May 2006 Examinations
Paper P10 – Test of Professional Competence in Management
Accounting
Question Paper
Examiner’s Answers
2
28
The answers published here have been written by the Examiner and should provide a helpful
guide for both lecturers and students.
 2006 The Chartered Institute of Management Accountants. All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recorded or otherwise, without the written permission of the publisher.
 The Chartered Institute of Management Accountants 2006
25 May 2006 – Thursday Afternoon Session
Instructions to candidates
You are allowed three hours to answer this question paper.
You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, make
annotations on the question paper. However, you will not be allowed, under
any circumstances, to open the answer book and start writing or to use your
calculator during the reading time.
This booklet contains the examination question and both the pre-seen and
unseen elements of the case material.
Answer the question on page 16, which is detachable for ease of reference.
The TOPCIMA Assessment Matrix, which your script will be marked against,
is on page 16.
Maths Tables and Formulae are provided on pages 23 to 26.
Write your full examination number, paper number and the examination
subject title in the spaces provided on the front of the examination answer
book. Also write your contact ID and name in the space provided in the right
hand margin and seal to close.
Contents of this booklet:
Page
Pre-seen material – Zubinos coffee
shops
2
Pre-seen appendices 1-4
10
Question requirement
16
Assessment Matrix
17
Unseen material
18
Maths Tables and Formulae
23
P10 – Test of Professional Competence in Management Accounting
P10 – Test of Professional Competence
in Management Accounting
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May 2006
Zubinos Coffee Shops
Market overview
The number of chains of coffee shops in the UK has increased four-fold in the last five years,
with thousands of branded coffee shops now operating around the UK. The total turnover for all
branded coffee shops in the UK exceeded £1 billion (£1 billion is equal to £1,000 million) during
2005. Over the last few years a number of UK based branded coffee shops have emerged to
compete with the internationally recognised coffee shop brands.
A further shift in the market growth is that the coffee bar culture has extended beyond the UK’s
major cities and is now successfully penetrating smaller towns. This has mainly been driven by
the larger of the coffee shop brands. Consumer awareness of branded coffee shops has also
increased in the last few years.
The range of products offered has also changed over the last few years and branded coffee
shops are now meeting customer demand for a larger range of foods and better quality products
by using premium ingredients. Furthermore, branded coffee shops are able to command a
higher average price for their products by using quality and service as differentiators, as price
appears not to be a particularly sensitive factor.
In addition to the branded coffee shops, there is a large number of non-specialist food and
beverage outlets including department stores, supermarkets and bookshops, which continue to
expand their own cafes. They are enjoying the success of the “coffee culture” that has been
established by the branded coffee shops.
Market research is very important in this fast moving consumer driven marketplace and the
over-riding factor that continues to be the most important reason that consumers select a coffee
shop is its convenience of location. There were over 500 branded coffee shops in London at the
end of 2005.
Zubinos’ personnel
The career histories of Zubinos’ Directors and key employees are shown in Appendix 1 starting
on page 10.
The first Zubinos coffee shop
On returning to the UK in early 2001, Luis Zubino, the founder of Zubinos, bought a flat in
London and set about locating suitable premises for his new business venture. His original plan
was to have over five coffee shops opened within five years and he wanted the cash generated
from each coffee shop to finance the opening costs for the next coffee shop. He had put
together a business plan to get a personal loan, which was secured on both his own flat and his
parents’ house. This loan, together with his savings, was used to acquire £300,000 of equity in
Zubinos.
Zubinos was formed in March 2001 with 2 million authorised shares of £1 each, of which
300,000 shares were allocated to Luis Zubino and these shares were fully paid up at par value
in March 2001. At the time these shares were issued, £1 per share at par value was considered
a fair value.
Luis Zubino opened the first Zubinos shop in June 2001 in London, in rented premises. He fully
understood that it was location and convenience that would be critical to the success of the
coffee shop. He had been lucky in being able to rent a large corner shop on a busy junction,
which was surrounded by offices and on the route to nearby public transport, thereby having the
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benefit of many passers by. Luis Zubino hired a large number of staff to ensure good customer
service and to minimise waiting times during peak busy periods such as lunch breaks.
Most coffee shops only serve a selection of hot and cold drinks and a small range of snacks and
cakes. What distinguished Zubinos from many of the other branded coffee shops back in 2001,
was that Zubinos also sold a range of freshly made sandwiches, with high quality fillings and
other food items. Zubinos also sold a specialised brand of ice cream, which Luis Zubino
imported from Italy, as he considered that the quality and taste was far superior to many other
ice cream brands available in the UK. He was convinced that ice cream, which is a product that
is kept frozen, could generate high margins, as it would have very little waste and none of the
problems associated with the short shelf life of other foods.
Within six months, the first Zubinos shop was generating a high turnover and had established a
high level of repeat business. Zubinos became a popular meeting place. The level of
profitability was below plan as more staff had been employed to meet demand and Luis Zubino
considered that he did not want to lose customers’ goodwill by increasing waiting times to be
served. By December 2001, he handed the day-to-day management of the shop to Val Pline,
who had proved herself to be the hardest working and most trustworthy of all the staff employed
at the coffee shop.
Luis Zubino briefed Val Pline on his plans for the shop for the next few months and agreed to
pay bonuses to her when the turnover reached a certain level and again when net profit (after
staff and fixed costs) reached £100,000 in any financial year. Val Pline was impressed with the
business plan and her new responsibilities. Only six months previously, she had joined a coffee
shop with limited experience and now she found herself running the coffee shop with the
possibility of earning bonuses when it became even more successful.
The growth of Zubinos
Within two and a half years, by the end of 2003, Luis Zubino had opened a further five coffee
shops, which was twice as fast as his original business plan had envisaged. All five shops were
in rented premises to reduce the initial set-up costs, but Luis Zubino had not reduced the level of
expenditure on the coffee shops design and fittings. The atmosphere that the coffee shop
design had created was good, and was attractive to the target market of young people. Early
on, from his market research, and from personal experience in his parents’ business, Luis
Zubino wanted his coffee shops to appeal to the 20-to-35 year old age range. This was for
several reasons:
•
The target age range market segment has more time and more disposable money;
•
They attracted other people of similar ages into the coffee shops, as they become the
place to meet up;
•
The target age range would be attracted to the “trendy” atmosphere that Luis Zubino has
created at Zubinos.
Luis Zubino wanted to expand the number of Zubinos coffee shops, but could not find suitable
premises to rent in the locations he wanted. By mid-2004 he appointed a management
consultancy firm for financial planning advice on how he could expand the business. Zubinos
had only been in existence, at that stage, for fewer than four years.
The consultant with whom he dealt with was George Shale, and the two quickly established
good rapport and worked well together. It was George Shale’s idea to open only a few more
Zubinos coffee shops in the London area where sites were difficult to obtain and rent very
expensive. George Shale recommended that Zubinos should start to expand into towns and
cities elsewhere in the UK where shop location would not be such a problem, rather than
continue to expand within the fiercely competitive London market.
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When Jane Thorp joined Zubinos in early 2003, she could immediately see the large potential of
the Zubinos brand. By the end of 2003, Zubinos had six shops operational with plans for four
further shop openings in 2004. Eight further shops were opened in 2005, resulting in eighteen
coffee shops in total operational by the end of 2005. The geographical split of Zubinos coffee
shops was ten in London and eight coffee shops outside of London. Zubinos has not had any
problems with building up its customer base after each new shop opening in the smaller towns
and cities into which it had expanded.
George Shale also suggested that Zubinos could consider opening Zubinos coffee shops on the
premises of another retailer. He undertook to try to locate a chain of retailers who would rent
out part of their shop space. This has been done with other coffee shop chains, which have
coffee shops located in motorway service areas and chains of bookshops. Luis Zubino liked the
idea of a Zubinos coffee shop in a chain of other shops and a search for a suitable retail chain
started in May 2004. However, with the expansion of Zubinos into eight provincial towns and
cities, Zubinos has not yet pursued the identification of a suitable retail chain into which it could
open Zubinos coffee shops.
The Zubinos business has a high turnover. However, profitability was still lower than some of its
competitors, for several reasons as follows:
•
High rental costs for three of the ten London coffee shops;
•
High staff costs, as good customer service remains a high priority for Zubinos;
•
Lower than average gross margins on some products due to the higher than average
procurement cost of the quality ingredients that Luis Zubino has selected;
•
Lower margins on coffee products as over 80% of its coffee beans are procured from
suppliers who deal only with “Fair Trade” coffee producers (see below).
Staffing issues and performance related bonuses
Luis Zubino was kept very busy with expanding the Zubinos business and left each of the coffee
shop managers alone to run each Zubinos coffee shop. Most management responsibilities were
devolved to the shop managers, who were responsible for local procurement of food supplies,
staff recruitment and day-to-day staff management.
Vivien Zubino, Luis Zubino’s wife, managed one of the London Zubinos coffee shops after they
married in 2002. She also undertook much of the procurement of coffee supplies, together with
Jane Thorp, until the full time Procurement Director, Maria Todd, joined Zubinos in September
2004. However, there were often duplication of orders or gaps in delivery of supplies as both
Jane Thorp and Vivien Zubino were constantly busy with other responsibilities.
Payroll was operated by an out-sourced agency centrally and Luis Zubino managed all other
staff issues. It was only with the appointment of Anita Wiseman in November 2004, that human
resource (HR) matters were undertaken centrally. Zubinos employed over 360 staff (some part
time) by 31 December 2005.
Anita Wiseman wants to formalise job responsibilities and recruitment and ensure that staff are
offered promotion in newly opened branches of Zubinos. Following on from the dismissal of
three employees during 2005 for minor thefts, of both produce and cash, she also suspected
that staff management and the required control procedures were not in place in the coffee
shops. Coffee is a high value product and one employee was dismissed for selling stolen bags
of coffee beans. This theft was only identified because he had been foolish enough to steal,
and then sell, the bags of coffee beans on the premises of the Zubinos coffee shop in which he
worked. A fellow employee had reported the incident to Luis Zubino.
Anita Wiseman has introduced quarterly performance related bonuses for all employees based
on the sales revenue and the net margin for each coffee shop. The bonus is paid quarterly to
recognise the previous quarter’s results and to motivate staff to stay with Zubinos, so reducing
the high staff turnover. However, the bonuses paid for the last two quarters of 2005 were lower
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than previously paid, as the targets were more challenging. Some coffee shop managers and
other employees were disappointed with their reduced bonus payments despite working as hard
as ever over the Christmas 2005 period.
Fair Trade produce
Luis Zubino, having a strong social conscience, felt that the coffee beans that Zubinos coffee
shops should use should be bought from suppliers of Fair Trade coffee. Additionally, from his
initial research into the industry, he was convinced that Zubinos could charge a price premium
for the use of Fair Trade coffee.
Fair Trade benefits 800,000 farmers worldwide selling a wide variety of products. Farmers are
organised into small co-operatives, whereby products are procured at an agreed minimum price,
which is above the price that some small independent farmers would be able to achieve for their
crops on the open market. Fair Trade produce is successfully breaking the cycle of poverty for
farmers in many countries and the coffee industry is one where Fair Trade has been very
successful. Luis Zubino felt strongly that in today’s world where consumers are demanding
more humane and more environmentally sensitive products, the use of Fair Trade coffee in
Zubinos coffee shops is a responsible and sensible choice of supply.
From the opening of the first Zubinos in 2001, Luis Zubino bought 100% of all coffee from Fair
Trade suppliers. As the range of coffees expanded in Zubinos coffee shops, he found that some
coffee and cocoa beans were unavailable through Fair Trade suppliers. On average, Zubinos
procures over 80% of its produce from Fair Trade suppliers. Luis Zubino would still like this to
be 100%. When Maria Todd joined in September 2004, Luis Zubino requested her to increase
the proportion of coffee supplies procured from Fair Trade suppliers. This necessitated a
change from some of its current suppliers to achieve this objective. The extensive use of Fair
Trade coffee is used in some of Zubinos’ marketing literature, and it has raised the profile and
awareness of Fair Trade with some of its customers.
IT development
Jane Thorp commissioned an IT company in early 2005 to completely update the Zubinos
website. The total cost of this IT work was forecast to be £220,000, but the final cost was a little
over £300,000 including new hardware equipment. The new website has helped to create
stronger brand awareness. The new Zubinos website also has an on-line communications area
which allows users to “chat” on line. Since November 2004, a range of Zubinos merchandise
can also be ordered on-line. This range of merchandise includes coffee machines and coffee
supplies, which have been selling well, despite little direct publicity.
George Shale is continuously frustrated by the lack of financial and business information in a
usable format. The company had grown fast and he has prepared several proposals requesting
that a new database financial forecasting system is implemented. He also wants the shop
managers to be more involved in sales and profit forecasting and the system that he had
proposed would allow shop managers to input their data for consolidation. However, Luis
Zubino felt that the shop managers are already under a heavy workload and that the quality of
the data that they could input into the proposed system would be little better than that currently
submitted by e-mail to Zubinos Head Office. The current standard of forecasting by shop
managers is not very good and has generally underestimated the growth in sales. The
database proposal has been turned down previously on cost grounds, as Luis Zubino considers
that the cost does not justify the slightly improved level of forecasting.
