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SBL - Practice Session 6 - Q + S - MachineShop Flipbook PDF
SBL - Practice Session 6 - Q + S - MachineShop
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SBL Practice Session 6 - Question Question MachineShop MachineShop sells small electrical machines and tools to both trade customers (who use the machines/tools in their work) and retail customers (who use the machines/tools at home). The company is based entirely in Arboria, a prosperous industrial country with an established consumer culture. The company has experienced rapid growth within Arboria and the directors now wish to expand into other countries either by acquisition or organic growth. As the company has grown, the need to establish formal internal control procedures is also an issue. The following exhibits (1–6) provide information relevant to MachineShop: Exhibit 1: ‘About’ page from MachineShop’s website. Exhibit 2: Financial Machine Shop.
information
about
Exhibit 3: Business newspaper article about the 50th store opening. Exhibit 4: Minutes of a meeting of the board of MachineShop Exhibit 5: Documentation of inventory control and procurement systems at MachineShop. Exhibit 6: Information about Fabrique Regle de Garrido (FRG).
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The case requirements are as follows: 1
It is March 2018. You are Aspen Spencer, a business analyst in the consultancy division of Moore & Charlton, the auditors of MachineShop. The board of MachineShop is considering the acquisition of Fabrique Regle de Garrido (FRG), a company based in Ceeland. As agreed at the recent board meeting (Exhibit 4), Viola Wang, the chief financial officer (CFO), has requested advice from Moore & Charlton about the acquisition. You have been forwarded an email sent to Dave Deen, the chairman and chief executive officer (CEO) of MachineShop, by a firm of chartered accountants in Ceeland which provides some background information about FRG (Exhibit 6). Required: Write a report to the board of MachineShop, which evaluates the potential acquisition of FRG and recommends whether MachineShop should acquire FRG. (20 marks) Professional skills marks are available for demonstrating scepticism skills in questioning the reasons for the potential acquisition of FRG. (4 marks) (24 marks)
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It is April 2018. You are an audit manager at Moore & Charlton responsible for the audit of MachineShop. Moore & Charlton have been asked by Viola Wang, MachineShop’s CFO, for advice on whether it would be appropriate for an internal audit function to be set up. Required: Prepare a briefing note to the finance director of MachineShop which makes the case for setting up an internal audit function. (12 marks) Professional skills marks are available for demonstrating commercial acumen skills in showing the contribution that internal audit could make. (4 marks) (16 marks)
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It is April 2018. You are an IT consultant at Moore & Charlton. Following the board meeting at which Mr Butcher, the director of operations, first mentioned the greater use of IT, your firm has been asked by the board of MachineShop to advise on the use of big data and the use of IT in the procurement process. Required: (a) Prepare two presentation slides, with accompanying notes which explain the meaning of big data and how it could be adopted at MachineShop. (8 marks) Professional skills marks are available for demonstrating communication skills in clarifying complex issues and conveying relevant information in an appropriate tone. (2 marks) (b) Write a briefing paper to the board of MachineShop which evaluates the potential application of e-procurement at MachineShop. 3
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SBL Practice Session 6 - Question (10 marks) Professional skills marks are available for demonstrating evaluation skills in considering the implications of e-procurement to MachineShop. (2 marks) (22 marks)
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It is now May 2018. You are a business analyst at Moore & Charlton. Viola Wang has contacted you to thank you for your report of April 2018 concerning the acquisition of FRG. In preparation for the next board meeting, where the acquisition will be discussed, she would like your advice on how the acquisition of FRG should be financed. Ms Wang has asked you to assume that a price of $5 million would be paid to acquire FRG. MachineShop could issue bonds on the debt market of Arboria. It is estimated that the yield required on such bonds would be 7%. Alternatively, the company could issue new share capital to Arboria Capital, a venture capitalist operating in Arboria. One million shares would be issued to the venture capitalist at $5 per share. Require d: Write a report to Viola Wang which evaluates whether the acquisition of FRG should be financed by an issue of bonds or an issue of 1 million shares to a venture capitalist at a price of $5 per share. (12 marks) Professional skills marks are available for demonstrating analysis skills in assessing the two methods of financing. (4 marks) (16 marks)
