the tables, $150,000 per year for three years has a present value of $416,000, and at 12.5% per cent, the present value is around $357,000. Even taking the higher amount, the apparent asking price becomes $818,000, with an expected return on investment (ROI) of around 12% (i.e., $98,000/$818,000). Using the lower amount, we get an ROI of about 13% (i.e., $98,000/$759,000). These returns would be satisfactory, especially given the fit that CDSI



appears to offer Chord. Any savings from replacing some or all of the current owners with less expensive employees, or from any reduction of Chord’s costs as a result of acquiring CDSI (e.g., human resource management talent, source of CAD jockeys), would increase the ROI, thus making this option more attractive.

Qualitative Some arguments for acquiring CDSI are as follows:

1. As Mr. Chase had pointed out, a going concern with a proven history has a lot to offer over starting a business from scratch. There could be significant synergistic benefits. For example, CDSI could have human resource and accounting systems in place that could be utilized by Chord.

2. The activities in which CDSI is currently involved, primarily the provision of CAD jockeys on a part-time or temporary basis, web-site design and the provision of other CAD applications, are consistent with Chord’s core competency. Indeed, all of these activities are included on Chord’s list of services under consideration for diversification and with which you have previous experience.

3. The hiring of Ella Nehrik, who would bring with her a background and expertise in human resources management in addition to her industry specific knowledge, would be a tremendous start toward resolving your various human resources issues.

4. CDSI would be a complimentary and flexible fit with Chord’s other activities and would add flexibility in staffing cable industry contracts as well as offering some variety to those employees who desire it. In this way the addition of CDSI would help improve employee satisfaction and thus help alleviate employee retention problems.

Some arguments against acquiring CDSI are as follows:

1. As pointed out by Mr. Garneau, the purchase of CDSI carries with it the risk of inheriting unknown problems. For example, the same economic factors affecting Chord’s client could also be affecting CDSI’s customers.

2. The acquisition could substantially tie up your personal available capital resources (see ‘Financing’ below).

3. If Chord wishes to retain some of its current people, there may be some unexpected costs until the acquisition is completed and the staffing situation can be appropriately ironed out.

Financing Under the proposal, Chord would have to come up with $402,000 on closing. Since it appears that it would be in everyone’s best interests for Nehrik to be retained, the business could borrow back her share of the payment after taxes (i.e., $74,000), leaving $328,000 for Chord to find in investment funds. This amount could be further reduced if you decide to hire back one or both of CDSI’s other two owners and they agree to loan back some of their sale proceeds. As well, while no asset information is provided for CDSI, it is clear that a net worth in excess of $220,000 exists in the company. Thus, it may have some borrowing power if the need arises.



If necessary, it has been indicated that you could provide the capital if the accounts receivable are collected from Chord’s main client (i.e., $300,000 in accounts receivable to be collected, plus $200,000 in personal funds).

It can be concluded, then, that the financing can be accomplished provided that the parties are in favour of the transaction and that Chord is able to collect the $300,000 outstanding accounts fairly quickly.

RECOMMENDED STRATEGY

From previous analysis, it can be concluded that Chord’s greatest chance for long-term profitability is through diversification of clients and services. With the current excess in capacity, you have an opportunity to delegate your current duties to your most competent staff so that you can focus on pursuing the various diversification options. The acquisition of CDSI would greatly assist in achieving the diversification objective and could provide employment for those CAD jockeys that you would otherwise have to lay off. The CCC proposal also has more in favour of it than against.

On the surface, it might seem a bit risky to recommend both the joint venture and the acquisition of CDSI, but these options could be made to work well together while, at the same time, eliminating or mitigating some of the obvious concerns facing Chord. The following general strategies are recommended:

1. Continue to operate Chord and add some new services to your product line. In the short-term, keep two of your CAD jockeys to fulfil the current contracts of 70-miles of cable survey map drafting per month. Delegate the administrative functions to others so that you can focus on finding new business and developing diversification. Utilize the initial slow time for training of some of the better CAD jockeys to expand their skill sets in support of the long-term diversification effort. However, Chord will still need to reduce staff at least for a few months.