However, a new IT system to capture sales and product analysis data at source, which will also
help with stock control, was commissioned in October 2005. This project has been scaled down
from the original specification and is forecast to cost £110,000.
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Introduction of a business investor
By summer 2004, Zubinos had eight coffee shops open and had found suitable locations for two
more. However, Zubinos’ bankers, Kite Bank, were reluctant to increase the level of loans. At
the end of June 2004, Zubinos had three loans in place, totalling £600,000. All loans were at
12% interest per year. These were:
•
An initial five-year loan for £300,000 taken out in December 2001;
•
A second five-year loan for £200,000 taken out in December 2002 to fund further
expansion;
•
A third five-year loan taken out in April 2004 for £100,000, to cover a shortfall in working
capital due to all cash resources being used for expansion.
Instead, the bank introduced Luis Zubino to the manager of the bank’s private equity provider,
who is Carl Martin. Carl Martin and Luis Zubino established a good working relationship early
on in their business meetings and Carl Martin was impressed with the business plan and the
growth of the Zubinos business in the last few years. He felt confident that if Kite Private Equity
(KPE) were to invest in the Zubinos business, the additional private equity finance, together with
less expensive loan finance, would allow the Zubinos business to expand far more rapidly.
After many discussions and the preparation of additional, more detailed business plans, KPE
agreed to invest in the Zubinos business in January 2005.
KPE invested £2⋅4 million in equity finance initially, but the agreement was to also provide loan
finance when required by expansion plans. The agreed value of loan finance was up to
£5⋅0 million over the next 4 years at an annual interest rate of 10% per annum, secured against
Zubinos assets. KPE appointed Carl Martin as its representative on the Board of Zubinos.
The balance sheet, income statement and statement of changes in equity for Zubinos for the
last two financial years are shown in Appendix 2 on page 13.
Shareholdings at December 2005
Since the formation of Zubinos in 2001, other Directors have purchased shares in Zubinos.
They have paid between £2 and £5 per share, based on the agreed fair value at the time they
acquired shares.
Luis Zubino and the rest of the Zubinos shareholders welcomed KPE into the business. KPE
purchased 400,000 shares at £6 each (£1 each plus a share premium, based on an agreed fair
value, of £5 per share). The shareholdings at 31 December 2005 are shown below.
Luis Zubino
Vivien Zubino
Jane Thorp
Maria Todd
Anita Wiseman
George Shale
KPE
Total shareholdings
Number of shares
300,000
120,000
30,000
24,000
36,000
90,000
400,000
1,000,000
% shareholding
30.0%
12.0%
3.0%
2.4%
3.6%
9.0%
40.0%
100.0%
The Zubinos Board comprises the above six shareholders plus Carl Martin, KPE’s nominated
representative. Luis Zubino is Chairman of the Board in addition to his role as Managing
Director.
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Analysis of gross margin
George Shale commissioned a new IT system in October 2005 that will capture and analyse
sales and cost of sales data without all of the manual intervention and spreadsheet analysis that
is currently required to produce management information. The system is due to be operational
in early 2006.
The analysis of the gross margin across the eighteen Zubinos coffee shops for the year to
31 December 2005 is shown as follows. It should be noted that the figures below are for all
eighteen Zubinos coffee shops, but eight of them were operational for only part of 2005.
Sales revenue
Coffee
products
Other
drinks
Sandwiches
Icecream
Other
foods
Total
£000
£000
£000
£000
£000
£000
4,734
1,344
3,584
896
3,360
13,918
926
642
1,260
182
1,962
4,972
3,808
702
2,324
714
1,398
8,946
80%
52%
65%
80%
42%
64%
Cost of food & drinks
Gross margin
Gross margin %
Zubinos’ expansion plans
The current five-year plan was approved by KPE, and subsequently the Zubinos Board, in
December 2005. This plan includes the expansion of Zubinos to 75 coffee shops by the end of
2010. An extract from this current five-year plan is shown in Appendix 3 on page 14.
Much of the expansion planned is due to be financed by cash generated by operations, as well
as additional loan finance from KPE. The amount of loan finance will be determined by whether
the new openings will be in rented premises or whether the company will be required to
purchase the site. Much will depend on the location selected and the alternatives available in
each town or city targeted for expansion.
During 2005, eight new Zubinos coffee shops were opened. Up to the end of 2004, all coffee
shops, except one, were in rented premises. Zubinos has previously purchased one property in
London in 2003, in which it has its head office above the coffee shop. During 2005, two of the
newly opened Zubinos coffee shops were in large premises that had been purchased, as Luis
Zubino was unable to locate a suitable site that could be rented. The cost of the two coffee
shops that were purchased were over £1 million each, including the shop fitting costs.
Jane Thorp uses a number of criteria for the selection of new sites for future Zubinos coffee
shops. These include:
1.
Competition – the strength of the competition in the proposed market place and whether
the competition will stimulate growth, but not be too strong so as to restrict profits.
2.
Resources. Whether there are adequate resources, staff and supply links to set up a new
coffee shop.
3.
Consumer demand. Is there sufficient demand for a Zubinos coffee shop and what is the
current level of demand and how is it being met? A further issue is whether the area has
the income to create profitable demand for Zubinos.
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Some relevant factors in the Zubinos expansion plan are the population size and the population
density. When population becomes concentrated it often tends to take on a different character.
Urbanisation produces the need for a higher level of products and services. Jane Thorp uses a
number of easy measures such as the presence, or absence, of well-known chains of clothes
retailers, to determine the potential for a new coffee shop location.
Jane Thorp had prepared a paper for the December 2005 Zubinos Board meeting, proposing
that each Zubinos coffee shop should have a few computers available for customers’ use, for
browsing on the internet or for passing business people to send e-mails. The proposal is for the
computers to be available free of charge for all customers. The Board considered the proposal,
but decided against it for several reasons, not just on cost grounds, but on space considerations
and also concerns over damage or theft. Luis Zubino stated that Zubinos did not need to offer
its customers such facilities, as Zubinos coffee shops already were very busy at peak times.
Jane Thorp is confident that this innovative free service is a good way of retaining customer
loyalty and for attracting new customers.
Labelling of foods
One of the London-based Zubinos coffee shops had just broken the barrier of sales of £1 million
in a rolling 12 month period. The manager at this coffee shop decided to try to increase sales
further by introducing additional nutritional data for some food and drink products. The coffee
shop manager decided, without consulting anyone, to display the calorie information as a ploy to
improve sales. However, when she calculated and displayed the calorie content of many of the
coffee products and foods, she was disappointed to find the calorie content very high. Many
customers were also very surprised and switched to other drinks and did not purchase any
cakes or pastries. This led to a small reduction of sales revenue.
This Zubinos coffee shop manager then started a new initiative during summer 2005 in the
Zubinos coffee shop in which she manages. She introduced a small range of low fat and low
calorie snacks and meals, which proved to be very popular. However, when this was discussed
with Jane Thorp in Marketing, a major disagreement arose concerning the range of foods that
Zubinos should be offering, and Jane Thorp’s view that there should be a standard menu at all
Zubinos coffee shops. The manager was furious that Zubinos Head Office had not welcomed
her low calorie meal initiative.
Other recent developments in the Zubinos business
In April 2005, Zubinos introduced its first delivery service from three of its central London coffee
shops. This delivery service to local businesses provides coffee and a catering service on
customers’ premises. Customers place orders on-line to their local Zubinos coffee shop.
Despite a few initial problems, the delivery service is working well, although sales are still very
low. Customers are automatically invoiced after delivery, instead of the usual cash payments in
the coffee shops. There has been some additional work caused by payments received not
matching with the invoiced amounts, and shop managers have simply written off the small
differences. There is no system yet in place to chase up payment for deliveries if the customer
does not pay within Zubinos’ 30-day terms.
Zubinos wants to continue to be innovative and to be ahead of its competitors in terms of the
types of foods offered. Jane Thorp and Maria Todd are in contact with a number of food
manufacturers to explore offering a wider range of foods. They need to ensure that any new
food ranges fit in with Zubinos’ current pricing and food quality levels.
Proposed expansion of Zubinos overseas
Jane Thorp and Luis Zubino believe that during 2007, when Zubinos plans to have over 26
shops open in the UK, it will be in a position where it could consider expanding overseas.
Already, a number of contacts of Luis Zubino, who live in Europe, are keen to operate Zubinos
coffee shops in Europe.
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The current five-year plan, which was approved by KPE and the Zubinos Board in December
2005, is based on operating 50 coffee shops in the UK by 2010 and 25 coffee shops in Europe.
However, Luis Zubino would like to have more than 25 coffee shops operating in Europe by
2010. There are a number of reasons why Zubinos should consider expanding abroad and
these include:
•
Saturated home market where competition is so intense that it can no longer gain any
significant market share improvement;
•
Competition may be less intense in a different market;
•
Comparative advantage in product against local competition, particularly in areas
dominated by British people living and holidaying abroad, which is becoming increasingly
popular in some areas of Europe, especially Spain.
Appendices follows on pages 10 to 15
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Appendix 1 (Page 1)
Zubinos’ personnel
Luis Zubino – Chairman and Managing Director
Luis Zubino, now 29, had worked in his parents’ café for two years after he left school. He did
not want to go to university and instead saved enough money to travel extensively. He is an
intelligent man, who has his father’s entrepreneurial spirit. After spending several years abroad,
he returned to the UK in 2001 and established Zubinos.
Vivien Zubino – Director
Vivien Zubino, now aged 30, married Luis Zubino in 2002, after the opening of the first Zubinos
shop. She is a director of Zubinos and now works part time at one of the Zubinos coffee shops
in London. She has assisted her husband in achieving his ambitious plans and has helped to
create the designs for the Zubinos coffee shops and also some of the innovative menus
available at Zubinos coffee shops. She has always supported her husband and his ideas, which
has contributed to the high growth achieved to date. Vivien Zubino purchased shares in
Zubinos during 2002.
Jane Thorp – Marketing Director
Jane Thorp was the first professional appointment that Luis Zubino made in early 2003. He
knew by then that Zubinos had the potential to be successful, and understood the importance of
branding, and the company needed a strong Marketing Director. Jane Thorp had previously
worked in marketing for a mobile phone company and more recently for a leading high street
fast food chain, which she did not like. Jane Thorp, aged 32, relished the challenges that
Zubinos posed and was determined to help both Luis and Vivien Zubino to create a successful
business. She invested personal funds into the company in 2003 when she bought 30,000
shares, which was then nearly 7% of the issued share capital.
Maria Todd – Procurement Director
Maria Todd, now 35, had worked in procurement for an international food retailer and was
frustrated with the lack of initiative she was allowed to use. She had extensive procurement and
contract experience and welcomed the challenges that a growing company, such as Zubinos,
could offer her. Maria Todd invested £120,000 of personal funds to buy shares in the company.
Maria Todd joined Zubinos in September 2004 and is based in its Head Office, which is located
above one of the London Zubinos coffee shops. The first floor above the shop accommodates
around 28 employees including two junior procurement staff. Prior to Maria Todd joining
Zubinos, most of the procurement decisions were made by a variety of people. She is frustrated
by the lack of discipline in the company, as many coffee shop managers still order some
supplies from local food wholesalers to meet demand. The coffee shop managers state that
they need this flexibility to provide customers with the foods in demand. However, Maria Todd
considers that the coffee shop managers are simply not planning their food ordering very well
and are continuously running out of a variety of products. One shop even ran out of the
specially mixed Zubinos coffee beans recently.
Anita Wiseman – Human Resources Director
Anita Wiseman, now 29, has known Luis Zubino since their school days. She has a degree in
Human Resource management and has worked in human resources (HR) for a chain of
department stores before joining Zubinos in November 2004. Prior to Anita Wiseman joining the
company, much of the HR management work had been out-sourced or handled by Luis Zubino,
who had delegated authority for hiring new employees to each coffee shop manager.
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Appendix 1 (Page 2)
Zubinos’ personnel (continued)
George Shale – Finance Director
George Shale, aged 39, had worked for a leading audit group for over 10 years before he
moved into management consultancy. Zubinos appointed the consultancy firm that George
Shale worked for in mid 2004 for financial planning advice. George Shale was the consultant in
charge of the Zubinos case and worked closely with Luis Zubino on a new five-year plan.
George Shale was so convinced by the business plan that he had helped to produce, and in
Luis Zubino’s ability to grow the Zubinos business, that he joined Zubinos in December 2004.
He bought 90,000 shares in Zubinos. Prior to George Shale joining the company, much of the
finance work was managed by Zubinos’ external auditors, and supplemented by temporary
finance staff. Since joining Zubinos, George Shale has recruited a small team and has taken all
accounting and finance matters in-house.