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It is now June 2018. You are an audit partner at Moore & Charlton, responsible for the audit of MachineShop. You have developed a good working relationship with Dave Deen. Dave has just told you, in confidence, that he would like to spend less time managing the dayto-day operations to pursue other interests. He is thinking of appointing a new CEO from outside MachineShop to take over his operational responsibilities and would like your opinion on whether it would be a good idea for him to stay on as chairman. He would also like your views on the desirable qualities of a new CEO. Require d: Write a letter to Dave Deen which: (a) Discusses the advantages and disadvantages of Dave Deen staying on as chairman after a new CEO has been appointed from outside Machine Shop. (8 marks) Professional skills marks are available for evaluation skills for assessing the role of Dave Deen as chairman. (2 marks) (b) Explains the qualities which a new chief executive of MachineShop should possess. (10 marks)
Professional skills marks are available for commercial acumen skills in assessing the desirable qualities of a CEO for MachineShop. (2 marks) (22 marks)
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SBL Practice Session 6 - Question Exhibit 1 Sign Signininororregister
Customer Support Customer Support
register MachineShop Our products Our products finder
Store finder Store
About MachineShop Our mission is ‘empowering homeowners to do it themselves!’ We are Arboria’s leading retailer of electrical machines and tools for home improvement. We sell a range of tools for both trade professionals and retail customers who need tools for maintaining their own homes We now have 50 stores across Arboria and continue to open new ones. We also provide after service support for all products bought from us, through our wholly owned subsidiary EngSup. We are owned and managed by the people who started MachineShop’s first store 15 years ago. We pride ourselves in continuing to give customers the same personal service as when we opened our first store. We may have grown into a big company, but we remain a small company at heart.
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Exhibit 2: Financial information for MachineShop Summarised consolidated statements of profit or loss Year ended 31 December 2017 $’000 50,000 (36,000) ––––––– 14,000 (4,000) (2,000) ––––––– 8,000 (500) ––––––– 7,500 (1,875) ––––––– 5,625 –––––––
Revenue Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Interest Profit before tax Tax at 20% Profit after tax
Year ended 31 December 2016 $’000 39,000 (28,080) ––––––– 10,920 (3,000) (2,000) ––––––– 6,000 (200) ––––––– 5,800 (1,450) ––––––– 4,350 –––––––
Capital employed at 31 December 2017 $000 7,000 39,000 ––––––– 46,000 –––––––
Long-term debt Equity Capital employed
There are 10 million shares in issue with a nominal value of $1.
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SBL Practice Session 6 - Question Exhibit 3: Article from ‘Business Life’ 11 January 2018 MachineShop, headed by Dave Deen, goes from strength to strength. The company, which sells small electrical machines and tools, opened its 50th store last week. MachineShop sells to both trades people and retail customers. It is estimated that 65% of sales are to retail customers. MachineShop opened its first store 15 years ago. Currently a further two stores are opened every month. The company has no direct competitors. Most firms offering similar machines only sell them to trades people. In many respects MachineShop has defined a new market, a consumer market made up of individuals who wish to do their own home improvements. MachineShop is the only company which, at present, seems to understand the dynamics of this market. MachineShop is a private company, still wholly owned by its directors. CEO Dave Deen is well known as one of our most successful and colourful entrepreneurs. He is proud of how he has grown MachineShop from one store into a national chain. All directors work full time for the company, and have been with the company since it was founded. While the company has been successful in its core business, it has not been so successful in its acquisitions. In 2015, it acquired two companies based in Arboria which still trade as independent companies. The purchase of LogTrans was prompted by the need for MachineShop to have a dedicated and reliable logistics supplier. The post-acquisition performance of the company was spoilt by a dispute between Dave Deen and the senior management of LogTrans. This was due to a personality clash, caused by a different way of doing business. Eventually, the senior management of LogTrans was removed and replaced by people more aligned with the corporate culture of MachineShop. EngSup was also acquired in 2015 to provide an enhanced service facility to people who had purchased machines from MachineShop. Customer feedback showed that many customers were unimpressed by MachineShop’s after- sales service. EngSup already provided support for many retail electrical products and so MachineShop bought the company with the intention of using it to provide support for MachineShop’s customers. However, initial feedback was negative because EngSup’s service engineers provided a poor level of service, coupled with an arrogant approach to the customer. A retraining scheme, together with selected redundancies, has now addressed these problems. As the company reaches 50 stores, we wish it luck with the next stage of its development.
