Exam focus the pre-seen case study for the May and September 2012 Strategic level exams.

CIMA has recently released the pre-seen case study that will be used for all Strategic level exams for the next two sittings. In this article Kaplan Content Specialists, Andrew Howarth, Ben Dickson-Green and Christine Bligh will give you an overview of the pre-seen, as well as examine what you should be trying to get out of it. They will then go on to look at the specific issues from the pre-seen that you should be aware of in each of the Strategic exams. The scenario - B The pre-seen provides detailed information about B, a retailer of groceries and other consumer goods, which operates across three continents. It has a geographical structure, with separate divisions controlling Bs operations in Europe, Asia and North America. As is common in the pre-seen, information is given on Bs operations, its strategic mission and goals, as well as its operations and culture. The supermarket industry is frequently in the news across the world, with fierce competition and saturated home markets forcing businesses to look at developing markets, such as Asia, for their continued growth. In addition, supermarkets are also trying to deal with a growing demand for acceptable levels of corporate social responsibility with regards to both their treatment of workers and their environmental impact. What should you do with the pre-seen? Make sure that you have read the pre-seen thoroughly and have an awareness of the key issues facing B and its industry, as outlined in the pre-seen document. Try and perform some detailed strategic analysis of the pre-seen, using the key models you are familiar with, such as SWOT. Dont forget to carefully analyse any financial information you are given. What should you not do with the pre-seen? Dont use the pre-seen to try and get a dead-cert view on what the requirement will be. The pre-seen is usually kept open, meaning that in the actual exam the examiner can test almost any topic. The safest approach is to get to know the pre-seen well enough so that you can sensibly answer any question the examiner chooses. The pre-seen is designed to give every student an equal level of familiarity with the industry in question. This means that CIMA does not expect you to spend a significant amount of time undertaking industry research. The full text of the pre-seen can be found at http://www.cimaglobal.com/strategicpreseen and you should read the pre-seen before reading the remainder of this article.

1 April 2012

B - The P3 perspective What are the key issues that can be taken from the pre-seen relating to the P3 exam? There are a number of possible relevant areas: Competition risk - B operates in a competitive market. It is possibly the market leader in Europe, with a share of 20%, but this means that the competition will constantly be looking for ways to erode Bs share. Bs directors will need to look for new, innovative ways to stay ahead some of which will work, whilst others wont, which will be costly for B. Market/product/reputation risk - Bs market risk should be low as it sells a necessity food. Even in times of recession people still need to eat. Other products may have higher risk e.g. the discount stores and their electronics, since these are luxury items and in tough times sales will fall. Bs food products do have a risk in that because they are food they could be harmful if tampered with, which could harm Bs reputation. B should have stringent supplier contracts in place to avoid this eventuality. Information technology (IT) risk - IT does not have Board representation which is surprising in a competitive company of this size. There is no mention of a strategic plan despite spending on an EPOS system across most (not all) of the Group, which would have been costly. By not having EPOS systems in all stores, management information will take longer to collate, delaying decisions which may give the competition scope to gain some competitive advantage. Inventory control systems are poor leading to stock outs which reduce potential revenue. Investment is required in this area. Foreign exchange risk - B is based in Europe where the major currency is the euro but there are other currencies within Europe, such as the pound. B also operates in North America where the dollar is used, and in Asia where there are several possible currencies. In summary, if B wishes to repatriate funds from most of its stores it will involve transaction risk. Translation risk will be seen in the Groups financial statements, which may give rise to fluctuations in reported profit, which shareholders do not like. B has treasury departments which should oversee any cash movements although these departments do not appear to be well integrated. Interest rate risk - the scenario doesnt state whether Bs loans are at a fixed or variable rate which could give rise to interest rate risk. The fixed or variable nature of the interest rate needs to be reviewed, subject to changes in the bank lending rate. Political risk - B operates in several countries and should monitor political movements at all times in these areas. Due to its size, B would probably be welcomed on to various government advisory committees which might directly or indirectly help their business. A contingency plan should be developed for each possible political risk that could be generated.