Bob West – Business Planning Manager
Bob West, aged 35, used to work for George Shale at the management consultants and was
recruited by George Shale to fill the new post of Business Planning Manager at Zubinos in June
2005. Bob West has always worked as a consultant and been involved with many young startup business ventures, and has a lot of experience. However, he has not been involved in the
food retailing business before joining Zubinos.
Jack Rayfield – Shop management and security
Jack Rayfield, aged 52, joined Zubinos in 2003 having worked in retail management for the past
20 years. He was recruited by Luis Zubino who considered him to be a reliable hard working
manager who could take care of the day-to-day operations involved with the shops. Since Jack
Rayfield joined, he has introduced many new procedures and tightened up some poor business
practices. One of the procedures that he has introduced is daily banking of cash and
reconciliations to records of revenue for each shop.
Jack Rayfield is very good on HR matters and has played an active role with shop managers in
the recruitment of staff, particularly for new Zubinos coffee shops. However, recently he has
clashed with Anita Wiseman over many issues.
Val Pline and Sally Higgins – Zubinos’ Area Managers
Both Val Pline and Sally Higgins had originally joined Zubinos in junior supervisory roles in its
early days and then progressed to coffee shop managers. In September 2005, they were both
appointed to the new roles of area managers. Val Pline is responsible for all London and the
South East-based Zubinos coffee shops and Sally Higgins has responsibility for all other UK
coffee shops.
They have both received management training and have been rewarded with performance
related bonuses linked to sales revenue and net margins. They are now responsible for the
recruitment and management of all staff for the coffee shops that they manage. Due to high
staff turnover, which is not unusual in this business sector, they have spent much time on staff
recruitment and on staff training issues.
TURN OVER
P10
12
May 2006
Appendix 1 (Page 3)
Zubinos’ personnel (continued)
Carl Martin - Investment Director, Kite Private Equity (KPE)
Carl Martin, aged 39, is the liaison manager at KPE who is responsible for a range of clients into
which KPE has invested equity and loan finance. The companies that KPE has invested in vary
greatly and are operating in a wide range of industries, including manufacturing, service and
retail sectors. Carl Martin was appointed to the Zubinos Board in January 2005, to manage
KPE’s shareholding.
Due to Carl Martin’s demanding role in many other companies, he has left the Zubinos
management team to manage the Zubinos business. He is content that the monthly sales and
profits that had been achieved during 2005 were ahead of the agreed forecast. Therefore, he
has not been as “hands on” as he would have been if targets had not been met. Carl Martin
gets on very well with Luis Zubino, and they both have much mutual respect for each other’s
roles. Luis Zubino appreciates that Zubinos would not have been able to grow as quickly
without the KPE finance and is very pleased that Carl Martin has not really interfered with the
way that Zubinos is run.
May 2006
13
P10
Appendix 2
Zubinos’ Balance Sheet, Income Statement and Statement of changes in equity
Note: All data in this appendix is presented in international financial reporting format
Balance Sheet
As at 31 December 2005
£’000
£’000
Non-current assets (net)
As at 31 December 2004
£’000
£’000
7,025
Current assets
Inventory
Trade receivables and rent prepayments
Cash and short term investments
420
209
391
Total assets
Equity and liabilities
Equity
Paid in share capital
Share premium reserve
Retained profits
2,958
395
124
85
1,020
604
8,045
3,562
1,000
2,630
1,751
600
630
854
5,381
Non-current liabilities
Loans:
Bank loan at 12% (repayable in 2006)
Bank loan at 12% (repayable in 2007)
Bank loan at 12% (repayable in 2009)
KPE loan at 10% (repayable in 2010)
300
200
100
300
2,084
300
200
100
-
900
Current liabilities
Trade payables
Tax
Accruals
1,367
283
114
Total equity and liabilities
600
689
160
29
1,764
878
8,045
3,562
Note: Paid in share capital represents 1 million shares of £1.00 each at 31 December 2005
Year ended
31 December 2005
£’000
Income Statement
Revenue
Total operating costs
Operating profit
Finance costs
Tax expense (effective tax rate is 24%)
Profit for the period
Statement of changes in equity
Share
capital
£’000
Balance at 31 December 2004
New shares issued during 2005
Profit for the period
Dividends paid
Balance at 31 December 2005
600
400
1,000
Year ended
31 December 2004
£’000
13,918
12,651
1,267
-87
-283
7,962
7,225
737
-69
-160
897
508
Share
premium
£’000
630
2,000
2,630
Retained
earnings
£’000
854
897
1,751
Total
£’000
2,084
2,400
897
5,381
Note: For the purpose of the case, it should be assumed that the accounts for the year ended 31
December 2005 are final and have been audited.
P10
14
May 2006
Appendix 3
Extracts from Zubinos 5-year plan
Actual
Plan
2005
2006
2007
2008
2009
2010
10
18
26
36
48
60
8
8
10
12
12
15
End of the year
18
26
36
48
60
75
Average number of coffee shops for
the year
14
22
31
42
54
68
UK
8
8
9
5
5
5
Overseas
-
-
1
7
7
10
£000
£000
£000
£000
£000
£000
13,498
22,176
37,072
57,378
82,553
110,751
420
1,560
2,200
2,900
3,800
4,800
13,918
23,736
39,272
60,278
86,353
115,551
Pre-tax operating profit
1,267
2,160
3,613
5,606
8,203
10,977
Capital expenditure
4,800
2,700
3,400
3,800
4,100
5,000
Number of coffee shops:
Start of the year
New openings
Analysis of new shop openings:
Coffee shops revenue
Revenue from new product
launches in each year
Total revenue
Note: The extracts from the 5-year plan shown above were approved by KPE and the Zubinos
Board in December 2005.
May 2006
15
P10
Appendix 4
UK National News
TUESDAY DECEMBER 20 2005
ZUBINOS is winning a
share of the coffee wars
THE coffee shops chain, Zubinos, renowned
for its choice of coffees and fresh foods,
today opened its eighteenth coffee shop and
is now expanding nationwide.
Managing Director, Luis Zubino
commented “our customers are very
important to us and we provide them with
the coffees that they want and a wide variety
of top quality foods in an appealing
atmosphere”.
Zubinos has eight coffee shops outside
the capital. They are much larger than many
of its competitors’ coffee shops. Zubino
stated, “our customers want to feel as if they
are at home and we have created the
authentic
European
coffee
house
atmosphere. Our sales are growing rapidly,
which confirms to us that our customers like
what we provide”.
It is forecast that sales for 2005 will be
over £14 million, which is nearly 75% up
from sales of around £8 million during
2004.
Zubinos appears to have managed to
compete effectively against the many
coffee shops chains, most of which have
nationwide coverage. However, as Zubinos
expands, the market expects there to be
some consolidation. A leading UK coffee
shop chain, Café Café, recently bought 12
coffee shops from the global coffee shop
chain Whistle.
When asked about Zubinos expansion
plans, Luis Zubino stated, “it is our
intention to continue to expand within the
UK and to open Zubinos coffee shops
overseas in the next few years”.
KPE, the private equity arm of Kite
Bank, is financing much of the Zubinos
expansion. KPE is quoted as being “very
pleased with Zubinos operational and
financial performance to date”.
End of pre-seen material
P10
16
May 2006
Zubinos coffee shops – Unseen material provided on examination day
Additional (Unseen) information relating to the case is given on pages 20 to 24.
Read all of the additional material before you answer the question.
ANSWER THIS QUESTION
You are the consultant appointed by the Zubinos Board.
Prepare a report that prioritises and discusses the issues facing Zubinos and
makes appropriate recommendations.
Note:
May 2006
The TOPCIMA Assessment Matrix, against which your script will be
marked, is on the next page for your reference.
17
P10
May 2006 – Assessment Matrix for TOPCIMA - Zubinos
Criterion
Technical
Application
Diversity
Focus
Prioritisation
Judgement
Integration
Marks
5
10
5
15
10
15
10
Logic
20
Ethics
10
TOTAL
100
Clear Pass
Pass
Marginal Pass
Thorough display of
relevant technical
knowledge.
Good display of relevant
knowledge.
5
Knowledge clearly applied
in an analytical and
practical manner.
9-10
Most knowledge areas
identified, covering a wide
range of views.
5
Clearly distinguishes
between relevant and
irrelevant information.
13-15
Issues clearly prioritised in
a logical order and based
on a clear rationale.
9-10
Clearly recognises
alternative solutions.
Judgement exercised
professionally.
13-15
4
Knowledge applied to the
context of the case.
6-8
Some knowledge areas
identified, covering a range
of views.
4
Information used is mostly
relevant.
9-12
Issues prioritised with
justification.
6- 8
Alternative solutions or
options considered. Some
judgement exercised.
9-12
Marginal Fail
Some display of relevant
technical knowledge.
3
Identification of some
relevant knowledge, but
not well applied.
5
A few knowledge areas
identified, expressing a
fairly limited scope.
3
Some relevant information
ignored, or some less
relevant information used.
8
Evidence of issues being
listed in order of
importance, but rationale
unclear.
5
A slightly limited range of
solutions considered.
Judgement occasionally
weak.
8
Fail
Clear Fail
Identification of some
relevant knowledge, but
lacking in depth.
Little knowledge displayed,
or some misconceptions.
2
Knowledge occasionally
displayed without clear
application.
3-4
Several important
knowledge aspects
omitted.
2
Information used is
sometimes irrelevant.
1
Little attempt to apply
knowledge to the context.
No evidence of knowledge
displayed, or fundamental
misconceptions.
0
No application of
knowledge displayed.
1-2
Many important knowledge
aspects omitted.
Very few knowledge
aspects considered.
0
5-7
Issues apparently in
priority order, but without a
logical justification or
rationale.
3-4
A limited range of solutions
considered. Judgement
sometimes weak.
1
Little ability to distinguish
between relevant and
irrelevant information.
1-4
Little attempt at
prioritisation or justification
or rationale.
1-2
Few alternative solutions
considered. Judgement
often weak.
5-7
1-4
0
0
No ability to distinguish
between relevant and
irrelevant information.
0
No attempt at prioritisation
or justification.
0
No alternative solutions
considered. Judgement
weak or absent.
Diverse areas of
knowledge and skills
integrated effectively.
Diverse areas of
knowledge and skills
integrated.
Knowledge areas and skills
occasionally not integrated.
Knowledge areas and skills
sometimes not integrated.
Knowledge areas and skills
often not integrated.
Knowledge areas and skills
not integrated.
9-10
Communication effective,
recommendations realistic,
concise and logical.
16-20
Excellent evaluation of
ethical aspects. Clear and
appropriate advice offered.
9-10
6-8
Communication mainly
clear and logical.
Recommendations
occasionally weak. 11-15
Good evaluation of ethical
aspects. Some appropriate
advice offered.
6-8
5
Communication
occasionally unclear,
and/or recommendations
occasionally illogical. 10
Some evaluation of ethical
aspects. Advice offered.
3-4
Communication sometimes
weak. Some
recommendations slightly
unrealistic.
5-9
Weak evaluation of ethical
aspects. Little advice
offered.
3-4
1-2
Communication weak.
Some unclear or illogical
recommendations, or few
recommendations.
1-4
Poor evaluation of ethical
aspects. No advice offered.
0
Very poor communication,
and/or no
recommendations offered.
0
No evaluation of ethical
aspects. Unethical, or no,
advice offered.
0
5
1-2
© CIMA – January 2006
Zubinos coffee shops – Unseen material provided on examination day
Read this information before you answer the question
Success of new product line
In early September 2005, Sally Higgins, a Zubinos area manager, introduced a range of low
calorie snacks and meals in one of the shops in which she manages. This initiative had caused
quite a disagreement between Sally Higgins and Jane Thorp, who had not been consulted
regarding the new food and drink items, which Sally Higgins had procured from a small local
supplier.
By October 2005, it was clear that the new low calorie product line was very popular and
accounted for 8% of the turnover for September 2005 in the one shop in which it was
introduced. After some discussion, Luis Zubino and Jane Thorp agreed that the low calorie
product line appealed to Zubinos customers and to offer this new low calorie food range in all
Zubinos coffee shops. Maria Todd was requested to organise central procurement for all the
low calorie food and drink products. Jane Thorp recommended that a suitable marketing
strategy for the low calorie foods would be to have a range of takeaway calorie-controlled meal
boxes, under the brand name of “Zubinos Light” retailing at £3⋅00 each.
The first “Zubinos Light” meal boxes were available in all eighteen Zubinos coffee shops during
November 2005 and immediately became popular. Furthermore, some limited market research
of the customers who bought the “Zubinos Light” meal boxes established that over 95% of these
customers were new Zubinos customers. Jane Thorp was delighted that this new product was
also bringing new customers into Zubinos.
