ACCA

Paper P3 Business Analysis

Revision Mock Examination June 2012 Answer Guide
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How to pass

Attempt the examination under exam conditions BEFORE looking at these suggested answers. Then constructively compare your answer, identifying the points you made well and identifying those not so well made. Simply read or audit the answers congratulating yourself that you would have answered the questions as per the suggested answers.

How to fail

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Question 1

Tutorial help and key points

Start by analysing the case study carefully, picking out particular facts and issues to help you quickly understand ABC's current position: declining sales, total profits and profit margins yet large debts have been taken on to finance capital expenditure foreign competition no diversification of product range outside bicycles separate market segments for different types of bike, and different ways of reaching customers in each case being taken over is not a realistic strategic option at the moment solutions appear to be either rationalisation, or selling in the Far East, with overseas manufacturing.

A quick analysis of the financial information given reveals falling sales of all products except racing bicycles. There has been a severe drop in the gross profit margin on all products between 2010 and 2012: Gross profit as % of sales 2011 % Mountain bikes Standard bikes Racing bikes Exercise bikes 21 11 28 17 2013 % 13 2 21 11

This is the sort of quick, 'back-of-an-envelope' calculation you can do with your calculator onto the question paper that will help enormously when it comes to planning your answer. Other points to note are the steep rise in administration and distribution costs, but the fall in promotional spending. Where is all of this money being spent, if not on promotions? Might this be related to the falling sales volumes? The increased borrowing for capital expenditure has resulted in high interest costs. The end result is a sharp fall in pre-tax profits.

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(a)

1 mark for each relevant point: up to 4 marks for the evaluation of each product type up to 4 marks for evaluation of position of overall company 2 marks per relevant model correctly used, up to 4 marks 2 professional marks available, to be given if the answer follows a clear structure and presents scenario information that is congruent with conclusions raised

...up to a maximum of 25 marks. Current strategies of Ace Bicycle Company (ABC): National producer of four types of bicycle in the UK. Forecast profits for 2012 are 82% lower than actual profits for 2010: falling gross margin % on all four types of bicycle falling sales volumes of three of four models in UK increasing cost base, exacerbated by interest cost of loan taken for capex.

Four different models marketed in four different ways.

Possible models to use to evaluate the different product groups of ABC: Porter's Generic Strategies: ABC attempting cost leadership, low focus with mountain bikes and standard bikes. ABC attempting differentiation, high focus with racing bikes and exercise bikes. Unlikely that either strategy can work properly for ABC due to rising cost base and multiple marketing strategies (discussed below), risk of being 'stuck in the middle'.

BCG matrix: Low market growth High market growth

High market share

Cash cow Racing, Mountain?

Star

Low market share

Dog Standard Mountain

Problem child Exercise

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[NB: Other models, such as Ansoff's Matrix and the product lifecycle, could have been used here to gain marks.] Evaluation of the performance of the four product groups and their contribution to overall company results: Mountain bikes: Marketing strategy focused on low prices. 75% of products sold carry ABC brand, therefore ABC brand seems valuable in this segment. Small increase in selling price per unit at expense of large fall in volume suggests highly elastic, price sensitive market. Direct cost per unit rising faster than selling price per unit. This is likely to get worse as foreign competitors enter market. ABC must change direction for this segment else mountain bikes will become as unprofitable as standard bikes very quickly.

Standard bikes: Largest segment in terms of sales volume, but lowest profitability for ABC in both absolute and relative % terms. 75% of bikes sold through retailer own-brand: little recognition of ABC brand in this sector high retailer power over ABC for price reductions this power will be intensified by increasing foreign competition for this easy-to-produce product.

This segment has no growth potential in UK, if ABC is to stay here in the long-term it has to produce units for lower cost, probably in and close to the growing markets in Far East. Withdrawal in UK might have negative consequences for retailer relationship and workforce unless it is carried out gradually and thoughtfully.

