Kaplan analysis of May 2013 strategic pre-seen material

Kaplans three Content Specialists for the CIMA Strategic Level papers Christine Bligh, Ben Dickson-Green and Andrew Howarth present their Top 10 key issues based on the pre-seen material for May 2013. These are the key topics and themes which they expect to be developed in the unseen material in the May 2013 E3, F3 and P3 exams.

STRATEGIC ANALYSIS MAY 2013

T Railways has an overall strategy of offering efficient, cost effective, safe and reliable rail services as well as the reduction in carbon emissions of Country T. This has been translated into several financial and non-financial objectives, as well as some detailed key performance indicators to allow the organisation and its stakeholders to monitor progress. These strategies and objectives have been set after wide consultation with stakeholders and are extremely important to the Government. As such, whichever strategy is proposed in the exam, you need to be able to assess whether it meets the overall strategy and objectives of the organisation. Remember that while T Railways is not a profit-seeking organisation it still needs to try and meet its financial objectives - so the organisation would still be expected to calculate the financial impact of any new strategies before proceeding. Note that it is very likely that, as T Railways is wholly financed and owned by the Government, any major investments or strategies will have to be approved by them and/or the Rail Regulator in Country T. Its also worth being aware that the pre-seen actually gives a list of possible strategies that T Railways could adopt, so make sure you have thought about the benefits and drawbacks of each for the company.

PERFORMANCE MANAGEMENT
There is little information on performance management within the scenario, but any such system would need to be undertaken with care. Performance management should be designed to help ensure that employees act in the best interests of the organisation (i.e. work towards the organisations goals). For T Railways, this means that any performance management system should help the divisions to achieve their KPIs such as targets for safety and carbon dioxide emissions. However, dont forget that T Railways has financial objectives as well and these may be harder to measure fairly within the group. TPTS maintains the tracks and trains for the group, meaning that they may be able to simply pass on the costs of this to the other divisions whether those costs are reasonable or not. In addition, if the divisions are being assessed based on customer feedback, the results could be distorted by problems caused by TPTS for example slow track repairs will cause delays, which customers may incorrectly blame on TCL or TFR.

CORPORATE SOCIAL RESPONSIBILITY

T Railways has a number of powerful stakeholders, including the Government, the Rail Regulator and the public. Their operations are a crucial part of the Governments overall transport and economic policy for Country T. There is additional complexity as these stakeholders are linked the Rail Regulator is appointed by the Government, who in theory also answers to the public, who are also T Railways customers. This is of huge importance to T Railways as it means that they need to consider the needs of these stakeholders very carefully and how they may change in the future. The company may wish to attempt to adopt a foresight approach and predict possible future shifts in Government policies so that it has plans in place to deal with them. For instance, T Railways operations could be seriously undermined if the Government improves Country Ts road network or decides to no longer offer as much financial support to the company. Changing Government attitudes to issues such as carbon emissions could also have a significant impact on T Railways future plans. This underlines the importance of good environmental analysis for T Railways. The company currently uses the rational planning model, which would tend to include detailed environmental analysis, but they need to ensure that it is complete and up to date.

OBJECTIVES
The firm is a nationalised entity, wholly owned by the government of Country T. Therefore its objectives are different from the profit-focused private companies objectives which we have seen in most of the previous pre-seens. The financial objectives emphasise the need for T Railways to break even and provide value for money, rather than to generate profit or increase shareholder wealth like a private entity would. However, as with previous exams, this does not change the fact that all future decisions will have to be taken with the entitys objectives in mind. Whatever future plans are to be appraised in the exam, it will be important to relate your discussion back to the entitys stated financial and strategic objectives.

INVESTMENT APPRAISAL
Investment appraisal is commonly tested in Section A of the F3 exam, so look out for potential investment opportunities. Some of the possible opportunities in this case are: Upgrading freight trains to replace the old diesel locomotives Increasing the number of freight trains to take advantage of the problems caused by road congestion Investing more in existing facilities such as car parks and platform infrastructure Upgrading trains across the entity to reduce carbon emissions (in line with the strategic objectives) Investing in better recycling facilities in order to achieve the target of recycling 85% of waste by 2015 Expanding the rail network

Investing in other forms of transport (perhaps trams or low-emission buses for example). NPV is the most commonly tested investment appraisal method, but dont ignore other methods too, such as payback period and accounting rate of return. T Railways is a not-for-

profit nationalised entity which does not have the primary objective to maximise shareholder wealth, so it would not be surprising to learn that the entity uses these basic methods of investment appraisal instead of NPV.