In January 2006, a major advertising campaign, using radio and posters, was commenced, and
was due to run to the end of June 2006 at a total cost of £425,000. By the end of February
2006, Zubinos found that it had become the victim of its own success. All eighteen shops were
almost always sold out of the “Zubinos Light” meal boxes and Maria Todd had been having
numerous procurement problems. The original supplier, ART, was unable to increase the
quantity beyond its contract level of 2,000 boxes a day. A new supplier, BBK, was introduced in
late January 2006, despite Maria Todd’s concern over quality. By the end of April 2006, it was
estimated that over 5,000 boxes per day were in demand and Zubinos was again almost always
sold out. (Note: it should be assumed that there are only 20 days per month for which “Zubinos
Light” meal boxes will have this level of demand, to coincide with normal working patterns).
A further two suppliers are being considered, CCV and DTY. The results from the initial
inspections by Maria Todd and Zubinos’ food agency, and the cost per box quotes, are shown
below, compared to existing suppliers:
Supplier
ART
BBK
CCV
DTY
Excellent
Below
expectations
Below
expectations
Excellent
Excellent
Below
expectations
Very good
Excellent
£1⋅20
£1⋅60
£1⋅10
£2⋅00
2,000
2,000
5,000
8,000
12 months
6 months
6 months
3 months
Food quality
Cleanliness of food
preparation areas
Cost per meal box
Maximum daily capacity
Initial contract period
May 2006
19
P10
Supplier CCV would be only able to supply meal boxes to Zubinos in one geographic area of the
UK, whereas DTY has a supply chain established for nationwide delivery. Maria Todd has not
identified any other suppliers at this time and needs to urgently select a further supplier for the
“Zubinos Light” meal boxes.
Luis Zubino’s planned three month absence
Luis Zubino informed his fellow directors at the end of April 2006 that he is planning to take a
three-month break from the business, following his recent split from his wife, whom he married
four years ago. Luis Zubino’s absence from the business is planned for June, July and August
2006.
Luis Zubino was clearly upset with the break-up of his marriage, which he felt was partly due to
the very long hours that he has spent building up the Zubinos business. Luis Zubino discussed
with George Shale his concern, that if his marriage is not reconciled, his ex-wife could demand a
payment potentially amounting to several million pounds, if they were to get divorced. Any
divorce settlement is likely to be sometime within the next two years.
Management Information
George Shale and Bob West are continually frustrated by the lack of management information in
a usable format. Over the past two years a few new IT systems have been introduced but there
are several inconsistencies between the systems. The monthly management accounts are
prepared using financial data for each shop, but there is little statistical information on
customers, such as repeat customers and customer profile. Also the analysis between main
product types (coffees, food, ice creams, “Zubinos Light” meal boxes) cannot easily be obtained.
George Shale recruited two accountants, on six-month contracts, at the end of March 2006 to
analyse information on a weekly basis, so that trends in customer spending can be tracked.
Bob West has discussed with Luis Zubino several times the introduction of a data based
management information system that would capture all of the required information at source.
However, the proposed cost of the database is over £800,000 and Luis Zubino considers that
the cost could escalate to over £1,000,000 and he is adamant that the administration systems,
although basic, can manage at present.
Staff issues and extended opening hours
Due to the rapid expansion and the popularity of Zubinos, many of the staff have been working
very hard and working long hours and they report that they feel under too much pressure.
Furthermore, due to the popularity of Zubinos, it was decided to extend the opening hours, into
the evening and instead of closing at 7pm, they are now open until 11pm each night, seven days
a week. Many of Zubinos staff have complained about later working and this has resulted in
some employees leaving the company, despite Zubinos pay being a little higher than the market
rate.
Over the last few months, Zubinos has employed many European Union (EU) immigrants on
temporary short-term contracts. Zubinos is paying below the market rate in this industry for
these employees, but slightly above the legal minimum wage rate. The cost of these employees
is approximately 12% below other Zubinos staff. The EU immigrants are also prepared to work
long hours. The EU immigrant workers have accepted the shift patterns given to them, which
often involve early morning shifts to accept deliveries from 5 o’clock in the morning. While these
employees are given time off during the day, they are often scheduled to work a further shift
later in the day, right up to closing time. Some of the EU immigrant employees choose to work
straight through from early morning to closing time with very few breaks. These employees
speak English poorly and offer poor customer service. Many Zubinos coffee shop managers
have now noticed that the level of customer complaints has increased.
TURN OVER
P10
20
May 2006
There have been several complaints and some adverse press coverage concerning
disturbances to neighbours and people whose flats are above Zubinos coffee shops because of
Zubinos’ later closing time at night. However, the rental agreements for the rented shops allow
this late closing time. Another factor that has caused problems to Zubinos’ neighbours is the
deliveries from its food suppliers between 5 and 6 o’clock in the morning to Zubinos coffee
shops in some city centres. The parking of large delivery vehicles and the noise caused by
unloading has led to several complaints, including a pending legal action for noise nuisance.
New Zubinos coffee shops in 2006
Luis Zubino wanted to open the planned eight new coffee shops in 2006, partly financed from
the approved £5⋅0 million loan finance that KPE has made available to Zubinos. During January
to May 2006, there have only been two new coffee shops opened. There are plans already in
place for a further two openings later this year. The number of new Zubinos coffee shops has
fallen behind schedule, as Luis Zubino, who plays a crucial role in the site selection process,
has not pursued the expansion programme, as he usually would have done, due to his personal
problems with his marriage breakdown.
Bob West is now trying to secure rental agreements on a further four shops. He has been
unable to find suitable rental sites for two of them. He has drafted a proposal for the June 2006
Zubinos Board meeting, requesting approval to purchase two retail premises at a total cost of
£2⋅2 million for both sites.
The capital cost and shop fitting costs are also forecast to exceed the current planned capital
expenditure budget during 2006, due to two reasons:
•
All four of the new coffee shops that have been opened or are currently being prepared
for opening, are in larger premises, with higher fittings costs;
•
The latest, more expensive, refrigerated display units have been ordered for the new
Zubinos shop openings in 2006, which are far superior to those in other Zubinos shops.
The average capital expenditure for each new Zubinos coffee shop in 2006 is now forecast to be
£330,000, compared to an average of £250,000 in 2005.
The latest forecast for 2006, prepared at the end of April 2006, assumes a total of only 6 new
shops opening during 2006. The forecast cash which will be generated from operations for
2006 is £2⋅2 million. This will be used to partially fund the planned capital expenditure which is
currently forecast for 2006 to be £4⋅7 million (and this capital expenditure forecast assumes the
purchase of the two retail premises, as detailed above).
Operating costs
In an attempt to reduce operating costs, Maria Todd has chosen to change a few suppliers who
are providing high cost food items, and has managed to procure very similar food items at a
lower cost. She has also chosen to procure a higher proportion of coffee from UK wholesalers,
which has resulted in large cost savings.
The cost savings have been achieved due to two reasons. Firstly, the coffee beans are
purchased from UK wholesalers who bulk buy and the cost per kilogram is lower than the Fair
Trade coffee that Zubinos had previously purchased. Most of these new coffee purchases are
not Fair Trade coffee. Secondly, Zubinos pays for these new coffee purchases in UK sterling
and is not exposed to any risk of currency movements.
Zubinos is now considering whether its marketing literature should be changed to reflect that
only 60% of its coffee purchases is now Fair Trade coffee, whereas previously it was over 80%
Fair Trade.
May 2006
21
P10
Franchising proposal
An international franchising company, GlobalFranch (GF) has approached Luis Zubino at the
end of April 2006 with a proposal to assist Zubinos to expand via franchising. The proposal was
presented to the Zubinos Board in May 2006, and Luis Zubino’s initial response is favourable.
GF has stated that it has over thirty franchisees ready to open franchised outlets and it
considers that the Zubinos business could be a very successful franchised business. GF has
also stated that it is considering offering its franchise service to two other coffee shop chains,
which are based in Europe, but has decided to allow Zubinos to have first refusal. GF has
therefore stated that it needs a final decision by the end of June 2006.
GF’s proposal is to franchise out the Zubinos coffee shop brand and expand both in the UK and
overseas, particularly in the rapidly growing Far Eastern market. GF would like to offer its
services and its experience to recruit and manage franchisees, which would then operate
franchised Zubinos coffee shops in the UK, Europe and the Far East. GF insists on a minimum
contract period of 5 years, with a one-year notice period. GF also stipulates that in order to
allow the franchisees to build up their business, Zubinos should limit the number of its coffee
shops which it operates to no more than 40% of the planned franchised coffee shops by the end
of 2009.
The financial forecast shown below is based on the following number of franchised shops:
Number of forecast franchised shops
2007
2008
2009
2010
2011
New openings in year
20
30
50
80
120
Cumulative franchised shops
20
50
100
180
300
The proposal is that for each new franchised shop, Zubinos would receive 9% of the gross sales
revenue. Zubinos would also supply all of its regular coffees and own brand product lines to
franchised shops at agreed prices, which would include a mark up of around 6% on cost.
GF has stated that its fees for locating franchisees and managing the franchising business for
Zubinos would be a fee of £20,000 for each new shop opened plus a fee of 6% of the franchised
revenue for the first year of each shop opening. After the first year of each shop opening GF
would charge a flat fee of 2% of the franchised revenue for the contract period. GF has
prepared the following forecast cash flows (pre-tax) for the next 5 years:
Franchise income payable to
Zubinos:
2007
£million
2008
£million
2009
£million
2010
£million
2011
£million
Revenue
0⋅9
3⋅5
8⋅2
16⋅9
31⋅9
Mark up on supplies to franchisees
Total Franchise income
0⋅2
1⋅1
0⋅7
4⋅2
1⋅5
9⋅7
2⋅7
19⋅6
4⋅4
36⋅3
Franchise fees payable by Zubinos
to GF:
£20,000 for each new shop
6% of revenue for first year
2% of total franchised revenue
Total franchise fees payable
0⋅4
0⋅6
0⋅0
1⋅0
0⋅6
1⋅6
0⋅2
2⋅4
1⋅0
2⋅8
0⋅9
4⋅7
1⋅6
5⋅0
2⋅1
8⋅7
2⋅4
8⋅5
4⋅3
15⋅2
TURN OVER
P10
22
May 2006
Zubinos exclusive coffee machines
Jane Thorp launched a new product line in November 2004, selling exclusive coffee machines
to customers for their homes or offices. These are sold on Zubinos website and also in Zubinos
coffee shops. Until the summer of 2005, they were not well-marketed, but following a
promotional campaign, the coffee machines have sold particularly well, and customers have
repeatedly bought further coffee supplies from Zubinos.
The coffee machines have been procured from a leading coffee machine manufacturer on an
exclusive contract for Zubinos. The coffee machines use specially designed sachets of coffee
that can only be bought from Zubinos coffee shops, or available from Zubinos website. The
unique selling point is that customers can enjoy their favourite type of Zubinos cup of coffee in
the comfort of their own homes. The projected cash flows for the next three years for the sale of
the coffee machines and coffee supplies are as follows:
Sales - Coffee machines
- Coffee supplies
2006
£million
1⋅1
1⋅1
2007
£million
1⋅3
2⋅9
2008
£million
1⋅7
7⋅1
Costs - Coffee machines
- Coffee supplies
1⋅2
0⋅2
1⋅4
0⋅6
1⋅9
1⋅4
There have been a significant number of dissatisfied customers who have returned faulty
machines over the last few months. Originally, as a gesture of goodwill, Jane Thorp had
instructed all shop managers to give customers with faulty machines, a free replacement
machine and free samples of coffee sachets. However, the number of faulty machines has
increased in March and April 2006. The manufacturer has examined a number of returned
machines, and has identified a design fault. All new manufactured coffee machines from May
2005 will have this fault corrected.
Appointment of a consultant
At the Zubinos Board meeting in the middle of May 2006, it was agreed that a consultant would
be appointed to advise the Board on the issues facing Zubinos.
End of Unseen material
Maths Tables and Formulae are on pages 23 to 26
May 2006
23
P10
MATHS TABLES AND FORMULAE
Present value table
Present value of 1.00 unit of currency, that is (1 + r)-n where r = interest rate; n = number of periods until
payment or receipt.
Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
1%
0.990
0.980
0.971
0.961
0.951
0.942
0.933
0.923
0.914
0.905
0.896
0.887
0.879
0.870
0.861
0.853
0.844
0.836
0.828
0.820
2%
0.980
0.961
0.942
0.924
0.906
0.888
0.871
0.853
0.837
0.820
0.804
0.788
0.773
0.758
0.743
0.728
0.714
0.700
0.686
0.673
3%
0.971
0.943
0.915
0.888
0.863
0.837
0.813
0.789
0.766
0.744
0.722
0.701
0.681
0.661
0.642
0.623
0.605
0.587
0.570
0.554
4%
0.962
0.925
0.889
0.855
0.822
0.790
0.760
0.731
0.703
0.676
0.650
0.625
0.601
0.577
0.555
0.534
0.513
0.494
0.475
0.456
Interest rates (r)
5%
6%
0.952
0.943
0.907
0.890
0.864
0.840
0.823
0.792
0.784
0.747
0.746
0705
0.711
0.665
0.677
0.627
0.645
0.592
0.614
0.558
0.585
0.527
0.557
0.497
0.530
0.469
0.505
0.442
0.481
0.417
0.458
0.394
0.436
0.371
0.416
0.350
0.396
0.331
0.377
0.312
7%
0.935
0.873
0.816
0.763
0.713
0.666
0.623
0.582
0.544
0.508
0.475
0.444
0.415
0.388
0.362
0.339
0.317
0.296
0.277
0.258
8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
0.500
0.463
0.429
0.397
0.368
0.340
0.315
0.292
0.270
0.250
0.232
0.215
9%
0.917
0.842
0.772
0.708
0.650
0.596
0.547
0.502
0.460
0.422
0.388
0.356
0.326
0.299
0.275
0.252
0.231
0.212
0.194
0.178
10%
0.909
0.826
0.751
0.683
0.621
0.564
0.513
0.467
0.424
0.386
0.350
0.319
0.290
0.263
0.239
0.218
0.198
0.180
0.164
0.149
Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
11%
0.901
0.812
0.731
0.659
0.593
0.535
0.482
0.434
0.391
0.352
0.317
0.286
0.258
0.232
0.209
0.188
0.170
0.153
0.138
0.124
12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104
13%
0.885
0.783
0.693
0.613
0.543
0.480
0.425
0.376
0.333
0.295
0.261
0.231
0.204
0.181
0.160
0.141
0.125
0.111
0.098
0.087
14%
0.877
0.769
0.675
0.592
0.519
0.456
0.400
0.351
0.308
0.270
0.237
0.208
0.182
0.160
0.140
0.123
0.108
0.095
0.083
0.073
Interest rates (r)
15%
16%
0.870
0.862
0.756
0.743
0.658
0.641
0.572
0.552
0.497
0.476
0.432
0.410
0.376
0.354
0.327
0.305
0.284
0.263
0.247
0.227
0.215
0.195
0.187
0.168
0.163
0.145
0.141
0.125
0.123
0.108
0.107
0.093
0.093
0.080
0.081
0.069
0.070
0.060
0.061
0.051
17%
0.855
0.731
0.624
0.534
0.456
0.390
0.333
0.285
0.243
0.208
0.178
0.152
0.130
0.111
0.095
0.081
0.069
0.059
0.051
0.043
18%
0.847
0.718
0.609
0.516
0.437
0.370
0.314
0.266
0.225
0.191
0.162
0.137
0.116
0.099
0.084
0.071
0.060
0.051
0.043
0.037
19%
0.840
0.706
0.593
0.499
0.419
0.352
0.296
0.249
0.209
0.176
0.148
0.124
0.104
0.088
0.079
0.062
0.052
0.044
0.037
0.031
20%
0.833
0.694
0.579
0.482
0.402
0.335
0.279
0.233
0.194
0.162
0.135
0.112
0.093
0.078
0.065
0.054
0.045
0.038
0.031
0.026
P10
24
May 2006
Cumulative present value of 1.00 unit of currency per annum, Receivable or Payable at the end of
1−(1+ r )− n 
each year for n years  r


Periods
(n)
1
2
3
4
5
1%
0.990
1.970
2.941
3.902
4.853
2%
0.980
1.942
2.884
3.808
4.713
3%
0.971
1.913
2.829
3.717
4.580
4%
0.962
1.886
2.775
3.630
4.452
Interest rates (r)
5%
6%
0.952
0.943
1.859
1.833
2.723
2.673
3.546
3.465
4.329
4.212
7%
0.935
1.808
2.624
3.387
4.100
8%
0.926
1.783
2.577
3.312
3.993
9%
0.917
1.759
2.531
3.240
3.890
10%
0.909
1.736
2.487
3.170
3.791
6
7
8
9
10
5.795
6.728
7.652
8.566
9.471
5.601
6.472
7.325
8.162
8.983
5.417
6.230
7.020
7.786
8.530
5.242
6.002
6.733
7.435
8.111
5.076
5.786
6.463
7.108
7.722
4.917
5.582
6.210
6.802
7.360
4.767
5.389
5.971
6.515
7.024
4.623
5.206
5.747
6.247
6.710
4.486
5.033
5.535
5.995
6.418
4.355
4.868
5.335
5.759
6.145
11
12
13
14
15
10.368
11.255
12.134
13.004
13.865
9.787
10.575
11.348
12.106
12.849
9.253
9.954
10.635
11.296
11.938
8.760
9.385
9.986
10.563
11.118
8.306
8.863
9.394
9.899
10.380
7.887
8.384
8.853
9.295
9.712
7.499
7.943
8.358
8.745
9.108
7.139
7.536
7.904
8.244
8.559
6.805
7.161
7.487
7.786
8.061
6.495
6.814
7.103
7.367
7.606
16
17
18
19
20
14.718
15.562
16.398
17.226
18.046
13.578
14.292
14.992
15.679
16.351
12.561
13.166
13.754
14.324
14.878
11.652
12.166
12.659
13.134
13.590
10.838
11.274
11.690
12.085
12.462
10.106
10.477
10.828
11.158
11.470
9.447
9.763
10.059
10.336
10.594
8.851
9.122
9.372
9.604
9.818
8.313
8.544
8.756
8.950
9.129
7.824
8.022
8.201
8.365
8.514
11%
0.901
1.713
2.444
3.102
3.696
12%
0.893
1.690
2.402
3.037
3.605
13%
0.885
1.668
2.361
2.974
3.517
14%
0.877
1.647
2.322
2.914
3.433
Interest rates (r)
15%
16%
0.870
0.862
1.626
1.605
2.283
2.246
2.855
2.798
3.352
3.274
17%
0.855
1.585
2.210
2.743
3.199
18%
0.847
1.566
2.174
2.690
3.127
19%
0.840
1.547
2.140
2.639
3.058
20%
0.833
1.528
2.106
2.589
2.991
6
7
8
9
10
4.231
4.712
5.146
5.537
5.889
4.111
4.564
4.968
5.328
5.650
3.998
4.423
4.799
5.132
5.426
3.889
4.288
4.639
4.946
5.216
3.784
4.160
4.487
4.772
5.019
3.685
4.039
4.344
4.607
4.833
3.589
3.922
4.207
4.451
4.659
3.498
3.812
4.078
4.303
4.494
3.410
3.706
3.954
4.163
4.339
3.326
3.605
3.837
4.031
4.192
11
12
13
14
15
6.207
6.492
6.750
6.982
7.191
5.938
6.194
6.424
6.628
6.811
5.687
5.918
6.122
6.302
6.462
5.453
5.660
5.842
6.002
6.142
5.234
5.421
5.583
5.724
5.847
5.029
5.197
5.342
5.468
5.575
4.836
4.988
5.118
5.229
5.324
4.656
7.793
4.910
5.008
5.092
4.486
4.611
4.715
4.802
4.876
4.327
4.439
4.533
4.611
4.675
16
17
18
19
20
7.379
7.549
7.702
7.839
7.963
6.974
7.120
7.250
7.366
7.469
6.604
6.729
6.840
6.938
7.025
6.265
6.373
6.467
6.550
6.623
5.954
6.047
6.128
6.198
6.259
5.668
5.749
5.818
5.877
5.929
5.405
5.475
5.534
5.584
5.628
5.162
5.222
5.273
5.316
5.353
4.938
4.990
5.033
5.070
5.101
4.730
4.775
4.812
4.843
4.870
Periods
(n)
1
2
3
4
5
May 2006
25
P10
FORMULAE
Valuation Models
(i)
Irredeemable preference share, paying a constant annual dividend, d, in perpetuity,
where P0 is the ex-div value:
d
P0 =
k pref
(ii)
Ordinary (Equity) share, paying a constant annual dividend, d, in perpetuity, where P0 is
the ex-div value:
d
P0 =
(iii)
ke
Ordinary (Equity) share, paying an annual dividend, d, growing in perpetuity at a
constant rate, g, where P0 is the ex-div value:
P0 =
d1
or P0 =
d 0 [1 + g ]
ke − g
ke - g
(iv)
Irredeemable (Undated) debt, paying annual after tax interest, i(1-t), in perpetuity, where
P0 is the ex-interest value:
P0 =
i [1 − t ]
k dnet
or, without tax:
i
P0 =
kd
(v)
Future value of S, of a sum X, invested for n periods, compounded at r% interest:
S = X[1 + r]n
(vi)
Present value of £1 payable or receivable in n years, discounted at r% per annum:
1
PV =
[1 + r ]
(vii)
Present value of an annuity of £1 per annum, receivable or payable for n years,
commencing in one year, discounted at r% per annum:
PV =
(viii)
n
1


1−
 [1 + r ] n 
r 

1
Present value of £1 per annum, payable or receivable in perpetuity, commencing in one
year, discounted at r% per annum:
PV =
1
r
P10
26
May 2006
(ix)
Present value of £1 per annum, receivable or payable, commencing in one year,
growing in perpetuity at a constant rate of g% per annum, discounted at r% per annum:
1
PV =
r −g
Cost of Capital
(i)
Cost of irredeemable preference capital, paying an annual dividend, d, in perpetuity, and
having a current ex-div price P0:
kpref =
d
P0
(ii)
Cost of irredeemable debt capital, paying annual net interest, i(1 – t), and having a
current ex-interest price P0:
kd net =
(iii)
i [1 − t ]
P0
Cost of ordinary (equity) share capital, paying an annual dividend, d, in perpetuity, and
having a current ex-div price P0:
ke =
(iv)
P0
Cost of ordinary (equity) share capital, having a current ex-div price, P0, having just paid
a dividend, d0, with the dividend growing in perpetuity by a constant g% per annum:
ke =
(v)
d
d1
+ g or ke =
d 0[1 + g ]
+g
P0
P0
Cost of ordinary (equity) share capital, using the CAPM:
ke = Rf + [Rm – Rf]ß
(vi)
Weighted average cost of capital, k0:
 VE 
 VD 
k0 = ke 
 + kd 

VE + VD 
VE + VD 
May 2006
27
P10
P10 – Test of Professional Competence
in Management Accounting
Examiner’s Answers
REPORT
To:
Zubinos Board
From:
Consultant
Review of Zubinos
Contents
1.0
2.0
3.0
4.0
5.0
6.0
7.0
Introduction
Terms of reference
Prioritisation of the issues facing Zubinos
Discussion of the issues facing Zubinos
Ethical issues
Recommendations
Conclusions
Appendices
Appendix 1
Appendix 2
Appendix 3
Appendix 4
Appendix 5
Appendix 6
1.0
SWOT analysis
PEST analysis
Balanced scorecard performance measures
Evaluation of Zubinos Light meal boxes
Evaluation of GlobalFranch proposal
Alternative valuations for Zubinos
Introduction
Zubinos is a branded coffee shop chain formed in 2001 with 20 shops operational in the UK at
May 2006. Zubinos is a private company owned by six shareholders, including the founder Luis
Zubino, who together own 60% of the shares, plus a private equity investor, KPE, which bought
shares in January 2005. KPE owns the remaining 40% of the shares. KPE has also undertaken
to provide up to £5⋅0 million in loan finance.
Zubinos has been growing rapidly and in 2005 profit after tax reached £897,000, a rise of almost
77% in profitability since 2004.
P10
28
May 2006
2.0
Terms of reference
I am a consultant appointed by the Zubinos Board to prioritise and discuss the issues facing
Zubinos and to make appropriate recommendations. Zubinos has experienced high growth
since the first coffee shop opened in June 2001, and is investing much capital expenditure to
expand the Zubinos chain of coffee shops throughout the UK, and it has plans to expand into
Europe.
3.0
Prioritisation of the issues facing Zubinos
3.1
Sourcing of supplies for Zubinos light meals – top priority
The top priority is to secure new sources of supply to meet the demand for this new and popular
product line. It is always frustrating for both the customer, and the shop, when demand exceeds
supply and the customer ends up being frustrated if he cannot procure what he wants.
Additionally, instead of Zubinos being able to exceed its customers’ expectations, it has failed to
meet its basic need of supplying what the customer wants. If this continues, it could lead to a fall
in demand and bad publicity for the company. For this reason, it has been placed as the top
priority as Zubinos’ customers should be supplied with products that are in demand.
3.2
GlobalFranch franchising proposal – second priority
The second priority is to consider and assess the franchising proposal, which has been made by
GF, and to either accept its proposals, subject to negotiations, or to decline the proposal.
GF has given Zubinos only until the end of June 2006 and then will withdraw its offer. It may be
more difficult to set up a franchised operation later, particularly if one of Zubinos’ competitors
were to take up GF’s offer, if Zubinos declines it. However, Zubinos may choose to set up its
own franchise operation at a later date, although this will require bringing into Zubinos someone
with franchising experience.
This is treated as a second priority as the matter is of enormous strategic importance to Zubinos
and a decision has to be made within the next month.
3.3
Luis Zubino’s absence – third priority
The third priority must be to recruit a temporary Managing Director (or to appoint an existing
Zubinos director as MD) to fill Luis Zubino’s place While he takes three months leave, following
his marriage breakdown. Luis Zubino has been the driving force behind the success of the
Zubinos expansion to date, which has taken its toll on his personal life. It is necessary to have a
strong figurehead in this fast growing company and it is suggested that external expertise is
brought in as none of the other directors has the skills to manage the company.