Racing bikes: This segment accounts for 78% of forecast gross profit for 2013. This segment is cross-subsidising the other three. Premium prices account for higher profitability: successful high-quality-driven, working well product differentiation strategy

combined with direct sales to customers, cutting out retailer middle-man.

Probably low growth potential in UK but ABC racing bikes might be able to be successfully promoted overseas (particularly in Western Europe, where bike races are far bigger events than in UK). Prices rising slower than costs, but better strategic emphasis on racing bikes might combat this.

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Exercise bikes: Small volume niche market at present. Sales volumes falling though fitness industry is growing quickly, why is this? No obvious reason why ABC cannot design and sell other items of fitness equipment to gyms (product devt), or sell exercise bikes to consumers via other retailers (market devt). Product devt offers opportunity to deepen relationship with large gym chains. Possible leverage of ABC's racing bike brand name to exercise bike equipment to increase selling price per unit with intelligent promotion.

Overall position of ABC: ABC brand not yet damaged much by lower-quality mountain and standard bikes, as evidenced by successful differentiation to racing bike segment. Costs are rising far more quickly than inflation (suggested by selling prices) across the board for ABC - proper analysis of the drivers behind these cost increases is vital: distribution costs have risen 43%, why? promotion costs have fallen 20%, this is dangerous as ABC should be focusing on improving brand image of racers admin costs have risen 33%! No obvious reason for this.

Unlikely that competitive strategies can work properly for ABC due to rising cost base and multiple marketing strategies, risk of being 'stuck in the middle': cannot provide sales volumes or cost savings for cost leadership in standard and mountain bikes is not currently spending enough on promotion or product development for real success in racing bike or exercise bike market niches brand equity risk of continuing to sell average quality mountain bikes with ABC brand. 25 marks maximum

(b)

Up to 2 marks for each well-made, relevant point: up to 8 marks for a discussion of sales volume and cost drivers for move up to 6 marks for a discussion of other factors that must be considered

...up to a maximum of 13 marks. Key factors that should be taken into consideration before ABC decides to develop manufacturing or assembly operations in China: Main drivers of move These are high demand and lower labour and distribution costs for Chinese operations, each factor should be carefully analysed.

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Demand for bikes may seem higher, but are they the same as the bikes manufactured by ABC? Standard, mountain or racer? Cost of changes to design or components may wipe out a lot of any short-term contribution gains from selling in China. Besides, high demand does not equal high sales, ABC has no experience of marketing in China. Labour costs may be lower, but they are only 25% lower than UK. Also, productivity of Chinese workers may be lower than British workers, wiping out some of the benefit of lower wage rates. Distribution costs may be lower if made and sold in China, but China is a vast country and internal distribution costs will therefore be much higher than in the relatively tiny UK.

Other factors to consider Political barriers to foreign investment in China are very high. Cultural risk and language risk is also very high for a company with no experience of trading overseas. The quality levels of component suppliers in China is likely to be much lower than that of UK suppliers. Significant risk over security of intellectual capital if ABC decides to risk making or selling racing bikes in China. Highly questionable as to where ABC would source necessary financing for providing plant and equipment in China in its current financial position. 13 marks maximum (c) 1 mark for each relevant point: up to 4 marks for discussing benefits of organic growth up to 4 marks for discussing benefits of acquisitions up to 4 marks for discussing benefits of joint development

...up to a maximum of 12 marks. Benefits of organic growth: ABC has operational independence if acting alone. The rate of expansion is slower and managed more gradually via organic growth. ABC profits are all ABC's, and do not have to be shared. No risk of ABC organisational cultural clash with organic growth. Better security of intellectual capital than joint development.

Benefits of acquisitive growth: Quickest method of market entry. Good way of sidestepping barriers to market entry.

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Possible asset-stripping opportunities to help finance acquisition. Acquiring local managers may help reduce cultural or language risks. One less local competitor to deal with.