2. Accept the joint venture proposal from CCC. As previously noted, there are several positives to this proposal. Although it will run at a loss if it operates at the guaranteed minimum level, this will not be a real loss for Chord, and it is certainly not the intention of CCC to operate XPL at this minimal level. This option requires no additional capital investment, will utilize idle equipment, and will provide work for a minimum of two CAD jockeys in the near future (beginning no later than three months after finalizing the agreement) and perhaps for several more.

This option uses the same skills that Chord has used in the U.S., provides a vehicle for employing some of the better CAD jockeys, and may help provide Carol Milan with a full time training position. It has a minimal downside and, should the worst case scenario occur, it could be shut down fairly quickly. It will also help Chord utilize its available leased space and contribute to covering the lease costs.

3. Subject to acquiring additional financial information and ensuring that Ella Nehrik is on side, proceed to consummate the acquisition of CDSI. Of the choices, this is the one that requires some capital outlay. However, as we have seen, it has much to offer. In addition



to being a sound financial investment in its own right, it offers a series of synergistic benefits. These include flexibility in hiring and transferring CAD jockeys as they are needed by Chord and XPL, a vehicle through which Chord can diversify the services it provides, the skill set that comes with Nehrik in the human resources area, and quite possibly some internal systems and controls that Chord could find useful. As well, it is possible that CDSI’s operations could be moved to Chord’s premises, thereby utilizing some or all of Chord’s excess space and equipment.

Though this option comes with some risks and there will undoubtedly be some unforeseen problems, you should be well capable of dealing with them, since you are already knowledgeable in all of the areas. Overall, it appears that the benefits far outweigh the risks.

It is believed that following the above strategies would be far more effective in achieving your long-term objectives than suspending Chord’s operations temporarily or selling Chord. In any case, these options will still be available should the above strategies not prove to be profitable.

IMPLEMENTATION PLAN

Revised Mission Statement In view of the situation analysis and strategic recommendations, the following is a recommended mission statement

“We are committed to operating a profitable business by offering high quality services, in the general field of architectural technology, to various industries in the global marketplace, including the telecommunications industry in both Canada and the U.S. These services include survey map drafting, web-site development, design creation, CAD training and consultation, and providing temporary placement services for architectural technologists (i.e., CAD jockeys). At the same time, recognizing that our corporate success is largely dependent on our human resources, we are committed to providing as satisfying and rewarding a work environment as is practically achievable in our circumstances.”

Immediate and Strategic Actions Staff Reduction – You should immediately implement a plan to reduce your staff complement to the level required to operate during the transition stage. At a minimum, the ten easily replaceable CAD jockeys should be laid off, or possibly employed by CDSI, if feasible. You should be able to utilize the remaining employees to fulfil the existing contracts, to take over some of the administrative duties and to go through training programs to expand their skills in support of the diversification strategy.

Joint Venture – Immediately communicate your interest in accepting CCC’s joint venture proposal and do whatever you can to expedite the start-up of XPL. Because of the general difficulties in recruiting and training new staff, it may be more practical to keep a couple of the CAD jockeys (who will ultimately be employed by XPL) on Chord’s or CDSI’s payroll, than to lay them off now and hope to later rehire them. If you lay off any of the superior CAD jockeys,



they will likely be able to find new employers in the interim and may not be available when you need them.

Acquisition – Begin negotiations regarding the acquisition of CDSI. Make it clear to Ella Nehrik that she is a key aspect to the execution of the deal and that you expect her to take over the human resources function of Chord as well as CDSI, and to loan back her share of the after-tax proceeds from the sale of CDSI. It should be noted that the sale of Ms. Nehrik’s interest in CDSI could be structured in a variety of ways to preclude the immediate incurrence of tax, such as a share exchange or the deferral of payment of the proceeds. Investigate the potential gains Chord could expect from hiring the other two CDSI shareholders, and offer one or both of them jobs if the gains would exceed the costs. It is likely that Carl Ho has the skills to provide some of the higher revenue services, such as architectural design, which would support Chord’s diversification strategy. He could also be useful for training Chord’s superior employees and could help provide financing by loaning back his after-tax proceeds of the sale of CDSI.

Strategic Planning – Implement a continuing process for ongoing strategic planning. One available tool for monitoring corporate progress is the balanced scorecard.