This is treated as a third priority, although it could quite easily be within the top two priorities, as
this is a key role that clearly cannot be left vacant for three months. It is also possible that Luis
Zubino will not be as focussed on the company and its challenges and problems over the next
year while he sorts out his personal life. The company, and its investor, KPE, will want an
experienced dynamic entrepreneurial figure who will guide Zubinos through the problems it is
experiencing, and KPE will want to ensure that Zubinos delivers the agreed financial results in
accordance with the 5 year plan.
Examiners note:
For the purpose of marking scripts, the above order of priorities is the suggested priority
order for the top three priorities. However, candidates could have been awarded full
marks if the priority order given differed from the answer above, as long as the GF
Franchising proposal was stated as one of the two top priorities, given the potential
impact this could have on the company.
May 2006
29
P10
3.4
Human resource issues – fourth priority
The fourth priority is human resource issues. Zubinos has achieved its high growth by the good
service and hard work of its employees. However, with the recent longer opening hours and the
recruitment of EU labour, Zubinos is not looking after the key assets of the company, its staff,
which is very important in a service industry such as Zubinos.
The cost savings achieved by the use of less expensive EU labour must be considered against
the level of customer service that Zubinos is trying to achieve. If Zubinos upsets its customers
by providing poor customer service, which is starting to occur as evidenced by the increase in
customer complaints, then this could have a serious long-term detrimental effect on revenues
and profits. In this industry, which is characterised by the appeal of the coffee shop and its staff,
poor customer service is unlikely to be tolerated.
Zubinos needs to establish an acceptable shift pattern and working hours for its staff, which may
lead to the recruitment of additional part-time staff to meet the longer opening hours. It is not fair
to expect existing staff to just accept longer hours.
3.5
Buy or rent shops for new 2006 Zubinos openings – fifth priority
The fifth priority is to decide whether the Zubinos Board should agree to the proposal by Bob
West to purchase two retail premises at a cost of £2.2 million for both sites. As Zubinos has
limited loan capital available, a total of £5.0 million loans have been made available by KPE to
help to finance the whole of the capital expenditure programme over the next few years, it does
not seem wise to spend such a large amount purchasing two sites, rather than Zubinos usual
pattern of renting suitable sites. The purchase of sites also has other problems, including
property management issues. Clearly the £5 million loan facility will not stretch far if coffee
shops were to be purchased rather then rented. There surely must be suitable sites that could
be rented in other towns and cities in the UK.
It is important that Zubinos uses its loan facility from KPE carefully so that it can help fund the
ambitious growth programme in the agreed 5 year plan and this is why this issue has been
ranked as a top five priority. If funds are allowed to be used to purchase property now, then this
could have a detrimental effect on Zubinos ability to meet its capital expenditure plan in a year
or two, if the loan facility is already fully committed.
3.6
Reduction in operating costs – sixth priority
Maria Todd has changed a number of suppliers in an attempt to reduce operating costs, but it is
important that quality is maintained and is not compromised as it is the quality of Zubinos’
products that acts as a differentiator. Additionally, it is unwise for Maria Todd to change the
suppliers of coffee beans and to procure an even lower proportion of Fair Trade coffee than
Zubinos used to. It is recommended that 100% of coffee should be Fair Trade, in order for
Zubinos to continue to charge the premium prices that it charges. The reduction of Fair Trade
coffee from over 80% to 60% is not in the long term interest of Zubinos.
This reduction in the use of premium coffees could have a long-term adverse effect on its
revenues and that is why this issue is ranked as sixth priority.
3.7
KPE’s exit from Zubinos needs to be planned – seventh priority
The seventh priority is that Zubinos must start planning for KPE’s exit from Zubinos, around
2009 or before. Most private equity companies want to exit within 5 years. KPE bought 400,000
shares in Zubinos for £6⋅00 each in January 2005, (total investment £2⋅4 million), and would
probably expect a flotation on the Alternative Investments Market (AIM) or possibly a
management buy-out (MBO) before 2009. A further alternative is that KPE may accept an offer
for its shares from one of Zubinos competitors, if the price per share was attractive enough and
the competitor could obtain a controlling interest. For Zubinos to manage this change, in order to
achieve its long term business goal, it will need to bring in external expertise and probably
additional Board members with experience in an AIM flotation.
P10
30
May 2006
Other priorities, outside of the top seven priorities for Zubinos, are:
•
The decision as to whether Zubinos should introduce the management Information
systems that George Shale and Bob West both consider are required. It is important that
Zubinos has a good management information system in order to identify key data and to
spot trends (good or adverse) quickly.
•
The control of capital expenditure on new shop openings, which is now forecast at
£330,000 per shop opening, a 32% increase on the previous average cost of £250,000.
Cost control needs to be improved.
•
Noise nuisance issues and how Zubinos can be seen to be working with the communities
in which it operates. Being a good citizen is seen to be increasingly important by today’s
image conscious consumers.
•
Financial planning is required for the potential divorce settlement if Luis Zubino’s marriage
is not reconciled. Vivien Zubino may be able to claim 50% of the total Zubinos share
holdings of 42% (30 plus 12%), which could be worth over £5 million in 2 years time.
•
Faulty coffee machines sold to customers. Zubinos needs to agree with the manufacturer
how the faulty machines previously sold are to be replaced and at which company’s cost
– Zubinos or the manufacturer. It is in no one’s interest for the machines to be faulty, as
this is annoying to customers, who also cannot use their machines. It is not in Zubinos’
interests to have faulty machines, as Zubinos makes its profits only on the sale of coffee
supplies, as the machines are sold at a small loss.
•
Overseas expansion of Zubinos. The 5-year plan forecasts that Zubinos will open its first
overseas shop in 2007 and this overseas expansion plan needs to be carefully managed.
It needs to set up a new range of suppliers and to adapt itself to its local surroundings and
the needs of the different customers that it will be targeting. Just because Zubinos is
profitable in the UK, does not mean that it will be profitable in another country. There is
much legal work and procurement work to be done to minimise risk and also currency
exposure. Risk will be increased by this overseas expansion.
•
Staff management and staff training should be improved so that more employees become
tomorrow’s managers. With the rapid growth of Zubinos, the company must ensure that
all staff can reach their own potential.
•
An equitable system to reward staff should be introduced to motivate all employees but
that is related to a range of performance measures, not just financial measures. The use
of the Balanced Scorecard technique would be very suitable for this type of business.
•
What dividend expectations do the shareholders, and in particular KPE, have for the next
few years. No dividends have been paid yet but cash planning would be required if there
are expectations, as currently all cash generated from operations is used to finance part
of the ambitious growth.
A SWOT analysis summarising the strengths, weaknesses, opportunities and threats is shown
in Appendix 1.
A PEST analysis is shown in Appendix 2.
May 2006
31
P10
4.0
Discussion of the issues facing Zubinos
4.1
Overview
The company has grown very rapidly since it was formed and it now has a very ambitious 5-year
plan to be achieved and an agreed loan facility from its investor KPE. KPE owns 40% of the
equity of Zubinos, having bought 400,000 shares at £6.00 each in January 2005. Most private
equity companies will want to exit within 5 years. Therefore, KPE will wish to sell its shares in
Zubinos and have its loans repaid, or restructured by the end of 2009. It is possible that if
Zubinos remains as successful as it plans to be, then it could arrange a listing on the Alternative
Investments Market (AIM).
KPE has invested in Zubinos, but has not interfered with the running of the Zubinos business so
far, as Zubinos has achieved the agreed planned results. However, if Zubinos is to achieve the
agreed 5-year plan, then some changes need to be made.
The GlobalFranch (GF) franchising proposal requires a decision in June 2006. While it should
be noted that Zubinos could choose to franchise its coffee shops on its own, or with a different
franchising agency, the GF proposal looks attractive. KPE will be very tempted to see the level
of franchising income rise so rapidly.
Zubinos is at a crossroads in its development and using Ansoff’s model, it needs to move
towards being a Star or a Cash Cow, and not to develop into a “Problem Child”.
Zubinos is in the early stages of its life cycle and although the coffee shops industry is starting to
reach maturity, there is still much scope for Zubinos to develop and continue to differentiate
itself from its competitors.
4.2
Zubinos Light meal boxes
The selection of suppliers for Zubinos Light meal boxes is urgent as demand exceeds Zubinos
current supply. There is a need to ensure that the supplier chosen provides top quality food in
order to maintain the high reputation and to justify the expensive retail cost of the meals. The
marketing of Zubinos Light meal boxes is an example of a product at the start of its life cycle,
and clearly Zubinos need to maintain its reputation for a high quality product.
Currently Zubinos procures 2,000 boxes a day from ART and 2,000 boxes a day from BBK, but
the food quality and the cleanliness of BBK food operations are below expectations. It is
therefore recommended that ART is retained but the balance of 3,000 meal boxes per day are
procured from DTY which has the same excellent standards of ART, but is more expensive.
DTY also has the capacity to increase the number of daily meal boxes to 8,000 should demand
continue to increase.
It is very important that Zubinos should have a high quality offering in order to maintain this large
growth in this new market segment that it has recently targeted. If it were to choose the cheaper
supplier, CCV, this could save on procurement costs but could have a detrimental effect on
customers’ perceptions and the demand for these products. Therefore, the clear choice here is
to go for top quality, albeit at a higher price.
Appendix 4 shows the current annualised revenue of the Zubinos Light meals, based on current
supply of 4,000 boxes a day, to be £2⋅9 million. This single new product innovation has
exceeded the total 2006 plan figure for revenues from new product launches, which was
forecast to be £1⋅56 million in 2006.
If the supplier DTY is selected, then the higher cost at £2.00 per box, will erode overall gross
margins down from 53.3% to 44.0%. However, if Zubinos can achieve sales of the estimated
5,000 boxes per day, annualised revenues would rise to £3.6 million and the gross margin
generated would be almost £1⋅6 million. This additional gross margin would have a significant
effect on the bottom line profitability of Zubinos as there are little additional fixed costs, except
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for the advertising campaign of £0⋅4 million. This would result in additional net profits of over
£1⋅0 million as a result of this successful new product.
The increased level of profitability is so significant (as the profitability from Zubinos Light meals
represents an almost 80% increase on the pre-tax operating profit achieved in 2005), and this is
why the Zubinos Light meal boxes have been ranked as a top priority.
In summary, the choice of supplier must be to one which has excellent food quality and an
excellent standard for its cleanliness of food preparation areas and also be able to be flexible for
possible additional demand.
4.3
GlobalFranch franchising proposal
An international franchising company GlobalFranch (GF) has approached Zubinos with a
proposal to assist Zubinos to expand via franchising. The proposal made appears to be very
attractive, and could generate additional franchising profits of £21⋅1 million by 2011, if GF is able
to achieve the forecast franchising plan (£36⋅3 million total revenue less the total fees payable to
GF of £15⋅2 million).
GF is an international franchising company and would have a track record of achievement with
other companies that Zubinos could investigate. Therefore, the credibility of the franchising offer
is not in question here, but whether Zubinos should select the method of franchising as a way to
expand its business.
It should be noted that franchising is the most widely used method of expansion in the fast foods
and coffee shop industry and would be well suited to Zubinos. If Zubinos chose to franchise its
shops then Zubinos would be the franchiser and the individual owners (who would open
franchised Zubinos coffee shops) would be the franchisees.
Franchising out some of Zubinos planned expansion has the following advantages:
•
•
•
•
•
The franchisee provides the required capital expenditure to open a new Zubinos coffee
shop;
Quicker business expansion than would have been possible using its own management
and financial resources;
Reduced risk to franchiser due to the capital having been provided by the franchisee;
The franchisee would provide the management skills and maintains full control for all of
the day to day running of the franchised shop, including staff recruitment;
The franchisee has to be motivated to grow the revenues at the franchised shop and
retains the net profit after the agreed franchise fees have been paid.
The disadvantages to the Zubinos shareholders of franchising are:
•
•
•
•
Reduced profits because they need to be shared with the franchisee;
Need to monitor franchisee to ensure consistency of product quality and service quality;
Danger that poor franchise performance would harm the Zubinos’ brand;
Problems of protecting intellectual capital from being copied by franchisees who could
later become rivals.
Despite the many disadvantages it is recommended that Zubinos management should pursue
the possibility of expansion using franchising. This would be especially relevant for the
expansion into Europe, which could be difficult to manage from the UK, although this still raises
the concern of how to monitor the overseas franchisees.
As Zubinos already has an inexperienced and stretched management team, with no existing
manager experienced in franchising, Zubinos has two choices:
•
Accept the GF proposal, subject to negotiation of detailed terms;
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•
Recruit a franchising expert or use a franchising consultant to advise on how Zubinos
could launch its own franchised business.
