UVA-F-1371 CHOCOLATE CONFECTIONS CORPORATION As Chocolate Confections Corporation’s (CCC) corporate vice president of Human Resources (HR), Monica A. Bentz was delighted to have the opportunity to explain the many benefits of the recently approved HRIM (Human Resource Information Management) software project to the CEO and CFO. Authorized to approve projects costing up to $500,000, Bentz had sanctioned the purchase of the software a few months earlier, in July 2001. Prior to her decision, she had appointed a “working committee” to review the issue of replacing the HR department’s software package. Based on the recommendations of the Working Committee, Bentz had decided that CCC should purchase a software package offered by HumanAssets Incorporated, which was a product that had been designed by HR professionals in collaboration with information- technology technical specialists. HumanAssets’ product had been the most popular HRIM software in corporate America for many years, and at the reduced price of $490,000 (originally quoted to CCC at $750,000), it represented significant value to CCC. With first-year savings of almost $2 million and an estimated net _________________________________________________________________ ____________ This case was prepared by Professor Samuel Weaver of Lehigh University and Professor Kenneth Eades of the University of Virginia. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2002 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
Transcript
UVA-F-1371
CHOCOLATE CONFECTIONS CORPORATION
As Chocolate Confections Corporation’s (CCC) corporate vice president of Human Resources (HR), Monica A. Bentz was delighted to have the opportunity to explain the many benefits of the recently approved HRIM (Human Resource Information Management) software project to the CEO and CFO. Authorized to approve projects costing up to $500,000, Bentz had sanctioned the purchase of the software a few months earlier, in July 2001. Prior to her decision, she had appointed a “working committee” to review the issue of replacing the HR department’s software package.
Based on the recommendations of the Working Committee, Bentz had decided that CCC should purchase a software package offered by HumanAssets Incorporated, which was a product that had been designed by HR professionals in collaboration with information-technology technical specialists. HumanAssets’ product had been the most popular HRIM software in corporate America for many years, and at the reduced price of $490,000 (originally quoted to CCC at $750,000), it represented significant value to CCC. With first-year savings of almost $2 million and an estimated net present value of $2.7 million over a five-year life, the project was one of the best investments by CCC in many years.
Chocolate Confections Corporation
Founded in 1893, CCC started out as a local company specializing in rich chocolate candies. Over the years, the founding family had aggressively expanded the company through highly successful ad campaigns and acquisitions of other locally owned confectionary companies. By year-end 2000, CCC had worldwide sales of $3.7 billion and profits of almost $300 million (see Exhibit 1).
During the mid-1990s, CCC’s capital spending had averaged approximately $200 million a year—almost double the annual depreciation charge—and had allowed CCC to build two new plants, expand capacity, and invest in equipment to support new products. In 1999 and 2000, capital investment had returned to a more customary level of $140 million a year.
This case was prepared by Professor Samuel Weaver of Lehigh University and Professor Kenneth Eades of the University of Virginia. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2002 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to [email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.
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Exhibit 2 presents a historical financial review of the food-processing industry. It
summarizes the averages of financial ratios for 154 food-processing companies, including a DuPont financial analysis, margin and cost review, and annual sales growth of the industry. From these data, strategic observations regarding the past 18 years for the food-processing industry can be summarized as follows:
Margin enhancement occurred primarily as a result of production efficiencies. Production efficiencies were offset by reinvestment to build brands via additional
Within the food-processing industry was the snack-food subindustry. Domestic snack foods were a $52-billion industry with candy/gum as the largest component. The snack-food market was driven by impulse purchasing. CCC had the fastest-growing domestic market share within the largest segment of the snack-food industry:
Total Confections Chocolates Nonchocolates2000 1999 2000 1999 2000 1999
The confectionary industry had also shown moderate volume increases over the past five years, ranging from 2 percent to 5 percent a year. CCC was well positioned to benefit from the general industry trends together with the growth prospects of the snack-food and chocolate and confectionary industries.
