CASE ANALYSIS:

GROUP 4: NAMES ROLL NO

Aman Mishra 2009060

Abhishek Saxena 2009056

Amal Aggarwal 2009059

Aditya Rajpoot 2009058

Arpit Parihar 2009054

Ashwini Rungta 2009066

Ben C Kurian 2009067

Chetan Maskara 2009068

Gagandeep Khurana 2009069

Katyayani Joshi 2009070

 Background
Boston Chicken is a food joint started by Scott Beck which provides quality chicken meal.
The vision of Beck is to make Boston Chicken Inc. a cheap replacement for home meals. The
case shall be analysed on following lines:

 Critical evaluation of Boston Chicken’s strategy’s success factors and risks

 Evaluating Boston Chicken’s accounting policies
 Questions that shall determine Boston Chicken’s performance
 How the company is performing
 Assumptions the market is making about the company’s future performance and risks
 CASE ANALYSIS

1. Assess Boston Chicken’s Business strategy. What are its critical

success factors and risks?

FOLLOWING IS A DELINEATION OF BOSTON’S CHICKEN’S STRATEGY

• It Created a new segment in the highly competitive fast-food restaurant industry—

take-out home-cooked food.
• It was engaged in three businesses—operating restaurant, selling franchises, and
financing area developers and thereby diversified considerably.
• Major competitors were entities which had their own associated levels of entry
barriers and thus kind of gave Boston Chicken Inc a sort of insulation:
 Existing take-out chains such as KFC: this particular domain had few barriers
to entry, but had a different concept.
 New take-out competitors: potential barriers for entry
 Supermarkets: unlikely to be able to compete
• Boston Chicken’s success depends on its ability to expand rapidly and develop its
brand name.
• A key strategy of Boston Chicken’s Strategy was to create products which will
replace home meal. For example customers can take-out or can have immediate
consumption.
• Beck’s strategy was to form a team consisting of people from both fast food industry
and franchising operation.

FOLLOWING ARE THE SUCCESS FACTORS

• Boston Chicken focused on franchising to large regional developers.
• Franchisee is given to people having 15-20 years of relevant management experience,
strong financial resource.
• Earning mainly through franchisee fee, royalty, leasing etc.
• Rapid growth into new geographic markets.
• Communication Infrastructure: software to analyze day to day activity.

A number of recent operational changes:

• Long term agreements with supplies-locking in food price.
• Flagship stores.
• Adding menu items to increase sales at off--peak times.
• In store computer feedback.
 RISKS INVOLVED

• The concept can be easily copied. For example KFC introduced “rotisserie gold” and
became world’s largest Rotisserie gold chain.
• Controls given to large regional developer which to some extent leads to loss of
control over internal working and efficiency. There is acute inherent risk of losing
control of the business operations as a result of its focus on rapid growth.
• The much vaunted focus on growth could lead to reduced quality of operations,
increased food wastage, and lower profitability of franchise operations.
• The growth strategy also puts a heavy strain on cash management, since funds are
required for growth.

2. How is the company reporting on its performance and risks? What

are the key assumptions behind these policies? Do you think that its
accounting policies reflect the risks?

The company is reporting and reflecting its performance in the

financial statements in the following manner, which also entail
certain assumptions:

• Revenues are recognized for franchise fees and development fees when the store
opens.
• Revenues from royalties are recognized when the store generates sales
• Pre-opening costs are amortized over one year.
• Financing costs on notes receivable to franchisees are shown as earned. However, the
company makes no allowance for defaults on these notes.
• The amount of Notes receivable totaled more than $200m at the end of 1984, with a
further 131m of notes already committed
• The notes are structured to give the parent the option to convert the loan into equity in
the franchisee at a 12-15% premium over the equity price at formation of the
franchise
• We can estimate the income statement effect of changing the assumption for
franchisee defaults.
 1% 3% 5%
allowance allowance allowance

Net income before $20,450 $20,450 $20,450

tax

Bad debt expense 2,025 6,075 10,125

on $202,500 notes
receivable

Adjusted net $18,425 $14,375 $10,325

income before tax

Percent Change 10% 30% 50%

• The company shares both the upside and downside risk for financed franchise
restaurants according to agreement of franchise.

The accounting policies followed by Boston chicken do not reflect the risks. For
calculating risk, it would be more appropriate to calculate the profitability figures of the
company. Whether franchisees are profitable or not is a key factor for accessing the value
of the notes receivable.

We can estimate the profitability of store for franchisees by two ways.

(1) Use data for the company-owned stores

(2) Use data of franchise profitability provided by the company.