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Exhibit 4: Board meeting minutes Date: 2018
March
Members present: Dave Deen (Chairman and CEO), Mike Baldwin (Chief Buyer), Frank Butcher (Director of Operations) Viola Wang (CFO) Apologies: None Absent: None Proceedings Meeting called to order at 2.00pm by chairman, Dave Deen Chairman’s statement The chairman expressed satisfaction that MachineShop had just opened its 50th store in Arboria. The current pace of new store openings shows that the company is still serving a large market, where it can continue to prosper. Mr Deen reminded the meeting that the directors had always agreed on the importance of growing the business to exploit MachineShop’s knowledge of the home improvements market before the idea is copied within Arboria or elsewhere in the world. Mr Deen stated that the board has always been particularly keen to explore international markets to build a worldwide brand. He informed the meeting that he has identified Fabrique Regle de Garrido (FRG), a company in Ceeland, as a potential acquisition target. FRG sells large machines to trade customers, although it does not currently serve retail customers. Macro-economic trends suggest that a consumer society is emerging in Ceeland, which is similar to that of Arboria. He noted that some of MachineShop’s suppliers are located in Ceeland. Mr Deen has not yet opened negotiations with FRG as he would need the authority of the board to do that. Mr Deen provided the directors with a copy of a report which he had commissioned from a local accountancy firm in Ceeland which includes information about FRG. Mr Deen sees the potential acquisition of FRG as an opportunity to introduce the MachineShop business model into Ceeland. He fully expects the country to become increasingly similar to Arboria and so it will be suitable for the sort of service and products which MachineShop offers. He stated that achieving quick, substantial growth through acquisition will give the company a powerful bargaining position. It will allow MachineShop to develop economies of scale, including purchasing in bulk to further drive down product prices. This will help erect barriers to potential competition. Mike Baldwin was enthusiastic about expanding into Ceeland, and congratulated Mr Deen on identifying a potential acquisition target. Viola Wang suggested that advice be sought from the consulting division of Moore & Charlton, MachineShop’s auditors, about the potential acquisition of FRG. It was agreed that Viola Wang would engage Moore & Charlton to provide advice on this acquisition. Ms Wang also stated that additional finance would be required to buy the company as the company does not have spare cash balances. Debt might be the best option, as MachineShop’s current gearing is way below the industry average of 60%. However, she would look into the financing once a decision had been made to go ahead with the acquisition. Review operations
of
Mr Butcher reported that generally the expansion programme had been successful. All new stores had 9
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SBL Practice Session 6 - Question opened on time and initial sales had been good. This had been helped by successful advertising campaigns. However, the additional stores had put pressure on logistics. Some stores had experienced stock outs of some popular products in the period leading up to the December holiday period. The core reason appears to be unexpectedly high demand for some products, leading to stores requiring more goods than the central warehouse had available, and emergency orders had to be placed with suppliers. Mr Butcher said that he believes that the company needs to invest in more sophisticated information technology systems to improve the procurement and inventory control both at the stores and at the central warehouse. He also said that many competitors are investing in big data technology to help them react to changes in customer demand more quickly. While MachineShop does not currently make sales online, the company’s sales processing systems do provide a considerable amount of data which could be analysed more. Viola Wang commented that with the high number of stores which the company now operates, it needs to examine its internal control needs. Although MachineShop is privately owned and therefore not subject to stock market listing rules, the external auditors have often suggested that the setting up of a formal internal audit function would be beneficial.