Human Resources and HRIM Software
The HR department at CCC had grown in importance as the company’s employment rolls had grown, from 12 employees in 1900 to 14,000 by year-end 2000. HR’s responsibilities were
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broad and highly information dependent, both from the standpoint of what the company needed to know about each employee and what the employees needed to know regarding their benefits.
After a detailed review of the HRIM software, the Working Committee had concluded that HumanAssets’ product was the enabling tool for the twenty-first century. HumanAssets’ software met the needs of both CCC and its employees. It was designed to run on servers and to take advantage of distributed processing as well as the proliferation of PCs and PC skills. The software offered many potential benefits, both on its own merits and through its interfaces with other systems.
The Working Committee had summarized the benefits of HumanAssets’ product as follows:
Human Resources professionals could access data on an employee’s personal information, past-performance evaluations, training, benefits, career aspirations, etc. The software would give HR the ability to create numerous reports at a summary or detailed level with just a “click of a button.”
Human Resources could also administer CCC’s flexible-benefits program in-house rather than contract the administration out to a third party.
Payroll processors could assure timely and accurate payroll processing. Information-technology (IT) technical specialists could take advantage of the latest
technology. Moreover, the IT technical specialists would no longer need to rely on and maintain a “legacy” system that was written 20 years earlier by another software supplier, Dieter Brothers.
Employees could access and track data about their flexible-benefits packages, including medical/dental, 401(k), pension-fund, and savings plans. Employees could review data in their personnel files and modify information such as addresses and phone numbers, and all systems would be automatically updated with any changes.
Managers could automatically access a potential candidate’s background information for open positions. When building a task team, managers could “key off of” specific data and narrow a range of participants. Managers could spend more time managing and less time on tedious paperwork.
Senior management could better monitor headcount and where people were deployed with what type of skills throughout the organization. They could also use the new system to manage employee costs better.
CCC had policies in place that required a formal economic analysis for all equipment expenditures over $100,000. The company did not, however, have any policy requiring such analysis for software. Any expenditure of more than $500,000 required approval by the vice president for Finance, Mr. Lambly. In this case, however, because HumanAssets was willing to lower the price of its software package and installation to below $500,000, Bentz had the authority to approve the expenditure on her own. Therefore, the project was approved by the HR department without corporate scrutiny even though a capital expenditure of the same amount would have been required to go through the formal capital-investment analysis and approval process. The decision had been made, and there was nothing more to do than accommodate the
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project and expenditure. Throughout the approval process by the HR department, there was limited economic or financial analysis. Although the Working Committee had prepared a “Memo of Justification” for the HumanAssets recommendation, it was primarily a document that clarified objectives, documented the efforts of the committee’s reviews, developed an implementation approach and plan, and identified potential challenges.
Lambly questioned whether there was anything fundamentally different when investing in software or equipment, and concluded that the only difference was the lack of a CCC policy to address software purchases such as this one. Therefore, Lambly had asked that a policy be created to include software under the capital-improvement guidelines. In response to Lambly’s request, the CEO and CFO had asked that the same documentation required for a normal capital expenditure be created for the HRIM project. Based on their assessment of how this documentation compared with previous capital-expenditure requests of similar magnitude, the CEO would decide whether a change in current policies was justified.
As this project would not be in jeopardy, Bentz welcomed the opportunity to demonstrate how much value the HumanAssets software would add to CCC. She quickly expanded the Memo of Justification to include details of the benefits and the expenses associated with the implementation and on-going requirements of the system as well as a traditional discounted-cash-flow analysis.
Memo of Justification
The Memo of Justification defined the objective of the project: to assess the current human-resources information system and make recommendations for enhancements or replacement based on the needs of the system’s users and Chocolate Confections Corporation’s management. This objective was to be met with recommendations regarding an integrated human-resources/benefits/payroll solution that would move Chocolate Confections Corporation into the forefront of the human-resources/payroll computing community. Concurrent with the implementation of the project would be an extensive re-engineering effort aimed at streamlining human-resources and payroll business processes based on the capabilities delivered by the new integrated system.