Boston Chicken, Inc. Profitability

Using data for the company-owned stores

($ in thousands)
Company operated store revenue $40,916
 Average number of owned stores 39.5[(38+41/2)
Revenue per average store $1,036
Gross margins (100%-15,876/40,916) 61.2%
Less royalty and promotion fees 10.8 %( 5%+2%+3.75%)
Residual 50.4%
From this residual margin franchisees have to deduct wages and salaries,
administrative costs, depreciation, interest, and taxes.

Boston Chicken, Inc. Profitability

Using data on franchise provided by the company.

The average system sales per week for the third quarter of 1995 were 23,388 and
EBITDA margins were 15%-16 %.( $ in thousands)

Annual sales per store $1216(23,388*52)

EBITDA 194.6(0.16*1,216)
Depreciation(see below) (117.0)
Interest (59.3)[11,632/(314+78)/2]
Net profit before tax 18.3

Depreciation is calculated as follows:

1993 Boston Chicken capital expenditure $49,151
Number of new owned stores 28
Cost per store $1,755
Expected life 15 years
Annual depreciation per store $117

• The analyses indicate that the franchisees are profitable at this level of sales ($1,216).
• Some franchisees appear to be having cash flow problem. Boston Chicken had been
forced to make advances to franchisees to fund local and national advertising.

3. What adjustments, if any, would you make to the firm’s accounting

policies?

The company effectively has control over the financed area developers through its
option to purchase. At this stage we recommend that Boston chicken should opt for
 the consolidation of the Financial Statements which would entail the following
benefits:

(1) The royalty, franchise fee and interest income would be eliminated.
(2) The company would show its share of the sales revenue and cost from the stores.
(3) The notes receivable would be eliminated and the company would report its share
of the assets and liabilities of the franchisees

4. What questions would you ask management about the company’s

performance?

The analyses done above are based on limited information and average data is
incomplete, since it only takes one franchisee to fail, and Boston Chicken will incur a
large loss in Notes receivable. Hence the pertinence of gathering more comprehensive
information from the management. Some additional information required would be
 Same store sales
 Distribution of same store sales
 Late payments by franchisees.
 Security provided by developers such as any other assets outside the franchise
corporation.

5. How is the Boston chicken performing?

Looking at the financial ratios, we can predict the financial health of the company

Efficiency
ratio   1993 1994
Average
collection Acc receivables *days/year/
period net sales 17.81660005 24.82657487
Turnover of
cash ratio Net sales/Working capital 0.232 0.505

Efficiency ratios are used to predict how effectively company is utilizing its
resources. They are typically used to analyze how well a company uses its assets and
liabilities internally.

Average collection period is increasing that is now company is taking more time to
collect its credit sales which will ultimately increase short term borrowings but at the
 same time higher turnover of cash means company is able to generate more cash over
a period. So net effect will be minimum.

Liquidity ratio   1993 1994

current asset/ current
current ratio liability 1.271 2.175

cash flow from

operating cash flow operation/current
ratio liability 0.781 1.290

Liquidity ratios are a measure of how company manage to fulfil its short term
funding. Higher ratio indicates that company can easily manage its short term
liability. Over the year we can see ratios are increasing which is a good sign for a
company who is in expansion mode because such companies frequently needs cash.

Profitability
ratio   1993 1994
Gross profit (Sales-COGS)/Sales 0.734 0.834
net profit margin net profit/sales 0.015 0.168
Net income/shareholder's
ROE equity 0.007 0.062
ROA Net income/ Assets 0.006 0.038
Profitability ratios are used to assess a business' ability to generate earnings as
compared to expenses over a specified time period. Return on assets indicates revenue
they are generating by utilizing each unit of asset. Higher ratio of ROA and ROE over
the year means they are receiving more over the years with same amount of
investment. Also increase in Gross profit and net profit means they are generating
more with less cost involved.

Other ratio   1993 1994

Royalty & franchise- Royalty & franchise-
related revenue per related fees/ number
store of stores 70.84 112.03
Company-operated
Company-operated store/number of
revenue per store stores 785.5 997.95
Earnings per share Net profit/ Number $ 0.06 $ 0.38
 of Shares

Boston chicken is able to maintain high profitability, liquidity and efficiency ratio
which reflect company have a potential to sustain over the period. Also since they are
expanding, so they need funds which can be easily arranged but also we can see that
over the year Revenue/ Store is also increasing. Therefore it can be concluded that
market is still unsaturated and there is lot more to explore.

6. What assumptions is the market making about the company’s future

performance and risks?
There are wide differences in opinion in the market about the company’s future
prospects.
 Analyst forecasts of future EPS are $0.63 in 1995 and $0.90 in 1996, with
45% growth until 2001.
 While other are forecasting that the quality of earnings is very low since all of
Boston Chicken’s income comes from fees, royalties and interest payment
from franchisees, most of whom were financed by the franchisers.
 Short interest positions in the stock were at an all-time high of 10 million
shares, more than 20% of the shares outstanding and double the short interest
position at the beginning of 1995.

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