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It was agreed that the external auditors would be asked to advise the board on whether it would be worth setting up an internal audit function, and to review the controls over purchasing and inventory control. Conclusion of meeting There being no further business, the meeting ended Exhibit 5 The following notes were extracted from the audit working papers produced by audit staff at Moore & Charlton. Inventory control and procurement systems at MachineShop All stores stock around 10,000 different product lines. The inventory levels for each store are determined in advance by the purchasing department which is located at head office. Each store operates a computerised inventory control system. When goods arrive at the store, the receiving department clerk scans the barcodes on the products, which updates the inventory records automatically. When customers buy products, the point of sale system at the checkout automatically updates the inventory records. Each product line has a re-order level and a re-order quantity. Twice weekly, the inventory control system produces a report showing product lines which have reached their re-order level. It also automatically generates a purchase requisition which is sent to MachineShop’s central warehouse, requesting replenishment of all product lines which have reached their re-order quantity. Each store manager has the authority to amend this purchase requisition if they wish, but can only remove items from the requisition; items cannot be added. Stores are required to perform physical inventory counts on a continuous basis. The counts are planned to ensure that all product lines are counted at least twice a year. Physical counts are compared to inventory quantities per the computerised inventory control system. Any discrepancies are then recorded in the inventory control system. The central warehouse also operates a computerised inventory control system and aims to hold sufficient inventory to meet demand for the next two weeks. Each week, purchase orders are placed with suppliers to replace all inventory which has been delivered to the stores that week. When the purchase requisitions are received from the stores, warehouse staff check that there is sufficient inventory, and the goods are taken to the despatch area ready for delivery to the store the following day. Deliveries to all stores occur twice a week. If the central warehouse does not have sufficient inventory to satisfy a particular purchase requisition, an emergency order is placed with the supplier. Suppliers deliver to the warehouse the next working day and goods are then sent to the store in the subsequent delivery. Suppliers generally charge a 10% premium for emergency orders.
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Exhibit 6
From:
Deen, Dave
To:
Spencer, Aspen
Sent: Wed 14/03/2018 13:54
Subject: RE: Fabrique Regle de Garrido (FRG) Good afternoon Aspen As promised, please find below some background information on FRG that has been provided to us by Smith & Patel, Chartered Accountants in Ceeland. Best regards Dave
From:
Smith & Patel
To:
Deen, Dave
Subject: Fabrique Regle de Garrido (FRG) Dear Mr Deen As requested, here is some background information about Fabrique Regle de Garrido (FRG). FRG currently has 30 depots in Ceeland supplying large machine tools solely to trade customers. It does not sell products to retail customers. It has an effective distribution network and a sales team which is experienced in selling to Ceeland businesses. FRG is a privately owned company, with 30 shareholders, including a local trade union. Figure 1: Extracted financial information for FRG All figures in $000 Revenue Cost of sales
2017 9,000 (7,500) –––––– 1,500 (700) (300) –––––– 500 (100) –––––– 400 ––––––
Gross profit Other expenses Finance costs Profit before tax Income tax expense Profit for the year Capital employed Share capital Retained profit Long-term loans
9,500 400 2,500
This information is based on financial statements filed with the company registrars in Ceeland and newspaper articles.
End of Question Paper
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SBL – Practice Session 6 - Solution
Question
Machine Shop
(a)
Internal growth, sometimes called organic growth, takes place when the company grows by building on and developing its own existing competencies. This is how MachineShop has grown to date. The frequent opening of new stores represents
its organic growth. The
company appears to be comfortable and successful in this approach.
As well as being familiar with this approach, internal growth has a number of other advantages for MachineShop.
First, MachineShop is the only company which really understands the market that it has positioned itself in. Consequently, there are no equivalent companies or competitors to target for acquisition and so there is no clear alternative to organic growth. This market knowledge is a core competence, creating and reinforcing competitive advantage.