The Working Committee began by analyzing CCC’s existing Dieter Brothers HR/payroll system. The committee surveyed all the users regarding existing-system limitations, how the existing system met their needs, and their recommendations for how a new system could help them do their jobs more efficiently. In addition, members of the Working Committee interviewed key CCC senior managers and visited several plant sites to ensure that the unique needs of these two diverse groups were taken into consideration during the evaluation process.
The key findings from these processes were that the following items were needed:
• A system driven by a Windows environment• A more user-friendly system
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• Easier and faster report-writing capabilities• More training on the existing system• Information in a more timely fashion
These findings were consistent with those identified in a survey conducted by the Forrester Consulting Group, which contacted 51 Fortune 1000 companies regarding their transition to the client/server environment. In addition to these findings, customer-service concerns were identified as they related to cycle time and the ability to gather data and present it in a variety of formats.
Given the limited flexibility of the existing system, the Working Committee concluded that a new system with the requested design features was necessary to meet CCC’s business needs. By selecting a product such as HumanAssets, which was based on open industry standards, the committee believed that CCC would be well positioned with an architecture that had the flexibility to take advantage of new technology as it became available.
An important part of the decision was the Working Committee’s conclusion that the client/server architecture best fit the parameters outlined by the user community. Based on an extensive review of the current HRIM/payroll computing industry (see chart below), the committee determined that the industry trend in new core applications was in the direction of client/server platforms. In addition, CCC’s Information Systems & Technology Committee had recommended client/server as the future direction of the corporation for computing needs.
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In total, the Working Committee sent out 10 Requests for Proposals (RFPs) to the industry leaders in HR/payroll-client/server products. Following review of the RFPs received, the group was eventually narrowed down to three vendors:
The three finalists presented their products in several demonstrations outlining their HR and benefits functionalities, as well as the technological base for their products. These demonstrations were attended by members of the Working Committee as well as representatives from the key functional areas.
Following the demonstrations, the Working Committee met with members of the functional contingents to solicit comments regarding their perspectives of the various products. In many cases, these discussions resulted in follow-up phone conversations with the vendors to gain clarification on issues, and in several instances resulted in return visits by the vendors to demonstrate further their products.
As a final part of the committee’s due diligence, it enlisted the support of Corporate Financial Analysis to conduct financial reviews of the three vendors under consideration. Based on this analysis, no financial issues arose that would eliminate any of the vendors from consideration.
The final key consideration for the committee was the respective costs of the three systems. On this point, HumanAssets had a clear advantage. All three vendors quoted prices in the range of $650,000–$800,000, and all three were willing to offer discounts from their original quotes. HumanAssets’ sales representatives, however, offered the largest discount, by lowering the price by $260,000, or 35 percent, to $490,000. This price reduction allowed Bentz to approve the project as part of the HR department’s budget, thereby avoiding the aggravation and time delays of having to seek corporate approval, which was required for all expenditures over $500,000. HumanAssets’ representatives stated that they were willing to be accommodating with the price of the system in order to position HumanAssets to assist CCC as a consultant in the latter’s re-engineering effort, which would be facilitated by the installation of HumanAssets’ software package.
The expenditures were due and payable as follows: 50 percent at the contract signing and 50 percent 60 days later. The average software installation required one month or less. HumanAssets agreed that CCC’s re-engineering effort would require well beyond the 30 days for installation and that the re-engineering aspect would be negotiated separately and at a later date. The figure below depicts the key dates of project implementation:
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Bentz’s Cost-Benefit Analysis
Given the strategic direction outlined by the Working Committee, the new system was expected to save considerable time for cost-center managers and HR staff members as the corporation moved into workflow processing and the “kiosk” environment. These time savings were aligned with the strategic mission of the Human Resources department (i.e., putting access to the new system in the hands of the users and getting CCC managers more involved in the HR aspects of employee management). It was estimated that the system would save each manager half an hour a week. With 600 cost-center managers at an average annual compensation of $100,000 (including benefits and bonuses), the annual savings were estimated to be $750,000 (600 $100,000 0.5/40.0). Similarly, annual savings of $500,000 were estimated for 50 HR managers and professionals with an average annual compensation of $50,000, whose time savings were estimated to be eight hours a week.