Collection of Accounts – One of your top priorities is the collection of the outstanding accounts receivable from your main client, as you will not be able to finance the purchase of CDSI without settlement of this account. Initially, this task should be handled by Mr. Chase. If, however, he is unsuccessful in his collection attempts, you may have to resort to turning over collection to a factor or seeking legal means of collection. This however should be a last resort, as you do not wish to permanently damage your relationship with this client and risk losing future contracts when the cable upgrade industry recovers. On the other hand, if your client has no intention of paying you for your services, you should stop providing them to this client and focus more of your efforts on finding new clients.

Financial Management and Accounting Information Systems The synergies of acquiring CDSI could help in improving Chord’s financial management and accounting information systems. If CDSI has an experienced controller, this person should also take over the finance and accounting functions of Chord. Otherwise, you could promote Linda Morton to the position of controller. She has appropriate prior experience and has demonstrated her loyalty and competence in several areas. She is also interested in enrolling in the CMA program, which will greatly increase her management skills. However, it may be necessary to offer Ms. Morton an equity share in the company to entice her to remain with Chord. You must carefully consider whether her value to the company is worth offering her a share of the business.

Currently, Chord’s working capital management needs to be improved and the responsibility for maintaining the accounting records should be delegated to someone other than Mr. Chase. Until the acquisition of CDSI is complete, Linda Morton’s duties as office manager should be expanded to include the task of working capital management and accounting. In preparation for the anticipated diversity of clients expected from the restructuring and diversification strategies, appropriate procedures for the following should be established and implemented: credit approval, payment terms, monitoring of accounts and follow-up.



Chord requires better banking arrangements. A more appropriate line of credit should be established that better reflects the realities of your business, i.e., collections typically take 90 days. Ms. Morton could be assigned the task of shopping for the bank that would offer Chord the financial support it requires for the most reasonable terms.

As part of the negotiations to acquire CDSI, you should hire a consultant to independently assess the value of CDSI. The assessment should include an opinion regarding its current internal systems, which would enable you to determine the potential synergies you could expect from the acquisition. Therefore, although Chord’s current accounting and management information systems are inadequate, no substantive action should be taken until it is determine what can be used from CDSI’s current systems. Consideration could also be given to amalgamating the accounting function of XPL with those of Chord and CDSI.

Management As previously mentioned, in the short term, Chord will have excess capacity in terms of employees, space and equipment as a result of the drastically decreased volume of work from your main client. By adopting the recommended strategies, most of your resource utilization problems will be solved as follows:

• XPL will utilize some of the excess space, equipment and employees.

• Diversification will increase the amount of work, thereby utilizing excess capacity.

• Depending on what resources are required to maintain the operations of CDSI, it may be possible to move CDSI’s operations to Chord’s premises, thereby utilizing the remaining excess capacity.

Another management issue, that of strategic planning, was previously addressed and need not be repeated here.

A third management issue pertains to the most effective use of your own time and talents. In the past, you handled not only the drafting work, but all of the administrative functions as well. As your operation grew, you continued to perform most of the administrative functions, which was not the most productive use of your time. Both of you are skilled architectural technologists and are not adequately trained in most of the administrative areas. Therefore, you should utilize your skills in the more specialized and lucrative areas and limit your involvement in the administrative functions to strategic planning and monitoring of results.

You should continue to use competent CAD jockeys to perform the routine drafting work and you should employ, on a full-time or contract basis, the management specialists you require to take care of the administrative functions. This would support the company’s diversification strategy to a great extent and help maximize the company’s revenue generating potential.

Organizational Structure and Human Resources Organizational Structure: There are several employees who have been identified as having particular skills that should be appropriately deployed. These include the following:



1. Linda Morton – Currently the office manager, but has the ability and experience to become the CFO. However, she may decide to leave unless you allow her to become a shareholder.

2. Carol Milan – Currently the quality control manager, but prefers her training responsibilities to her quality control responsibilities. With the acquisition of CDSI and the requirement to provide XPL with technical staff, there is a possibility that there will be sufficient training work for her to devote full time to the training function.