Second, although the final cost of developing through organic growth may be greater than through acquisition, the spread of cost may be easier to bear. Acquisitions usually require a major expenditure at a certain point in time. A slower rate of change, associated with more gradual expenditure and sustainable growth, may also minimise disruption to other activities within the company. Acquisition can be a significant distraction and it could easily prevent the directors from continuing their successful expansion of the MachineShop stores.
In some circumstances,
internal growth may be the only realistic option available to an
organisation. This may be the case at MachineShop.
It acknowledges that it is having
difficulty in identifying companies to acquire or with which to pursue a strategic alliance. FRG, analysed in depth in the second part of this question, is the best fit that MachineShop can find, yet it is a business which primarily deals with trade customers and larger machines and it has no experience of selling to domestic consumers.
Internal development avoids the political and cultural problems arising from post-acquisition integration and coping with the different traditions and company.
MachineShop
has
already experienced
such
expectations problems
of the acquired with LogTrans and
EngSup.
However, international expansion is often very difficult to achieve with internal growth. This can be due to government restrictions. For example, the government of Ceeland required,
SBL – Practice Session 6 - Solution
until recently, that firms trading in Ceeland were registered in that country and had at least one Ceelander director. Cultural differences also inhibit organic growth. The company will have little understanding
of how
business
is done
in the
country,
the
expectations
of
stakeholders or the way that business transactions are agreed and executed.
An acquisition takes place when ownership is taken of another organisation. A compelling reason to develop by acquisition is the speed of entry it apparently provides into a new product or geographical market. This speed of entry is often associated with scale. MachineShop is considering the purchase of a company which already has revenues of $9m. It would take a long time to build a company of that size. One of the concerns of Dave Deen is that the MachineShop concept will be adopted by emerging competitors in countries where it does not have a presence. A prime motive for considering the acquisition of FRG is that it has a depot network, distribution and sales team already in place. FRG is also familiar with the organisational and social culture of Ceeland. It is aware of its laws and corporate responsibilities, tax and legislative regimes. If MachineShop tried to grow organically in Ceeland, it would be starting from scratch in a country where it had no experience of trading.
The acquisition may provide an opportunity for MachineShop to exploit its core competencies in a new market, as well as satisfying Dave Deen’s desire for continuing growth and high profile business activity.
Rapid growth through acquisition may also offer immediate economies of scale. This is one of the attractions to Dave Deen. As the company grows larger, it should be able to reduce product costs, allowing it to raise the barriers to market entry, reducing the attraction of the market to potential competitors. Growth through acquisition is a quick way of delivering the scale and cost efficiency of operations required to deter potential competitors from entering the market that it understands and dominates.
Finally, acquisition may provide an opportunity for an organisation to address resources or competencies
in certain areas.
a lack of
This is what prompted MachineShop’s two
acquisitions in 2010. LogTrans was bought to provide the company with internal logistics capacity and EngSup was purchased to assist in post-sales support.
Strategic alliances take place when two or more organisations share resources and activities to pursue a given strategy. Both companies seek to gain benefits through co-operation. In the context of MachineShop and FRG, the prime motive would be what Johnson, Scholes and Whittington term as ‘co-specialisation’. An alliance would be used
to enter a new
geographical market where an organisation needs local knowledge and expertise. One of the features of strategic alliances is the range of alliances that might be pursued. Some alliances
SBL – Practice Session 6 - Solution
are very formal, others involve informal networking between
organisations with no
shareholding or common ownership involved.
A joint venture is an arrangement where a newly created organisation is jointly owned by the parents.
In this instance,
a new company could be created in Ceeland with the local
company providing labour, local expertise and countrywide knowledge. MachineShop would provide the products, marketing expertise and finance. At the other end of the spectrum, MachineShop could consider a looser network arrangement where FRG would provide space in their stores for a MachineShop franchise to operate. In this way, MachineShop would gain depot space which they could use to build their own market. This would be an ideal way of prototyping the MachineShop concept in Ceeland to see if the market really does exist and that parallels with Arboria are not unrealistic. In return, FRG would receive a franchise fee which would help it improve its financial position, as well as it potentially benefiting from crosspurchases by customers attracted to the store by the MachineShop facility. Such a loose arrangement could be put in place very quickly, compared to any formal joint venture, acquisition or organic expansion.