Critical to the success of the project was the overall process re-engineering that had to take place concurrently with the implementation of the project. Any efficiencies and staff reductions that would be realized would result from the re-engineering activities and not from the new system. In fact, based on the Working Committee’s findings, the implementation of a new client/server-based HRIM/payroll system might add to staffing levels if not accompanied by the re-engineering efforts.
The Working Committee conducted extensive research regarding re-engineering and staff reductions and met with senior HR management to arrive at the projected staff reductions. Based
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on current staffing levels in Human Resources, it was estimated that a total reduction of six staff members could be achieved. This reduction would result from the process re-engineering that CCC would conduct after successfully installing the HumanAssets system. Based on an average annual total compensation package (pay and benefits) of $45,000 per employee, the total savings associated with staff reductions would be $270,000 a year.
Given the capabilities of the HumanAssets application software, the Working Committee determined that the level of HR’s large and small project-systems-development support would diminish as CCC moved to the new environment. This result would occur, in part, because of the new reporting tools, the ease of their use, and the system’s flexibility with respect to changing screens and modifying data elements. The amount of savings on both large and small projects would impact HR’s budgets at both the corporate and division levels. Based on projections resulting from discussions with senior-level information-services management, the annual expense of maintaining the “legacy system” and responding to incremental HR requests was estimated to be $130,000.
A major focus of the Working Committee’s discussions with the vendors centered around the possibility of bringing the current flexible-benefits administration in-house at a saving to CCC. The committee believed that the HumanAssets benefits product would allow CCC to bring flexible-benefits administration in-house at an estimated annual saving of $325,000. This estimate included the possibility of hiring additional in-house administrative staff. If this proved unnecessary, the savings could approach $450,000 a year. Owing to the unique nature of CCC’s flexible-benefits package, the contract between HumanAssets and CCC would need to ensure that the former’s product could fulfill all the requirements of CCC’s flexible-benefits program.
The total first-year cost savings resulting from the implementation of the HumanAssets HR/payroll system and the completion of major HR re-engineering efforts would be $1,975,000 (see table below).
Note: The costs associated with maintenance contracts and the ongoing information-systems (IS) charge-backs would continue beyond year 2 and grow at 5 percent a year. All 2001 expenditures (year 0) would be capitalized and straight-line depreciated over a three-year period with zero salvage values.
In addition to the direct project expenditures noted above, the Working Committee recognized that the personal computers of the HR staff would need to be upgraded immediately. Because the PC upgrade would have occurred routinely over the next two years, the Working Committee did not consider the supporting infrastructure costs. The upgrade would include hardware, software, and other expenses, totaling $250,000. The committee also recognized that all such infrastructure expenditures were captured in the Information Technology department and were not charged to individual user areas.
Putting all the expenses and costs together (investment, benefits, annual implementation, and ongoing) resulted in the financial analysis presented in the table below. Based on this analysis and the details in Exhibit 3, the project provided strong economic incentives:
Net present value − 14% $2,694,278Modified internal rate of return1 − 14% 38.8%Internal rate of return 71.0%Payback period (years) 1.37Maximum cash exposure ($1,605,400)
1The modified internal rate of return (MIRR) was the interest rate that equated the cost of the investment with the accumulated future value of the intermediate cash flows that were assumed to be reinvested at an appropriate risk-adjusted cost of capital. The MIRR assumed that free cash flows were reinvested at the hurdle rate (14%), whereas the internal rate of return (IRR) calculation assumed reinvestment at the IRR rate. To compute MIRR, each cash flow was converted into a future value using the hurdle rate to compound the cash flow forward to the end of the analysis period. An IRR was then computed using the single, lump-sum total of all the accumulated, reinvested future values of the cash flows. In this case, the future value of the cash flow compounded at the hurdle rate of 14 percent equaled $8,278,663 at the end of year 5. The IRR of this five-year future value was 38.8 percent, which equaled the MIRR of the project.