3. Ben Hiro – Currently a project manager who has excellent technical skills but weak communication skills. In the long run, he may be more effectively utilized as director of quality control. Another alternative is to train him to provide some of the more lucrative services that are being considered in the diversification plan (e.g., web-site and logo design, architectural design).

4. Wendy Smits and Morgan Holiday – Currently project managers doing a reasonably good job in this role. Unfortunately, there may not be enough work in the short term to keep them fully occupied in this role. During the transition period, it may be advisable to put them through a training program to develop their skills in areas that would support the diversification strategy.

5. Ella Nehrik – Currently a shareholder of CDSI who has an excellent background in human resource management and has the best grasp of the CDSI’s industry specific knowledge. She should be retained to manage all of the human resources of both CDSI and Chord, and assist in overseeing the operations of CDSI.

6. Possible talent currently at CDSI – As previously mentioned, CDSI could currently have an efficiently operating financial management and accounting information system in place being run by qualified staff. In this case, it may be possible to assign them the responsibility of managing Chord’s finances and accounting information system as well as CDSI’s systems. In this case, it may not be necessary to promote Linda Morton to CFO and the risks associated with not allowing her to acquire a share of the business would be substantially mitigated. There could be other employees of CDSI who could be utilized by Chord, such as human resource systems employees and the personnel who provide the web-site design service. As well, Chord could use CDSI as a source of CAD jockeys when required.

Eventually, your organizational structure should appear similar to that presented in Appendix 5.

CAD Jockey Retention: A critical human resources issue is CAD jockey retention, which has been a problem in the past. To deal with this problem, you have mainly used the approach of offering attractive wages, since you could not offer much in the way of career advancement opportunities. In the short term, CAD jockey retention should not be a problem as the industry slow-down has decreased the demand for CAD jockeys with cable survey mapping expertise. Indeed, you will have to lay off some of your CAD jockeys in the short term.

As previously mentioned, you should use the transition period to train your employees to perform more than just cable survey map drafting work. You may also wish to adopt an ongoing training



program for your technical staff to develop their skills and promote flexibility. Although this program will be costly, at least initially, it will likely be a critical factor in the successful implementation of your diversification strategy.

In the long term, adoption of the diversification strategy and a good training program should provide CAD jockeys with more interesting career paths, variety in their work, and the potential for promotion. This in turn should lead to greater job satisfaction and, together with a competitive compensation package, should significantly reduce Chord’s employee retention problems in the long term.

Human Resources Systems: Currently, there are no structured human resources systems in place at Chord. In the past, you dealt with the recruiting and training of personnel on an ‘as needed’ basis, and staff reviews were done when you had the time to do them, rather than being scheduled at appropriate intervals. As indicated in your mission statement, your corporate success is largely dependent on your human resources. Therefore, it is important for you to establish human resources systems that deal with the areas of performance evaluation, compensation (including benefits), job descriptions and training. If the balanced scorecard approach is adopted for monitoring corporate progress to assist in ongoing strategic planning (as was previously recommended), it can be fully developed down to the level of personal balanced scorecards as a means of performance evaluation. These systems can be developed concurrently with the restructuring and diversification of Chord.

The acquisition of CDSI could be a great benefit in this regard. With Ella Nehrik’s background in human resources and the primary activity of CDSI being the short-term placement of CAD jockeys, it is likely that CDSI has excellent human resources systems in place, which could be adapted to apply to Chord’s expanded and restructured organization.

Marketing A significant contributor to your inability to diversify your operations in the past is your lack of a marketing strategy. Therefore, your survival and future success could depend on your developing an effective marketing strategy. Mr. Chase should continue to develop his U.S. and Japanese contacts, which could eventually generate some business. In the short term, you could make better use of your web-site for promotional purposes.

As with other areas of the business, it is possible that the acquisition of CDSI could help in the marketing area as well. It likely has an established clientele that may also be in the market for some of Chord’s expanded services, and its network of contacts could also be tapped into to generate new business.

In the medium term, you should contract with a marking specialist to design and implement an effective marketing strategy. Whether to hire some in-house expertise in the long term or continue to contract out this function should be decided at a future date after assessing the success of the newly adopted strategies.

Financial Accounting Two areas of financial accounting arise under the proposed strategies.