2 April 2012

Corporate governance risk - The Board of B has an equal number of executive and nonexecutive directors which doesnt quite meet with, for example, the UK Corporate Governance Code where the non-executives should be in the majority. More importantly there are no non-executives on the regional Boards. It is difficult to imagine the main Board non-executives being able to give relevant advice to the regional directors who may be on a different continent where there are very different conditions to work within. B appears to have all of the relevant committees required for its size. However, a major failing within B is the small size of the internal audit function and the fact that some areas of the business have not been audited at all. Legislation/compliance risk inducements have been paid to government officials. This is illegal and must stop. Being based in Europe, B might be resident in a country with a similar Act to the UK Bribery Act and, if so, can be fined heavily for non-compliance even if the bribery took place in another country. A control process needs to be put in place. Ethically, B should take a stand and insist that in all parts of its business, whichever country it is based in, bribery is not acceptable. Theft of stock has been noted. The cost of measures to stop this may outweigh the losses. Environmental risk - B has set itself some tough environmental targets, some of which it has met. The one it hasnt met (plastic bags) looks bad, but it may be that the target set was too high. This could be appeased using public relations, or lowering the target for the future. Employee/culture risk - staff have been highly trained which should lower some of Bs potential risks; however, there are nearly half a million staff which will take a considerable amount of time to manage. There appears to be a lack of trust in staff ability lower down the company or across functions e.g. treasury. B - The F3 perspective The F3 examiner tends to focus on syllabus section C in the Section A part of the exam i.e. Investment Decisions and Project Control. This means that the calculations in Section A of the exam tend to be either an NPV analysis or a Business Valuation. However, the examiner has said that she may sometimes incorporate other areas of the syllabus too, so you will need to prepare for the possibility of a wide range of topics being tested. A summary of the key F3 syllabus topics, linked to the issues in the pre-seen, is shown below. Investment appraisal - Investment appraisal is commonly tested in Section A of the exam, so look out for potential investment opportunities. For example, we might expect to see the following point being developed in the unseen material: Bs Board thinks that there are opportunities to take advantage of the rapid economic growth of some Asian countries, so you might have to deal with appraising a foreign currency investment project, perhaps to expand by direct investment in new stores, or by granting new franchises.

3 April 2012

Business valuations - in previous exams, business valuation methods such as P/E method, PV of future cash flows, and asset valuation, have been tested many times. In this case, the most likely way in which valuation will be tested is in the context of B finding a suitable target company and deciding to grow by acquisition rather than organically. It is not clear whether B has used an acquisition strategy in the past, so you might have to explain the advantages and disadvantages of such an approach to the Board. Learn the pros and cons of organic growth vs. acquisition, and make sure you have revised the various methods of business valuation. Financial objectives - the firm has three financial objectives, relating to gearing, dividend levels and earnings per share. Also, throughout the pre-seen there are several references to other objectives (value statement, mission, the strategic objectives, then the CSR obligations and environmental targets). Whatever future plans are to be appraised, it will be important to relate your analysis back to these objectives, especially the three financial objectives. Financing vs. dividend vs. investment policies - two of Bs financial objectives predetermine what its dividend policy and its financing policy should be. This puts a great constraint on the potential investment options of the firm. Be prepared to discuss alternative ways of setting objectives i.e. it is useful to be able to consider the interrelationships between dividends, financing and investments, rather than having two of the policies predetermined. Role of the treasury - B has three regional treasury departments and a central corporate treasury too. It is not clear what treasury roles are fulfilled at regional level and what roles are fulfilled by the central treasury function. Learn the roles of treasury carefully, and be prepared to explain to the Board the advantages and disadvantages of centralising or decentralising the roles of the treasury function. Stakeholder analysis - be prepared to identify the key stakeholders of B, together with their objectives and likely reaction to the various strategic options considered above. There are likely to be conflicting objectives which need to be managed carefully as new opportunities are considered. In particular, note that: The companys shareholders will be expecting any new investments to increase the share price and to maximise returns to shareholders (as stated in the strategic objectives). The company has a stated objective to increase its commitment to local suppliers. There is tension within the management structure of the company because of the tight control exercised by the main Board. The supermarket industry is highly competitive, which is dominated by a small number of large firms. Working capital management - B has a negative working capital cycle, in common with many other supermarket companies. This is largely because most customers pay by cash (i.e. very quickly) but most suppliers are paid in arrears.
4 April 2012