Benefits of joint development growth: Costs of market entry can be shared with a partner organisation. Cooperating with a local partner can help sidestep political barriers to expansion into a foreign country. Good way to share specialist knowledge or local knowledge with a partner. Access to partner's network of local contacts. Quicker market entry than organic. One less local competitor. 12 marks maximum

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Question 2

Tutorial help and key points

Be careful that you understand exactly what you are being asked to do in the two parts of this question so as to avoid repetition or answering the wrong part of the question, neither of which will score marks. Part (a) is asking you to acknowledge the disagreement between Connie Head and the senior partner, and to discuss good and bad points about appraisal systems in helping the organisation as a whole hit its organisational objectives. Be careful to give a balanced response here. Part (b), by contrast, is asking you to suggest ways in which appraisal systems might be linked to formal strategic management processes. Think about the implementation of strategy to help you.

(a)

2 marks for each well-made, relevant point: up to 10 for arguments in favour of an effective appraisal system helping the accounting firm achieve its goals up to 6 for arguments against an effective appraisal system helping the accounting firm achieve its goals

...up to a maximum of 15 marks. How an effective appraisal system might help the accounting firm achieve its goals: Appraisal can allow personal goals to be explicitly linked organisational goals through Management by Objectives (MBO). Individual performance can be assessed in a fair and rational way: a fair method of allocating rewards allows career planning by individual rational method of succession planning for organisation. of organisational and personal goals is to

A shared understanding motivating for staff: -

participation in setting targets shows respect and value to staff motivation enhanced by challenging yet achievable targets.

Learning by staff requires knowledge of agreed objectives. Provides tangible evidence of the return on investment from training and development expenditure. Appraisal systems help give structure to personal career development: encourages personal responsibility over career development

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allows organisational goals to be integrated with CPD goals of individual accountants.

How an effective appraisal system might not help the accounting firm achieve its goals: Senior partner is against system at present, this may reduce the system's effectiveness unless overcome. Reasons that appraisal systems may not work well include: uncertainty as to their purpose a refusal to resource the system, in terms of allowing managers and staff time to complete forms and hold meetings.

Some organisations take a short-termist approach: unwilling to tolerate failure as an opportunity to learn or improve in the future unwilling to view people as anything other than simply costdrivers. 15 marks max

(b)

Up to 4 marks for each relevant point: individual and organisational objectives place in the strategy process feedback and control

... up to a maximum of 10 marks. The contribution of performance management process: management to the strategic

Individual and organisational objectives Appraisal can allow personal goals to be explicitly linked organisational goals through Management by Objectives (MBO). to

Organisational goals can be broken into departmental goals, and these can then be further divided into individual tasks and objectives for staff. Helps to remove subjectivity in the reward and promotion decisions of organisation.

Connection to strategy process Allows human resource management (HRM) to be seen as a strategic adder-of-value in the organisation, rather than an operational nonvalue-adding activity. Explicit connection of individuals to strategic goals helps enhance goal congruence. Formally links together the top and bottom of organisation. Helps make deliberate strategy more tangible and meaningful for those responsible for its implementation.

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Feedback and control Appraisal allows feedback to be given both to the individual, and also upwards to the organisation more generally about team or departmental success in implementing organisational strategies. Communication of organisational and departmental goals, and progress towards achieving them, is enhanced. Individuals, and hence their line managers and departmental managers, can be held accountable for their actions and progress throughout the appraisal period. 10 marks max

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Question 3

Tutorial help and key points

Corporate governance may come up as a topic for the P3 exam, either as a topic in its own right, or as a part of a question on some other topic. Make sure you are prepared to address corporate governance, corporate social responsibility and ethics. Part (a) of the question focuses on the activities of Rex Lord. There should be obvious parallels for you to draw between the actions of Lord and recent corporate scandals, such as MGN, Enron and RBS, to name but a few. Part (b) focuses upon advantages to be drawn by MegaMart from appointing properly independent non-executive directors to the board. Link in textbookknowledge to the scenario facts for good marks here.