1. The joint venture with CCC will have to be accounted for using the equity method (in brief, this means that the investment will be carried at cost, reduced by any dividends received and adjusted for any proportional profit [increase] or loss [decrease]).

2. The acquisition of CDSI will be accounted for using the purchase method of consolidation accounting. It will be necessary to know the book value of CDSI in order to calculate the purchase price discrepancy, which will probably be in the neighbourhood of $850,000 - $220,000 = $630,000. After appropriate allocations to identifiable assets, liabilities and share capital, the difference will be set up as goodwill and must be amortized using the straight-line method over the estimated life of the goodwill, which should not exceed 40 years.

CONCLUSION

A decision to proceed with the acquisition of CDSI and the joint venture, together with a diversification strategy, should allow you to put Chord firmly on the road to recovery and provide you with the diversity of flexibility to circumvent a repetition of your recent difficulties. As well, the proposed implementation plan should result in appropriate management and operational systems that you will require to maintain a smoothly functioning organization.



Appendix 1

SWOT Analysis

STRENGTHS: 1. Strong technical competency.

2. Expertise in AutoCAD systems and design.

3. Creativity.

4. Quality controls in place.

5. Directors are compatible and complimentary.

6. Continual upgrading of computer capacity & workstation efficiency; use of LAN system with appropriate security measures.

7. Japanese/French language skills.

8. Web-site in place and web-site design skills are available in-house.

9. Good quality employees (e.g., Morton, Milan).

10. Good reputation.

11. Profitable.

12. Good contacts in the cable industry.

WEAKNESSES: 1. Minimal planning, particularly strategy.

2. No mission statement.

3. Dependence on one major client (i.e., no client diversification).

4. Single service business, limits potential clientele.

5. Poor working capital management.

6. Cash flow problems (e.g., frequently exceeds line of credit).

7. Slow collections of accounts receivable.

8. Recent loss of work causing overstaffing and other underutilization of resources.

9. Minimal accounting systems and inadequate accounting records.

10. Minimal accounting controls.

11. Limited managerial skills and resources.

12. Unproductive use of shareholders’ time (e.g., the time Chase spends on accounting could be more effectively utilized doing income-generating activities).

13. Minimal outside input (no outside directors).



14. Inadequate training (e.g., accounting, human resources).

15. No system for work-in-process monitoring.

16. No marketing.

17. Problems in recruiting and retaining staff (e.g., lack of career path offered to CAD jockeys causing high employee turnover).

18. Inadequate support staff.

19. No structured performance measurement/evaluation system.

OPPORTUNITIES: 1. Canadian market (e.g., CCC/XPL).

2. Diversification: • CDSI • Consulting • Branching • CAD training • Designing (various) • Turnkey services to cable industry.

3. Japanese/Quebec markets.

4. Foreign exchange rates results in competitive pricing advantage in the U.S. market.

5. Employment opportunities: • Garneau’s uncle • Local employment • Consulting & training services • Architectural design • Japanese contract for Chase.

THREATS: 1. Competition from suppliers who provide turnkey services.

2. Industry amalgamation resulting in levelling off of activity in the industry.

3. Competitors are larger than Chord.

4. Technological changes causing satellite & wireless to challenge cable in the television/Internet service provider industry (i.e., threats to cable industry from substitute products/competitors results in less need for Chord’s services).

5. Shortage of qualified job applicants.

6. Risk of bankruptcy of major client.



Appendix 2

Financial Analysis (in Canadian Dollars)

Contribution Margin per Mile from Survey Map Drafting Revenue – $120 x 1.5 $180.00 Drafting labour – 4 hours x $16 x 1.1 x 1.2 $84.48 Quality control – $5 x 1.1 x 1.2 6.60 91.08

$88.92

Projected Revenue from Drafting Survey Maps in 2001 Main customer – January to July: 500 miles x $180 x 7 months = $630,000 Main customer – August to December: 50 miles x $180 x 5 months = 45,000 Other customers* – 20 miles x $180 x 12 months = 43,200

$718,200

* It is assumed that business from other customers is constant at 20 miles per month throughout 2001.