Although B has little scope to change its receivables policy, the payables days look extremely long, so B is in danger of upsetting its suppliers. Also, the pre-seen identifies inventory control as a weakness of B. Therefore, part of the question could focus on alternative working capital management policies that B could introduce. B - The E3 perspective The E3 examiner can and will include issues from any part of the syllabus in the compulsory A section question. Dont assume that it will just be strategic analysis! The key issues to take out of the pre-seen include: Mission and objectives - the value statement and strategic objectives provided by B indicate that the company is strongly focused on three main areas: shareholder value (through dividends and share price increases), customer satisfaction and corporate social responsibility (CSR). However, note: There may be conflict between the companys objectives. For example, sourcing local produce and reducing carbon emissions may be expensive, leading to either higher prices being charged to customers or lower returns for investors. The financial objectives may be hindering the company. High dividend payouts and a 40% maximum gearing requirement may make it difficult for the company to afford rapid expansion. Strategy - the objectives of the company appear to involve expansion of the business to allow continual growth in share price and maintenance of the dividend payout ratio to shareholders. There are several strategies that B could consider that may help it to accomplish this, including expansion into Asia, growing the number of its convenience stores, improving quality and CSR, or expansion through acquisitions of rivals or franchising. Note that each division has very little control over its strategies, with the main board taking all the strategic decisions. Make sure you have thought of the advantages and disadvantages of centralised and decentralised decision making for B, as this could be a requirement in your examination. It can also be seen that strategies are reviewed infrequently, with a revised five-year plan being created every three years. In a fast-moving, highly competitive market this may mean that B falls behind its competitors and fails to respond to changes in the market especially in newer or emerging markets like Asia. Make sure you are able to discuss alternative strategic approaches. Controls - as mentioned, the company is geographically structured. Given the main boards desire for tight control over the activities of the divisions, they may be keen to adopt a formal performance appraisal system for each division. Make sure you are familiar with ROI/RI as these could form part of a question. There are some serious concerns over Bs existing controls, with an over-stretched internal audit function and problems with inventory control and theft. Make sure you consider possible control methods for dealing with these issues. Note that the examiner has previously expressed concern over student ability to deal with information technology and information systems. With the proposal to roll out Bs EPOS system, you need to ensure that you are comfortable discussing types of IT strategies and why and how they would help B. Note that B has no IT representation on
5 April 2012

any of its main or regional boards. Make sure you consider why IT should be of strategic importance to the company. Ethics/CSR/Governance - From a governance perspective, there are a few potential causes for concern, including: Lack of non-executive scrutiny in the regional boards this may mean that regional strategies are not being examined properly. Lack of an internal audit function of sufficient size (as mentioned above). Ethics and CSR are areas that appear to be of prime concern for B. A great deal of time and money is spent on this area, with environmental and social initiatives, as well as a well-regarded training programme for staff. However, there are some disappointments in Bs approach to ethics and CSR. These include the fact that they have failed to meet all of their published targets (with plastic bag usage not falling by as much as required) and, most worryingly, an apparent culture of bribery of officials in Asia and North America. This could significantly damage Bs reputation if it were to become public. Culture - B operates a bureaucratic and authoritarian style of management. Make sure you carefully consider the impact that this style of management will have on the organisation. Equally, a question may consider the organisations stakeholders. Little specific information is given about any individuals or other organisations in the scenario, but we do know that there are a very large number of shareholders. Given the large proportion of shares in public hands, B may find it difficult to deal with the varying demands of different shareholder groups. Financial analysis - one clear issue is the very high level of gearing at 39.6% (D/D+E). This means that B cannot raise further debt without breaching its financial objective of a 40% limit on gearing. However, there is no evidence that raising further equity finance would be difficult for B. Overall Remember that the key to success is being familiar with the pre-seen and having a good awareness of the key issues it raises for the exam that you are sitting. Good luck in your exam preparation!

6 April 2012