(a)

Up to 3 marks for each relevant point: Chairman and Chief Executive roles combined remuneration packages monitoring and control role and independence of auditors communication

...up to a maximum of 15 marks. Corporate governance issues raised by the management style of Rex Lord: Lord is both chief executive of MegaMart and also Chairman of the MegaMart board: there ought to be a division of responsibilities at the board level of any organisation, with separate people performing these two roles the Chairman of the Board should run board meetings, therefore allowing non-executive directors to properly hold executives to account for their actions an independent, non-executive Chairman can also ensure that communication is full, complete and unbiased towards the nonexecs, thus giving them the ability to perform their roles properly.

Remuneration of Lord (and presumably other directors too) looks suspicious and lacks transparency: shareholders 'asking questions' about Lord's lavish lifestyle a remuneration committee of independent non-execs should set performance-related remuneration packages ww w. st u d yi n t e ra ct i v e . or g

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the packages of all directors should be audited and fully disclosed in the annual report.

Monitoring and control of board activities is not taking place effectively there is no way that the problem of agency theory in respect of Lord's stewardship of MegaMart is being addressed Lord has 'almost total control' over the board - few, if any, of his decisions are questioned shareholders cannot have confidence that Lord's decisions are being properly scrutinised or challenged.

There is questionable activities occurring with audit in MegaMart: the external auditors have been providing advisory services on the acquisition activities of MegaMart their independence and ability to scrutinise MegaMart's financial results is therefore brought into question additionally, there is no mention of any internal audit in MegaMart - therefore no assurance for the board that internal control mechanisms throughout MegaMart are operating effectively.

Communication between Lord, MegaMart's board and shareholders is poor: Lord deliberately keeps communication to a minimum implied in scenario that lots of rumours around MegaMart are proliferating, this is usually a symptom of poor communication proper communication is necessary for shareholders (particularly large institutions) to exercise votes at AGM in an informed, responsible manner. Maximum of 15 marks overall

(b)

Up to 2 marks for each relevant point: scrutiny role source of independent thinking role on executive remuneration involvement in audit committee

corporate conscience for corporate social responsibility

...up to a maximum of 10 marks. Advantages MegaMart might gain through the appointment of nonexecutive directors: Independent non-execs can scrutinise the actions of execs: motivates execs to think more carefully about the plans they wish to implement can spot errors recommended. or suggest improvements to strategy

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Non-execs can be a source of independent thinking: execs spend whole working time in one organisation, can lead to narrow perspective non-execs usually bring a broad range of experience to their roles.

Non-execs form the remuneration committee for the execs: can insist upon clear performance measurement systems and targets for execs to hit full transparency of exec pay and remuneration can thus be achieved, reducing scope for rumour and 'bad press'.

Non-execs form the audit committee for the organisation: this committee can ensure the accuracy and 'true and fair view' of all formal communications from the board, including press releases and the annual report the audit committee also helps to enhance the risk management of the organisation by monitoring an internal audit function, thus enhancing control.

Corporate social responsibility is increasing in importance in modern world: non-execs can hold execs to account for social responsibility and ethical standards of the organisation, performing a 'conscience' role for the board this improves the reputation of the organisation, and reduces reputational and legal risk of organisation. Maximum of 10 marks overall

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Question 4

Tutorial help and key points:

This is an interesting question where three topics have to be related to the scenario. Part (a) needs a discussion on the key stakeholders of the school. The Mendelow stakeholder mapping matrix is a useful tool to do this. The introduction of e-learning will require change management strategies participation, education-communication, power/coercion, manipulation and negotiation. Knowing which particular strategies to use for each of the stakeholders will be important in implementing the new system. Part (b) requires you to talk about the usefulness of the balanced scorecard model as a method of measuring performance against the expectations of the key stakeholders.