The latter of these two options would take time, use existing already stretched management
resources and possibly not be as successful as accepting the GF proposal. At the end of the
day, if expansion is achieved much faster, it would be better for Zubinos to earn between 5%
and 10% of much larger revenues than the current operating margin of 9⋅1% on its own smaller
revenues. The key issue here is reduced risk.
However, the GF proposal, assumes that GF can recruit and deliver 300 franchised shops by
2011, which is a very ambitious target, and its fees are very costly. The fee of £20,000 per
franchised shop established is reasonable and it would probably cost this much for Zubinos to
select and recruit suitable franchisees. The additional support work undertaken in the first year
of operation is also reasonable at 6% of turnover. Obviously where GF makes its profits is in the
ongoing fee of 2% of all franchised revenues on an ongoing basis, subject to a minimum
contract period of 5 years.
Therefore, the 2% fees payable to GF over the next five years are high, but the franchised
revenues, which GF is confident can be delivered, are far greater. For example, in 2010, the
total franchised revenues to Zubinos would be £19⋅6 million, and the total fees payable are
forecast to be £8⋅7 million. Therefore the franchising proposal is forecast to generate an
increase in pre-tax profits of £10⋅9 million.
However, GF has stipulated that if its proposal is accepted, Zubinos should limit the expansion
of its own coffee shops to allow franchisees to build up their business. The proposal is that
Zubinos should limit the number of its coffee shops which it operates to no more that 40% of the
planned franchised coffee shops by the end of 2009. By the end of 2009, the franchised number
of shops is 100. Therefore Zubinos should not have more that 40 of its own shops open by the
end of 2009.
The current 5 year plan assumes that by the end of 2009 it would have 60 shops open.
Therefore, if Zubinos is to accept the GF proposal it must severely cut back on its own
expansion plans.
The estimated pre-tax profit per Zubinos shop in 2009 is almost £152,000 per coffee shop
(based on the agreed 5 year plan pre-tax profit of £8,203,000 and an average number of
operational shops during 2009 of 54).
Therefore the reduced pre-tax profits in 2009 of operating only 40 shops instead of 54 shops
(average for the year) would be a reduction of £2⋅1 million (14 shops at £152,000 each).
However, even with this reduced level of profitability, the net income from franchising is still
greater at £5.0 million (£9⋅7 million revenue less franchising fees of £4⋅7 million).
Appendix 5 shows the forecast overall effect of franchising on Zubinos’ profitability.
The other factor affecting Zubinos choice as to whether to franchise or not will be KPE’s attitude
to risk. It must be stated that business risk would be reduced by franchising as it is the
franchisees who provide the capital and who have responsibility for running each of the
franchised coffee shops. It is likely that KPE would be in favour of the GF proposal, as
franchising and having a far greater number of coffee shops would raise the profile of Zubinos,
making an AIM flotation more achievable by 2009.
4.4 Luis Zubino’s planned absence and financial planning for possible divorce
settlement for Luis Zubino
The Zubinos management team is already under-resourced given Zubinos’ high growth
achieved so far and the plans for the future. It is imperative that Luis Zubino’s position as MD is
filled during his planned three month absence, following his marriage breakdown.
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The case material does not state whether Vivien Zubino has stopped working part time for
Zubinos or not, but it can be assumed that her role would be easier to fill. Looking at the other
four Directors, Jane Thorp, Maria Todd, Anita Wiseman and George Shale, it is unlikely that any
of them has the skills to fill the key role of MD even on a temporary basis. Furthermore, the
Zubinos management team needs to bring in more external expertise, and it is therefore
recommended that a temporary MD is recruited. After Luis Zubino returns in September, there
should still be no shortage of opportunities for this skilled person to undertake in Zubinos. There
are many strategic decisions to be taken and managed over the next few months, including the
GF franchising proposal, the choice of location for 2006 shop openings and the change of
suppliers for Zubinos Light meal boxes.
It is therefore recommended that an experienced senior manager, who is familiar with start up
and fast growth businesses is recruited to fill the MD role on a temporary basis with a view to
retaining this person to assist the Zubinos team with the continued development of this fast
growing business.
There is also the concern over the possible divorce settlement if Luis Zubino’s marriage is not
reconciled. Under UK law the assets of the marriage are split and it is possible that Vivien could
be allocated a settlement worth 50% of the total Zubino family shareholding, as well as a share
of other assets held by Luis Zubino.
Appendix 6 shows alternative valuations for Zubinos’ shares, both with and without the GF
franchising proposal. Using a P/E ratio (assumed to be 16 and reduced by 40% as Zubino’s is
not listed) of around 10, Zubinos shares in 2 years time, in mid-2008, could be worth £48⋅0 per
share. If the divorce used a later valuation in 2009, then the value will have risen to £77⋅8 per
share due to the forecast higher level of profits from the much enlarged Zubinos business.
The Zubino family own 42% of shares, totalling 420,000 shares. If Vivien Zubino were awarded
a divorce settlement of 50% of the value of these shares based on the 2008 valuation of £48⋅0
per share then this would be worth over £10 million (420,000 shares x £48⋅0 x 50%).
The question is how would Luis Zubino finance a payment of £10 million out of his personal
funds and also would he wish to purchase Vivien’s shares as well as other personal funds he
might need to buy out his wife’s share of any joint property?
It is possible that Vivien Zubino would retain her 120,000 shares and would sell these when
Zubinos is floated on the AIM in 2009 to give KPE a way to exit. Therefore the divorce payment
would be reduced for the shares that Vivien would retain in her name and the divorce settlement
would be only £4⋅3 million (420,000 share x 50% = 210,000 shares less 120,000 share still in
Vivien’s name = 90,000 shares x £48).
It is possible that Luis Zubino could raise personal loan finance to pay for the divorce against the
value of his shareholding, or for Luis Zubino to sell some of his shares to either existing or to
additional shareholders to raise the capital.
Apart from the financial angle of the divorce, the motivational aspect for Luis Zubino is far more
important. Will he return to the Zubinos business after his three month absence and be fully
motivated to achieve the agreed 5 year plan?
KPE will no doubt put Luis Zubino under some pressure to ensure that Zubinos delivers what it
bought into. Private equity companies are very familiar with dealing with individuals who are the
driving force behind the business venture and will support him as much as they can so as to
ensure that the agreed level of profits is delivered. KPE is not interested in Luis Zubino as a
person, only in his ability to deliver the agreed profits.
4.5
Human resource issues
The employees of Zubinos are the day to day face of the company and it is the shop employees
who face customers each day. They are the key assets of the company and should be looked
after and kept highly motivated in a range of ways. In real life, companies use a range of
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motivational tools, including performance related pay, free shares, employee awards, training
and employee perks such as short holiday breaks for exceptional performance or for “employee
of the month”. It is recommended that Anita Wiseman uses as many motivational tools as
possible to ensure that Zubinos continues to have contented and hard working employees.
It is suggested that a range of performance measures is drawn up, in consultation with
employees, using the Balanced Scorecard approach, which uses a range of measures in
addition to financial measures. A range of Balanced Scorecard performance measures is shown
in Appendix 3.
Also the introduction of a share ownership scheme will encourage employees to work hard to
improve profitability and also for them to remain with the company. The employee shares could
be given free to all employees, and the number of free shares could be related to the company’s
agreed performance. While Zubinos is still an unlisted company, these shares would be difficult
to trade, but it is anticipated that Zubinos would become listed on the AIM around 2009 and this
would enable employees to trade their shares then if they wished. There is a potential for large
gains to be made by many employees and this would encourage goal congruence.
The proposed introduction of an employee share scheme, for motivational purposes, is
recommended and it should be introduced within the next year, rather than wait until the
company is listed in 2009.
The key human resource issues identified in the case material are:
•
•
•
•
•
Staff are working long hours;
Staff feel under too much pressure;
Employment of EU immigrants on short term contracts;
Increasing level of customer complaints;
Poor service offered by some EU immigrant employees.
Zubinos’ employees need to feel valued and not put under too much stress, which could lead to
health problems and could lead to poor customer service. It may be necessary to recruit
additional part-time employees to help ease the burden of the longer opening times and to help
current employees with the stress they feel they are working under.
The use of cheaper EU immigrant employees on short term contracts is not a shrewd business
decision. Zubinos has managed to reduce staff costs in the short term (by about 12%) but this
may have a detrimental effect on the long-term business if customers are not pleased with the
level of customer service.
In the service industry which Zubinos is in, quality of customer service is very important. Many
customers will not complain if they get poor customer service, they will simply “vote with their
feet” and not go back to a Zubinos shop again. Therefore to engender a high quality of customer
service that should meet, or exceed, customers’ expectations, Zubinos must employ high quality
employees. While the employees should have a wide range of backgrounds, it is not in Zubinos
interests to employee “cheap” EU immigrant labour, particularly if they speak English poorly.
It is recommended that Zubinos does not renew the EU immigrants’ short term contracts, and
that a large scale recruitment drive is started in order to recruit replacement staff as well as
additional staff to cope with the opening of new shops and to relieve the long hours currently
worked by some employees.
The culture of long working hours should be discouraged and as Zubinos is a young company it
perhaps has not yet established its own culture. What Anita Wiseman needs to ensure is that
the “bad habits” such as working long hours are not seen as being acceptable.
Customer surveys should be undertaken on a regular basis to establish what customers like and
dislike about Zubinos and its current levels of customers service. This should then be used as a
basis for deciding on what areas employees should be trained to improve upon.
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4.6
Buy or rent shops for new 2006 Zubinos openings
The agreed 5-year plan forecast that there will be eight new shop openings during 2006, and
total capital expenditure of £2⋅7 million, which includes other capital expenditure as well as the
eight new openings.
It is stated that the roll out of new Zubinos is behind schedule due to the lack of commitment by
Luis Zubino following his marriage breakdown. The case material states that 2 shops have
already opened this year and 2 are planned for later this year, leaving only 4 more rental sites to
be located. The proposal that Bob West has drafted for the June Zubinos Board meeting is for
the purchase of 2 sites, rather than rental as suitable rental sites cannot be located.
However, the purchase of shops would use up much of the KPE loan finance and it is not a
good use of the limited loan finance. The total loan facility from KPE of £5⋅0 million needs to
help finance most of the planned expansion to 75 shops by 2010 and it is therefore considered
that spending £2⋅2 million on just 2 shops is not recommended.
If suitable rental sites cannot be found in the city or town centre of the 2 particular cities or towns
that Zubinos has targeted for expansion, then the alternative is simply to move straight onto the
next targeted town and not even consider outright purchase of properties. The purchase of
property also raises property management issues, which Zubinos does not need at this stage of
its development.
It is therefore recommended that Zubinos should select 2 other towns which Zubinos could
expand into where suitable rental sites are available. In order to speed up the site selection
process and to ease the burden of work for Luis Zubino it is also recommended that an agent is
appointed to find and negotiate on all rental sites. Clearly Bob West has not got the site
selection skills necessary for the growth of the Zubinos business.
4.7
Reduction in operating costs and Fair Trade coffee
It is stated that Maria Todd has chosen to change a few suppliers to reduce operating costs. To
date Zubinos has been very successful and has achieved high growth. The reasons for the
growth are complex, but obviously include the high quality of products that it sells to its
customers. Maria Todd needs to be very careful when changing suppliers to a cheaper source,
that quality of the food products does not fall. Additionally, if customers like what they are being
offered, even if quality does not fall, if the product appears different (size, shape, packaging) it
may now not appeal to customers. In this industry customers’ perceptions are very difficult to
judge and even understand and therefore it is not recommended that changes are made to
reduce operating costs on products that are currently selling well, as this could change the
product in the customers’ perception.
The other change that Maria Todd has made is reducing costs by cutting down the amount of
Fair Trade coffee used. This is against one of the ideals that Luis Zubino had when Zubinos was
launched. The coffee business is not very price sensitive, but customers are willing to pay for
the differentiator of Fair Trade coffee and the premium usually paid exceeds that extra cost of
Fair Trade coffee. It is recommended that the current procurement policy is changed with
immediate effect and a greater quantity, if not 100%, Fair Trade coffee is procured.
If the procurement policy of Zubinos is to be allowed to continue by cutting operating costs to
achieve short term profits, then Zubinos could quickly see demand for its products fall as
customers move away to other branded chains who give them the perceived “value” for money.
To differentiate successfully, Zubinos needs to continue to offer high quality products and these
cannot be procured cheaply.
In real life, Costa Coffee uses all Fair Trade coffee and makes much PR from its ethical
procurement methods, which has helped it to win substantial market share in the UK over the
last few years.
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4.8
KPE’s exit from Zubinos needs to be planned
It is important that Zubinos starts to plan for the way in which KPE will exit in 2009. It is unlikely
that a private equity company would want to stay longer than 5 years and as it invested in
January 2005, it is likely that by 2009 it would want to exit.
By 2009, all of the early bank loans will have been repaid and it is forecast that all of the £5
million loan facility will have been borrowed by Zubinos. However, this loan could be repaid even
after KPE exit, or the loan could be re-structured or refinanced with the Kite bank.