BUSINESS VALUATION
In previous exams, business valuation has been commonly tested, generally in one of the following three ways: Valuing a target entity which is to be acquired Valuing a part of the business which is to be disposed of Valuing the entitys own shares.

It is possible that any of these scenarios could be developed in the unseen material for T Railways. For example: Acquisition T Railways might decide to expand and diversify by acquisition, in which case you would be presented with some financial information regarding the target entity and asked to value it. Disposal Alternatively, the pre-seen tells us that consideration is being given to a number of initiatives, such as splitting T Railways up, and privatising parts of the business. In either of these cases, it might be necessary to value certain parts of the business. If you are asked to value part of the business, be careful to value just the cash flows that relate specifically to that part of the business. Valuing the entitys own shares Finally, the Government has considered privatising T Railways. This means selling all or part of the shareholding to private investors, most probably through the stock market. The Government would need to calculate a price for T Railways shares if the privatisation were to go ahead. Summary In all cases, the fact that T Railways is not currently a listed entity means that the valuation process is more complex given the lack of market information (such as share price and P/E ratio). To help you value T Railways, look for P/E ratios and other relevant information for similar listed companies to be provided in the unseen material.

CORPORATE GOVERNANCE
In pre-seen material for previous sittings, a Board structure has been provided, usually in an appendix. This sitting it is notable that this piece of useful information is missing. Could it appear in the unseen material? T Railways Board structure would be very different from a typical profit-making company as the Government would sit on the Board and oversee any decision-making. There is very little detail regarding the directors or management of T Railways, but T Railways corporate governance might be improved by mentioning a range of directors / managers across all subsidiaries and functions, an internal audit function, an audit committee and possibly an external auditor such as the UKs National Audit Office (checking for value for money within Government operated organisations). T Railways might also benefit from a risk committee if it hasnt already got one, and regular, comprehensive risk assessments.

KAPLAN PUBLISHING

So far in the pre-seen, the Rail Regulator appears to be the only monitoring facility for T Railways, although their independence could be questioned since their senior staff are appointed by the Government. Here in the UK, for example, the Rail Regulator has input into the level of price increases which are allowed. The Government may be able to dictate the Rail Regulators actions since they lack independence.

INTEREST RATE / GEARING RISK

Currently T Railways only borrows from the Government at a rate of 4% per annum. This may or may not be a favourable rate. There are, however, very favourable repayment schedules which appear to be dateless. In the future, T Railways is considering whether to borrow from other lenders whose rate may be different (possibly lower). However, unless T Railways is forced to start repaying some of the Governments loans, it is unlikely that they would borrow from anyone else. Would you choose to repay a loan if you didnt have to? However, the Government could start to enforce repayment if they needed the cash for other purposes. Then T Railways would probably seek the cheapest rates they could find, with possibly the longest repayment schedule. The effect on their cash flow would be significant if they had to start repaying the capital in addition to the interest. Also, if T Railways needed to borrow further funds from a bank, they would probably undertake the revaluation of T Railways non-current assets. This would make their balance sheet more healthy and lower their gearing, which banks might look upon favourably. However, another scenario could prevail. The Government could choose to privatise the railway system, and T Railways would have to raise equity finance from potential investors. This would lower their gearing but dividends may need to be paid which would lower their profitability.

ENVIRONMENTAL RISK
T Railways has set itself some environmental targets. Being a Government organisation they will want to be the leader for environmentalism in Country T, so that other transport industries copy / follow. However, the ability to meet the targets may be questioned. Are they too tough? The cost of replacing all diesel engines with electric would be phenomenal. They may be setting themselves up for failure. It is likely that T Railways will need to store large amounts of diesel in strategic locations to be able to refuel their trains. Imagine the consequences of one of the stores leaking? Also, the weather will be a major risk for T Railways, especially in winter (although we are not entirely sure where Country T is). Rain, snow and ice can cause major disruption to the rail system which would lead to passengers using other forms of transport, thereby causing a reduction in T Railways revenue. T Railways will have high fixed costs and so a reduction in revenue will have a negative impact on their profits.

PRIVATISATION
T Railways may well be privatised in the near future. This would create an interesting cultural change within the business, and would require the directors to change their strategic approach. The objectives and KPIs of the company would have to change, to focus more on profitability and shareholder wealth. The shareholders needs would potentially have to be prioritised ahead of the needs of other stakeholders. Financing would shift from government to private investors. A privatisation would enable the examiners to test the differences between public sector and private sector organisations in detail.

KAPLAN PUBLISHING