Cash Requirements Under Proposed Reduced Operations Revenue per month (70 miles x $180) $12,600

Direct labour (note 1): Drafting (70 miles x $84.48) $5,914 Quality control (70 miles x $6.60) 462 6,376 Administration (note 2) 1,000 Rent (note 3) 2,500 Overhead (note 4) 760 10,636

Monthly cash requirement $ 1,964

Notes: 1. It is assumed that Chord will only keep enough employees to service the contracted work.

2. It is assumed that there will be some costs associated with administration, whether this is performed by one of the employees or by one of the shareholders.

3. Based on the worst case scenario: existing lease and no offsetting revenues or beneficial changes (i.e., $30,000/year ÷ 12 months = $2,500/month).

4. Based on 2000 data. Net margin is $652,000 (i.e., $1,890,000 + $16,000 - $954,000 - $300,000) and income before taxes is $502,000. The difference of $150,000 less the lease expense of $30,000 is $120,000, which is approximately 6% of revenue from survey maps (i.e., $120,000 ÷ $1,890,000). Using this formula, the monthly overhead is estimated as approximately $760 (i.e., 6% x $12,600).



Based on the above, monthly expenses will total approximately $11,000. Assuming expenses must be carried for one month of work-in-process plus the three months for collection, the cash requirement should be about 4 x $11,000 = $44,000.

The above projection is considered to be conservative, but it assumes that the shareholders will not require abnormal compensation from the company, that overhead costs other than rent are variable, and that there are no idle employee costs. Therefore, the cash requirement could be worse.



Appendix 3

Analysis of CCC Joint Venture Proposal

QUANTITATIVE Calculations pertaining to XPL’s minimum monthly income: Revenue (minimum net proceeds after finder’s fee = 100 km. x $85/km.) $8,500 Direct labour (100 km. x .62 x $84.48) 5,238 3,263 Management contract, including quality control (100 km. x $25/km.) 2,500 Income before rent, receptionist, other expenses $ 763

Chord currently pays $30,000 ÷ 12 = $2,500 per month for rent. If Chord only charges 10% of this to XPL for rent, there would only be $763 - $250 = $513 left for a receptionist and other expenses. Therefore, it is likely that XPL would incur a loss at an activity level of only 100 kilometres per month.

Calculations pertaining to Chord’s minimum monthly income: Revenue from management contract (100 km. x $25/km) $2,500 Direct labour for quality control (100 km. x .62 x $6.60) 409 Income before rent revenue $2,091

QUALITATIVE FOR

1. Chord would be directly compensated for its management of the survey mapping, resulting in a contribution margin of $20.91 per kilometre.

2. Chord has the startup assets on hand, which will be idle unless a great deal of new work can be found soon. Therefore, there would be no initial cash outlay.

3. The proposal would allow a mechanism for retaining a couple of the top architectural technicians, at little or no cost.

4. XPL would utilize some of Chord’s existing idle leased space.

5. The proposal would provide an entry point into the Canadian market.

6. Chord would indirectly benefit from CCC’s ability to offer turnkey services.

AGAINST 1. Chord would be required to assume all

product responsibility.

2. The effort needed to manage the proposed operation may detract from other activities designed to rejuvenate Chord.

3. This activity is less profitable than similar work in the U.S. (i.e., contribution margin of $20.91/km. versus $88.92/mile = $55.13/km. from U.S. clients). Should resources have to be rationed, Chord would have to give XPL priority treatment (i.e., Chord would incur an opportunity cost of $34.22/km.).

4. Although Chord would be responsible for operations, it would have to share control with CCC.



Appendix 4

Analysis of CDSI Proposal

QUANTITATIVE

Revised Statements of Income 2000 1999 1998 Gross revenue $4,360,000 $4,010,000 $3,650,000 Expenses other than salaries & taxes 3,926,000 3,622,000 3,285,000 Income before owners’ salaries and income taxes 434,000 388,000 365,000 Owners’ salaries 234,000 188,000 215,000 200,000 200,000 150,000 Income taxes (net income ÷ .6 x 40%) 80,000 80,000 60,000 Net income 120,000 120,000 90,000 Dividends 90,000 90,000 ? Increase in retained earnings $ 30,000 $ 30,000 $ ?