SBL – Practice Session 6 - Solution One of the main problems of strategic alliances is the ability of the initiator to find an appropriate partner. It is not known if the company which is currently being targeted (FRG) would be interested in a strategic alliance. Hence a search for a partner would have to take place, which could prove difficult and time-consuming. There may also be a concern, at MachineShop, that once the partner understands the dynamics of the market, they will steal the idea and promote it as their own. Networking also offers a relatively modest and low profile approach to expansion and this may not give Dave Deen and his fellow directors the visible growth they seek. It may be too conservative and not exciting enough.
Summ ary
A case could be made for adopting any of these three distinct approaches
and this is
recognised by MachineShop itself. This is probably why it believes that growth will be achieved through a combination of organic growth, acquisition and strategic alliance. The latter two are really quite problematic given MachineShop’s internal competencies and the market that it is in.
In the context of risk, a loose strategic alliance with a foreign agent seems an attractive route. However, the company would have to find a suitable partner and the approach may not deliver the visible growth required by the directors. An acquisition is risky, particularly in countries where MachineShop has no experience of trading. Furthermore, MachineShop’s limited experience of acquisition to date has not been particularly successful, despite both acquired companies being based in Arboria. Organic growth offers the advantages of being proven and familiar. However, it may be difficult to achieve the rapid growth demanded, and is particularly risky to pursue in countries where the company has little understanding of trading arrangements, organisational and social culture and stakeholder expectations.
(b)
Report
From:
Business
analyst To:
The
Board
of
MachineShop
Introducti on
This brief report looks at the potential acquisition of FRG by MachineShop. It uses the criteria of suitability, acceptability and feasibility, which is a standard
framework for evaluating
SBL – Practice Session 6 - Solution potential acquisitions. It concludes with my recommendation.
Suitabili ty
Suitability is concerned with whether a strategy addresses the circumstances in which an organisation is operating, the strategic position. In the context of MachineShop, does an acquisition make sense and, in the narrower context, does the acquisition of FRG make sense? Johnson,
Scholes and Whittington, noted authors on business
suggested that an acquisition makes
particular sense
strategy, have
if speed to market is vital. This
appears to be the case at MachineShop, where the board wants the company to grow quickly whilst there are no direct competitors.
In terms of capabilities,
the delivery of
economies of scale is also important and this has already been identified as a key benefit of the acquisition, further raising a barrier to entry to potential competitors. Finally, in terms of growth, acquisition appears to largely avoid the cultural problems that are bound to arise by trying to organically grow a company in a foreign land. Expansion in Ceeland is seen as an opportunity for rapid growth, exploiting important strengths, competencies
in particular the internal
of MachineShop. Acquisition, particularly in Ceeland, appears to offer the
rapid growth which the company seeks.
Acceptabi lity
Acceptability is concerned with the expected outcomes of a strategy. These can be seen in context of stakeholder reactions, risk and
return.
In the context of MachineShop,
the
primary stakeholders, the board, are likely to be excited by a foreign acquisition. It provides you with the high profile and the business
excitement that you enjoy. However, in
financial performance, the potential purchase
of FRG looks less attractive. Any financial
ratios calculated for FRG cannot really be compared with MachineShop, because the nature of the customers is quite different, with 65% of MachineShop’s sales being made to domestic consumers,
and so is the country and culture that the two companies operate in.
However, whilst acknowledging this limitation, an analysis of the latest financial figures (Table 1) does not appear to paint a particularly attractive picture. FRG has gross profit and operating margins well below that of MachineShop. FRG also has a relatively low Return on Capital Employed (ROCE) of 6·45%, compared to 17·5% for MachineShop. The gearing ratio is higher (20·16%) and the interest cover is lower (2·67) than MachineShop.