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The Meeting with Senior Management
As the meeting with the CEO and CFO and their immediate staffs approached, Monica Bentz was confident that they would find her analysis of the HumanAssets project to be within accepted CCC guidelines. Moreover, she expected to receive some recognition for having been responsible for creating substantial value for CCC with this single project. Any questions, she reasoned, would center around the approval process for the project, rather than the economics. As information technology became increasingly critical to remaining competitive, similar decisions in the future would need to receive the proper scrutiny within the corporation. Bentz believed that the use of “working committees” would become standard practice for such considerations.
Bentz knew that Lambly was actively questioning the use of a 14 percent hurdle rate for evaluating an “administrative” capital project like her HumanAssets project, though she did not believe his concerns were related directly to her project. Senior management had agreed to revisit the topic of the cost of capital. It was common knowledge within the firm that CCC used a hurdle rate higher than its “true” cost of capital (see Exhibit 4 for capital-market and CCC data). In the past, every time someone had questioned the prudence of using the 14 percent hurdle rate, however, it had been decided that the impact was negligible and that it was easier to stick with the same hurdle rate rather than change frequently to reflect new-market conditions. “No matter,” she thought. “Even if they change their minds about the hurdle rate, it can only make the HumanAssets project look better, because everyone knows that 14 percent is too high.”
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Exhibit 1
CHOCOLATE CONFECTIONS CORPORATION
Historical Financial Information (fiscal-year December; in millions of dollars)
Income before interest, taxes, and deprec. 390.3 428.2 434.0 368.5 510.8 Interest expense, net 26.9 27.2 27.0 35.4 44.8 Provision for income taxes 143.9 158.4 213.7 148.9 184.1 Net income $ 219.5 $ 242.6 $ 193.3 $ 184.2 $ 281.9
Cash and equivalents $ 71.1 $ 24.1 $ 16.0 $ 26.7 $ 32.3 Accounts receivable, net 159.8 173.6 295.0 331.7 326.0 Inventory 436.9 457.2 453.3 445.7 397.6 Other current assets 76.7 285.1 124.7 144.6 166.4
Current assets 744.5 940.0 889.0 948.7 922.3 Net plant, property, and equipment 1,145.6 1,296.0 1,460.9 1,468.4 1,436.0 Intangibles from acquisitions 421.7 399.8 473.4 453.6 428.7 Other assets 30.0 37.1 31.8 20.3 43.6
Beta = 0.70Share price = $65Shares outstanding = 77.3 million
Expected risk premium between S&P 500 and long-term government bonds is 5.8% (CAGR).
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Lehigh UniversityCCC Project Evaluation
Questions and Problems
1. The Working Committee “learned that all development efforts by D & B will be in the area of Client/Server as they discontinue enhancements in their mainframe environment and move into a total maintenance mode with that product.” How does this effect the software replacement decision?
2. “Re-engineering” is a popular phrase. In general, what does re-engineering mean? What specifically does re-engineering in this case mean?
3. The Memo of Justification identifies numerous costs and benefits. Please comment on the following items. Do these items represent incremental cash flows, should they be included in the analysis?a. Managers’ time savings of $750,000.b. HR manager/professional savings of $500,000.c. Total savings associated with staff reductions ($270,000 per year).d. Information systems charge-backs (both cost reduction and additional expenses).e. Maintenance contracts.f. Inflation.
4. Are there any other costs or benefits that should have been included?
5. Based on your answers to the individual savings or cost components in number 3 (above) and throughout the case, prepare a revised “discounted cash flow analysis” similar to Exhibit 3. As in Exhibit 3:
The tax rate is 40%. The appropriate discount (or hurdle rate) is 14%. There are no working capital implications – investment or savings. There is no salvage value after 5 years.
Calculate a revised set of performance indicators similar to Exhibit 3. 6. Should administrative IT software investment yield a positive NPV? Are there other considerations necessary