Normal salaries would total $270,000 (i.e., $90,000 x 3), so income in 2000 is overstated by ($270,000 - $234,000) x .6 = $22,000. The previous years are overstated by greater amounts. Therefore, the net margin for 2000 should have been ($120,000 - $22,000) ÷ $4,360,000 = 2.25%. If all three current owners were hired back, Chord should be able to realize an annual net income of at least $98,000 (i.e., $120,000 - $22,000).

There are various other factors to be considered, as follows:

a) The gross revenue grew by 8.7% in 2000 and 9.9% in 1999, which shows a decreasing trend. However, the income before owners’ salaries and income taxes shows an upward trend (i.e., 11.9% in 2000 over 1999, and 6.3% in 1999 over 1998).

b) There are currently three shareholders, all drawing management level salaries. Ella Nehrik, who has experience with human resource management, could help in the management of Chord’s human resources. It is unknown what functions Carl Ho and the other owner serve for CDSI, but if they had to do with providing web-site design and CAD applications, they could prove to be useful in managing these services should Chord decide to begin offering these services. As well, Carl Ho could provide architectural design services. However, if they simply functioned as CAD jockeys, Chord would be better off keeping some of its current CAD jockeys at $21.12/hour (which would be about $40,000 per year) than hiring these former CDSI owners at $90,000 per year.

c) The payments would be spread over three years, thereby reducing the actual net present value of the acquisition.



Appendix 4 (cont’d)

Assuming CDSI’s gross revenue remains at the 2000 level, the after-tax income from CDSI’s operations would be $98,000 (i.e., $120,000 - $22,000) if all three former owners were hired back. If two of the owners were not hired back and instead two CAD jockeys were retained to perform their duties, income would increase to $159,400, calculated as follows:

Originally stated 2000 net income before owners’ salaries & taxes $434,000Labour costs for two CAD jockeys (2 x $40,000) $80,000 Cost of one management salary 90,000 170,000 264,000Income taxes 105,600Revised estimated income $158,400

This amount would be sufficient to cover the three $150,000 annual payments to the current owners. However, Chord would still need to find the cash to make the initial $402,000 investment. If only Ella Nehrik was hired, she would be able to reinvest her after-tax share proceeds of $74,000, calculated as follows:

Initial proceeds at closing ($402,000 ÷ 3) $134,000 Less capital gain tax ($180,000 ÷ 3) 60,000 $ 74,000

QUALITATIVE FOR

1. This is an already existing company with clientele, a solid profit history and operations complimentary to Chord.

2. The company would come with built-in management and Nehrik would bring much needed expertise in human resources management.

3. In many respects, CDSI would provide both diversification for Chord and client services that would require staff with similar skills.

4. CDSI would provide a natural vehicle for Chord to develop and market other client services, such as CAD training, consulting, and web-site design.

.

AGAINST 1. This acquisition would require an initial

outlay of $254,000 [i.e., $402,000 – (2 x $74,000)] if both Carl Ho and Ella Nehrik were hired, or $328,000 (i.e., $402,000 - $74,000) if only one of them was retained.

2. CDSI’s main revenue driver is the temporary personnel business, which is unfamiliar to Chord.

3. Since CDSI requires employees with similar qualifications, there could be a compounding effect when these people are in short supply.

4. Chord would inherit any problems already present in CDSI.

5. Any impact of the cable industry slow down would not be reflected in CDSI’s 2000 results (i.e., there could be a decrease in demand for CDSI’s services over the next year or two).



Appendix 5

Chord Technologies Ltd. Proposed Organizational Structure

Board of Directors

Jeff Chase CEO

Ella Nehrik Human Resources

Training (Carol Milan)

Marketing

Advanced Architectural Technology Services (Jeff Chase, Carl Ho)

Administration CFO / Office Manager

(Linda Morton or other)

Receptionist / Bookkeeper

François Garneau COO

CDSI Operations

CAD Jockey Placement

Web-site Design

CAD Applications

Quality Control (Ben Hiro)

Project Managers (Smits, Halliday)

CAD Jockeys

XPL Supervision

Computer Systems, Design and Maintenance

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Chord Technologies Ltd. October_2001_Solution Exam CMA

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