Table
1:
Comparison
MachineShop and FRG
of
SBL – Practice Session 6 - Solution Calculation (1) Gross profit Operating margin margin ROCE Gearing ratio Interest cover ratio (1)
Gross profit/revenue Operating profit/revenue Operating profit/capital Long-term loans/capital employed profit/finance Operating employed charges
MachineShop FRG 28·00% 17·00% 17·50% 15·00% 3· 5
16·67 8·89 %6·45 % 20·16 %2·6 % 7
Other acceptable definitions will
be credited
Improving the financial performance of FRG might be seen
as an
opportunity for
MachineShop,
except that the post-acquisition performance has actually worsened at the
two companies
it acquired in Arboria and these were also marred by management and
labour disputes. At present, improving the financial performance of acquired companies does not appear to be a core competence of MachineShop. MachineShop also has no experience of acquiring a foreign company and the scale of the acquisition is much greater than its two acquisitions to date. FRG has a turnover of $9,000,000, almost nine times the combined revenue of the two Arborian companies which MachineShop acquired in 2010.
SBL – Practice Session 6 - Solution Feasibil ity
Feasibility is concerned with whether an organisation has the resources and competencies to deliver a strategy. Financial resources are in place to fund an acquisition through a combination of loans and retained profit. However, no negotiations have yet been opened with FRG. As a result, no comment on the financial feasibility of the acquisition can yet be made. However, the difficulty of satisfactorily valuing a private company suggests that many months of negotiation might lie ahead, particularly given the number and composition of the shareholders of FRG. Trade unions may require certain post-acquisition guarantees about labour retention and reward. Such protracted negotiations would partly nullify, at least, the speed of growth that acquisition appears to offer.
Overall, acquisitions have a poor record in delivering business success. There are usually problems of integration and cultural fit. MachineShop has experienced this to some extent with both LogTrans and EngSup. At LogTrans, the directors had to be removed post-merger because
of personality clashes.
At EngSup, there was a problem in instilling in service
engineers the need for appropriate customer service.
The post-financial performance of the two acquired companies has also been disappointing. Since acquiring LogTrans, gross profit, operating margin and ROCE have fallen and the company is more highly geared than it was before the merger with a reduced interest cover ratio. The same is true at EngSup. Table 2 summarises the data. MachineShop has to review its competencies in acquisitions, not just its competencies in its market. It must also recognise that both these acquisitions took place in Arboria, a country where it understands the culture, laws and regulations. It might be reasonable to expect that the acquisition of a foreign company would be even less successful.
Table 2: Performance
analysis,
LogTrans and
EngSup (2009–2012)
LogTrans – 2012 LogTrans EngSup – EngSup – Gross profit 17·86% 21·54% 21·43% 23·08% – 2009 2012 2009 Operating 9·29% 10·77% 11·43% 13·85% margin ROCE 9·56% 13·46% 12·50% 15·52% margin Gearing ratio 14·71% 9·62% 9·38% 6·90% Interest cover 2·1 4·67 4·00 5·63 It also has to be recognised that FRG is not a complete match to MachineShop. FRG is ratio 7 experienced in the business market, but has no experience of selling to domestic customers, a service that accounts for 65% of MachineShop’s sales.
Conclusi
SBL – Practice Session 6 - Solution on In theory, an acquisition would appear to be a suitable growth strategy given MachineShop’s strategic position and objectives. However, whether the acquisition of FRG is appropriate is more doubtful. FRG does not appear to be financially performing particularly well and it has no experience of selling to domestic customers.
Furthermore, MachineShop has no
experience of acquiring a company outside Arboria or, indeed, a company as large as this one. Its two previous acquisitions were within Arboria and were relatively modest in size. Both acquired companies should have represented relatively good ‘fits’ within the supply chain of MachineShop. However, performance post-acquisition has been disappointing, with both companies reporting drops in profitability. MachineShop would have to improve their competencies in managing acquisitions.
Overall, the proposed purchase of FRG appears to be very risky and MachineShop might be better looking elsewhere for a more suitable acquisition. It might also consider entering into a dialogue with FRG about a strategic alliance of some sort (perhaps
followed by
acquisition), which might offer an attractive alternative to immediate purchase
of the
company.