(a)

1 mark for each relevant point: up to 6 marks for Mendelow's Matrix up to 8 marks for change management strategies

...up to a maximum of 13 marks. Approaches the senior management team could use to reconcile the different stakeholders and their views of e-learning: Stakeholder groups and Mendelow's Matrix There are several stakeholder groups that Lakeside Business School (LBS) has to try to satisfy in this situation: the main University authorities, the students currently at LBS, school students thinking about attending LBS in the future, the lecturing staff etc.

Each of these groups can be further divided into sub-groups: some lecturing staff embrace the new technology, some resist it some students like the new technology, some prefer more traditional means of study.

Mendelow's Matrix categorises these stakeholder groups according to their relative level of power and interest: key players with high power and high interest must be fully involved in the future strategy of LBS those with little power but a high level of interest are able to influence more powerful groups and should be kept informed those with power but little interest are capable of becoming interested and so should be kept satisfied

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minimal effort is expended on stakeholders with neither interest nor power by categorising the stakeholder groups and sub-groups, LBS can decide its approach to each in helping them (or forcing them) to embrace the new technology.

Change management strategies Different change management strategies exist, and the choice of strategy to use with each stakeholder subgroup is determined by the position of that subgroup in Mendelow's Matrix. The main University authorities are certainly key players here, and if they want the new system to work, then work it must. However, due to the problems LBS faces, it is likely that negotiation and compromise between the authorities and LBS over the timing of the move would be necessary. Staff are in two groups, but because of their importance in delivering classes and the rarity value of their specialist knowledge, they are both relatively powerful: the non-computer literate have to be educated, so that they are convinced of the need for change the computer-literate staff should be involved here so as to help their colleagues to understand and adapt to the new system.

Students have relatively low power over the adoption of the new system, but they are likely to be highly interested in its outcome as it directly influences the quality of their education: it is necessary to communicate with the students, perhaps via their representatives, so that they understand the benefits of the new system and are not tempted to try to agitate and resist it. 13 marks maximum

(b)

2 marks for each relevant point: advantages of using the BS model: financial perspective customer perspective internal process perspective learning and growth perspective drawbacks of using the BS model

...up to a maximum of 12 marks. The usefulness of a balanced scorecard in resolving the problem faced by Lakeside Business School: The BS model Used to set up a set of four performance measurement (PM) perspectives for the organisation.

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Financial perspective All organisations, including university departments, need financing to fund their strategies, the financial perspective helps to control this. LBS can use financial PM data to help assess the cost-benefit profile of the new system, and perhaps to justify additional funding from the main university authorities to help implement the system if necessary: for instance, extra lecturers might be useful in providing 'breathing space' for lecturers to update their material and learn the new system.

Customer perspective The students of LBS are the 'customers' in this situation. LBS has been tasked with increasing its student numbers, which means convincing school students to join. By having student satisfaction, retention and attraction PM systems in place, LBS managers can increase the chances of success with this task.

Internal process perspective The move to e-learning will have a significant effect upon the 'internal process' of LBS, ie the processes of educating its students. It is important that LBS has internal process data to evaluate the effect of the new system upon student learning so as to ensure student success is maintained and enhanced.

Learning and growth perspective It is important that LBS retains and enhances the intellectual capital of its department, which means taking care over upsetting significant parts of its lecturing staff. Measures such as staff satisfaction and staff turnover would help in ensuring that the future prospects of LBS are not harmed by the new system.

Drawbacks of balanced scorecard approach: Although the BS model will confirm that the adoption of the new system is a good idea, and will help to maintain its effectiveness postimplementation, it will not be particularly helpful in addressing the issues LBS currently has. Project management models would be more useful in terms of helping to plan a phased rollout of the system to all courses and lecturers whilst minimising disruption to student studies. 12 marks maximum

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