(c)
Michael Porter developed his diamond to explore the determinants of national competitive advantage. Its primary use is at a national and regional level as a framework for exploring the competitiveness
of a nation (or region) and as a framework for determining
policy
initiatives. However, it might also be used in this context to analyse, in a more structured way, the competitive nature of Ceeland, the country which MachineShop is keen to expand into, and also to understand factors that might have contributed to MachineShop’s success in Arboria. The diamond has four principal determinants.
The first of these is factor conditions which are the inputs necessary to compete in any industry, such as labour, land, natural resources, capital and infrastructure. The case study scenario suggests that the transportation system in Ceeland is cheap and effective and ease of distribution is one of the factors which attracted MachineShop to the country. Furthermore, the country has a well-established digital communications structure, and as MachineShop expects to make extensive use of internet order placement, this is also important. Both of these are examples of advanced
factors which offer more sustainable
advantages than
basic factors, such as natural resources and unskilled labour and they would make Ceeland attractive to MachineShop. However, both these factors are also generalised factors which do not provide as decisive and sustainable a basis for competitive advantage as other more specialised factors.
The second facet is the demand conditions, the nature of home demand for an industry’s
SBL – Practice Session 6 - Solution product or service. This appears particularly significant in the context of MachineShop. Porter argues that the home market usually has a disproportionate impact on a firm’s ability to perceive and interpret buyer needs. One of the reasons for this is the attention the home market requires. Product development usually takes place in the home market. Pride and ego focus attention on succeeding in this market. Pressure from buyers is immediate and the proximity and cultural similarity of these
buyers mean
that their needs are well
understood.
MachineShop has reaped the benefits of supplying a vigorous, growing and demanding home market in Arboria which, it believes, may allow it to anticipate buyer needs in other countries. Dave Deen believes that macroeconomic factors suggest
SBL – Practice Session 6 - Solution that Ceeland is quickly beginning to resemble Arboria. MachineShop has to hope that his perception is correct and that consumers’ needs
are not just idiosyncratic to Arboria.
Further research needs to be undertaken to ensure that Ceeland’s cultural and social values will really lead to the changes in consumer behaviour that the economic trends are suggesting. If they do, then MachineShop will have definitely benefited from demands placed on it from the sophisticated and demanding buyers in Arboria.
The third element of the diamond is related and supporting industries. This concerns the presence in the nation of supplier industries or related industries which are internationally competitive. There is some evidence of this in the scenario (MachineShop already buy from a Ceeland supplier), although the government (see later) is encouraging the production of light engineering and so related, supporting industries may eventually develop in Ceeland.
The fourth element concerns firm strategy, structure and rivalry. Porter suggests that there is a strong association between vigorous domestic rivalry and the creation and persistence of competitive advantage success
in an industry. This has not really been a major factor in the
of MachineShop because
it has no obvious rivals in the market in Arboria,
particularly for domestic customers. A similar situation is likely to occur in Ceeland and so vigorous domestic rivalry will be lacking.
Porter also considers the nature of chance and the role of the government. The role of government is particularly significant in this scenario and it influences elements
of the
diamond. For example, it has: –
Invested heavily in transportation systems and information
technology (factor conditions), –
Lifted regulations on what type of machine can be used by an unqualified
operator (demand conditions), –
Removed the requirement for all companies trading in Ceeland to be registered in that
country and to have at least one Ceelander director (firm strategy, structure and rivalry), –
Encouraged the production of light engineering (related and
supporting industries).
So, although Porter’s diamond is probably more relevant to understanding and
countries,
it does
provide a framework for understanding
industries
the national competitive
structure that individual firms compete within. Ceeland appears to be relatively attractive from the perspective of factor and demand conditions. However, the stimulus experienced by a company operating in a country where there are internationally competitive suppliers or related industries, or where there is a great degree of rivalry between competitors, will be
SBL – Practice Session 6 - Solution missing.
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