The two probable ways that KPE would exit are:
•
•
Flotation of Zubinos on AIM
Management Buy Out (MBO)
An alternative exit route would be a take-over bid for Zubinos, if KPE and some of the existing
shareholders agree to it. After all, everyone has their price and it would be very tempting for
some of the current directors to sell their shares for over £1 million. It is likely that Zubinos could
be the target for a take-over bid in the next few years as the market place begins to consolidate
and competition becomes more intense.
In order to plan for the two eventualities of a flotation or an MBO, it will be necessary for Zubinos
to have external expertise and advice on its long term financial structure. It will also be
necessary to prepare much PR and lobbying if an AIM flotation is to be successful. These are
usually planned over a minimum of a two year period of time and therefore by the end of 2007,
Zubinos would need to have firmed up on the planned exit route for KPE and be preparing
detailed plans for the 5 year period to 2015, in order to convince possible future investors that
Zubinos is a suitable investment.
If Zubinos is to have a MBO where the existing directors and senior management buy shares in
the company and agree to buy out KPE’s shares, which would be worth in the order of £56.6
million to over £156 million (as shown in Appendix 6), then they need to identify how they could
collectively secure this level of financing. An MBO could also be done by having an agreed buy
out arrangement that lasts several years.
Zubinos needs to put in place the required management structure and IT systems over the next
2 years by 2007 in order to start the process for KPE to exit in 2009.
4.9
Improvements required in the control of operating costs and capital expenditure
Capital expenditure clearly needs to be better controlled as the average capital cost of each new
Zubinos has risen from £250,000 to £330,000, a rise of £80,000 some 32% increase.
In order to ensure that the agreed £5.0 million loan facility is used effectively to meet the
challenging expansion programme, it is necessary to ensure that the agreed capital budget is
not exceeded. The capital cost has increased due to larger shops and also due to the selection
of the latest more expensive refrigeration equipment. It may be necessary for Zubinos to cut
back on its high ideals and to fit slightly less expensive equipment. Additionally, any cost
overruns on one shop should be compensated by cost savings in other new shops. It may also
be able to negotiate cost savings by placing a contract covering the refrigeration equipment
required for several new Zubinos shops.
In respect of operating costs, it is very important that cost savings are not achieved to the
detriment of quality, as stated in paragraph 4⋅7 above. Staff costs need to be controlled
carefully, but training and staff recruitment costs will remain high as Zubinos continues to
expand rapidly. Additionally to achieve high growth and to have the required level of customer
service, additional staff may need to be recruited. The long term picture should always be
looked at rather than short term cost savings.
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IT systems. The lack of sophisticated IT systems is not unusual in small companies. However,
given the ambitious growth plans, Zubinos should be investing in its IT infrastructure now, to
ensure that it manages its growing business and stays competitive.
George Shale has been trying to introduce a data based management information system to
produce data on a weekly basis. In this fast moving customer led environment this is essential
and it is recommended that a standard “off the shelf” software package is procured and
implemented as soon as possible. The view on IT has been that the company cannot afford the
systems proposed, but instead, it should be viewed as to whether the company can afford NOT
to have these IT systems in place.
The 5-year plan has a challenging forecast for new product innovations. The company must
build up a range of new product launches to ensure customers stay interested in spending
money at Zubinos. It needs to be innovative and pro-active, and stay ahead of its competitors,
not by always playing “catch up”. It will be necessary to have a team of marketing and product
design employees who are solely responsible for bringing new products into Zubinos. At present
the company will be exceeding its new product revenue targets with the success of the Zubinos
Light meal boxes and the sales of coffee machines and coffee sachets for the machines.
However, the company cannot become complacent and needs to continually strive to bring more
new products to the customers.
In summary, cost control is important, especially in respect of capital expenditure, but savings in
operating costs need to be carefully weighed against the required quality and desired levels of
customer service.
4.10 Faulty coffee machines
The sale of coffee machines to customers for their homes and offices has been successful to
date and customers have bought further coffee supplies from Zubinos. From the data given, it
can be seen that Zubinos makes a small loss on the sale of coffee machines that are
manufactured for them and then sold onto the public. It is the coffee supplies that Zubinos sells
that will generate large margins of £0⋅9 million in 2006 (over 80% margin).
Therefore, it is imperative that once the coffee machines are sold they are used extensively, so
generating the need for the sale of further supplies of the exclusive Zubinos sachets of coffee. If
the machines are faulty this has two adverse effects on Zubinos:
•
It reflects badly on the Zubinos image if the machine is faulty and the customer may
simply not use it. This may deter the customer from returning to Zubinos for coffee on a
regular basis.
•
Zubinos cannot sell further coffee supplies to customers who have faulty machines,
thereby reducing forecast sales and margins.
The manufacturer has now identified a design fault which is causing the high level of faults.
Zubinos must agree with the manufacturer who has the responsibility for repairing or replacing
the machines that have already been sold. If the manufacturer denies the responsibility for
previously manufactured machines, then Zubinos should continue to replace customers’
machines free of charge and should bear the cost.
Zubinos has a number of strategic choices:
•
•
•
It could change its manufacturer, depending on contractual terms due to this design fault
It could discontinue the sale of machines
It could bear the cost of replacing previously sold machines if they become faulty.
As there is clearly a market that helps to retain the Zubinos brand loyalty, and gets customers to
return to Zubinos to buy further coffee supplies, it is recommended that Zubinos does continue
to sell these coffee machines. The sale of the machines generates revenue on the sale of coffee
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supplies and therefore, Zubinos should continue to replace any faulty machine of the old style
and it should closely monitor any returns following this fault rectification.
4.11 Overseas expansion of Zubinos
The risk will be greatly increased by expanding overseas and there are new problems. These
include transaction and translation exposure, logistics, staff recruitment and staff management
and supply chain issues.
The agreed 5 year plan shows a total of 25 Zubinos shops opening overseas by 2010 and if the
sites are all geographically diverse they will be difficult to manage. It would help to establish the
Zubinos name in Europe if these 25 shops are in only one or two countries and are
geographically close together over a few cities, to minimise supply problems.
New suppliers will need to be identified and also the Zubinos menu and range of foods and
drinks will need to be adapted to meet the requirements of the local market. Products that are
popular in the UK may not be in demand in hotter Mediterranean countries, for example.
There are also the legal and financial necessities that need to be put in place and information
systems will need to be capable of multi-currency transactions. It is recommended that George
Shale appoints one of his assistants to be in overall control of all of the European operations to
ensure prompt cost control and flow of data to Head Office.
If Zubinos does select the GF franchising proposal it is suggested that overseas expansion
should be 100% franchised outlets, as this would allow business people with local knowledge of
the market to run and operate franchised Zubinos which are much more likely to be successful
than a shop being managed by UK based management.
The O’Brien’s sandwich and coffee shop chain has been very successful with its franchising and
now has hundreds of franchised outlets especially in the Far East.
4.12 Zubinos Board
The Board of Zubinos is under much pressure to deliver the agreed 5 year plan results and to
keep its investor, KPE, satisfied. If Zubinos is to get a listing on the AIM market in 4 years time,
to allow KPE to exit though a flotation of shares, it is necessary to strengthen the Zubinos Board
and to get some non-executive directors appointed. Non-executive directors should be able to
give a wealth of experience to this young company, whose Board members lack many aspects
of commercial experience and have been under much pressure from the high growth that
Zubinos has experienced to date.
The company is very dependent on a few key individuals and it is recommended that the
management team be strengthened.
The person recruited into the role of temporary MD while Luis Zubino has three months leave,
should be a strong individual with a proven track record in a start-up high growth business. This
person could bring much needed expertise to the Zubinos management team.
Depending on whether the Zubinos Board agrees to the GF franchising proposal, a further
senior manager or director would need to be appointed to act as franchising manager for
Zubinos and to be the main contact with GF.
4.13 Dividends
No dividends have been paid to date and the 5 year plan does not state what dividend
arrangements have been agreed with KPE. It is likely that no dividends will be paid for the next
few years, allowing all cash generated from operations to be ploughed back into the company to
help finance the ambitious expansion programme.
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However, it may be necessary to pay a dividend to satisfy KPE in the interim period until it exits.
This will depend largely on the level of cash generated by Zubinos and Zubinos ability to meet or
exceed the agreed 5-year plan.
5.0
Ethical issues
5.1
Range of ethical issues in the case
There are a number of ethical dilemmas facing Zubinos, as discussed below, but the over-riding
ethical problem of key importance concerns the employees. It is very important that Zubinos
provides a high level of customer service, which is very important in this customer focused
business. By employing EU immigrant employees on short-term contracts and allocating them
long working hours is not ethically good business behaviour.
The ethical issues in the case material include the following:
•
Zubinos Light meal boxes should use suppliers that have high quality foods, and not use
cheaper suppliers which Zubinos management have recognised as below expectations.
•
Staff issues and long working hours, and anti social working hours.
•
Use of EU Immigrant employees.
•
Noise nuisance.
•
Fair Trade coffee.
•
Coffee machines.
5.2
Zubinos Light meal boxes
Currently Zubinos is using supplier BBK to supply 2,000 meal boxes a day although it is stated
that both the food quality and the cleanliness of food preparation areas at BBK are below
expectations. It is recommended that the supply contract with BBK is terminated and that a new
supply contract with DTY, which has an excellent standard in both of these criteria, is agreed
5.3
Long working hours by Zubinos employees
A company such as Zubinos in the retail industry is heavily dependant on its customers having a
high standard of customer service. Only a contented workforce will be able to meet these high
standards and Zubinos should not allow its staff to become demoralised, tired or dissatisfied, as
these negative feelings will affect the way that customers perceive the company and bad service
will have a direct correlation to loss of customers.
Following the decision to extend the opening hours at Zubinos until 11p.m at night, the company
needs to recruit additional staff to meet these longer working hours. The company should also
be mindful of the length of shifts and not to rota staff to work at both ends of the day. It has
clearly been exploiting the EU immigrant employees which is not ethically correct, nor is it good
business practice.
It is recommended that additional part-time employees are recruited to ensure that Zubinos
employees do not work excessive hours. It would also be ethically good practice if staff are
given a choice of shift patterns worked to fit in with family commitments.
5.4
Use of EU Immigrant employees
It is not good business practice to exploit a cheaper workforce and expect it to work at both ends
of the working day or to work very long shifts. Customer complaints have already highlighted
that the cost savings made by the use of cheaper, and more flexible, EU immigrant labour, may
have a detrimental effect on how the company is viewed by its customers. The company started
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with high moral aspirations (good customer service and high proportion of Fair Trade coffee)
and is successful.
It should be considered whether now that the company has started to alter these moral stances,
however subtly, its customers may view the company adversely. This type of industry is quite
fickle and small changes, can sometimes lead to large swings in volume of business and have
an adverse effect on profitability in the medium and longer term. Short term cost saving should
be avoided.
It is recommended that the EU immigrant employees should be treated fairly and they should be
allowed to complete their current short-term contract period. After the end of the contract period,
they should only have their contract renewed if they meet the high exacting standards of other
Zubinos employees, including high levels of customer service and good spoken English. It may
be necessary for Zubinos to have a recruitment drive, as many of the current EU immigrant
employees are not likely to have their contracts renewed.
5.5
Noise nuisance
For Zubinos to continue to be successful, it needs to find ways in which it can work within the
local environment of each of its shops. It needs to be able to appease its neighbours and reduce
the noise made by deliveries. It is suggested that Zubinos local management meet with
opponents of the noise nuisance and to try to work out an equitable system. Although some
deliveries may still need to be made early morning, perhaps it can be agreed that a small van
rather than a large lorry make the deliveries. Zubinos cannot afford to alienate or upset its
neighbours and it needs to be flexible in the way it works with its immediate neighbours.
There is also the impending legal case. It is suggested that this is settled by arbitration out of
court, as a court hearing will be expensive and will lead to more adverse publicity. This could
harm Zubinos’ reputation and could also have an adverse effect on future site selection and
rental negotiations.
It is also suggested that Zubinos becomes more involved in the local environment in which each
shop operates and perhaps also supports or promotes local charities. For Zubinos to be seen to
be acting in an ethically responsible way, it must start to contribute to the local neighbourhoods
in which it operates.
5.6
Use of Fair Trade coffee
Its reduced use of Fair Trade coffee is a detrimental step and may lose it many customers, if
and when they discover this fact. The company should be building on its strengths, such as the
high use of Fair Trade coffee, not cost cutting to generate a small increase in short-term
profitability. In respect of transaction exposure, the company should arrange forward contracts, if
contracts are available in the required currencies, to reduce or eliminate its currency exposure
on Fair Trade coffee purchases.
It is recommended that Zubinos immediately withdraws from sale all non-Fair Trade coffee and
sells ONLY Fair Trade coffee, even if some revenue is lost. It will be necessary to advertise the
fact that Zubinos uses only Fair Trade coffee and it would help if some new Fair Trade products
were also launched as part a local and national advertising campaign. It is vital to the future
success of Zubinos that it does not lose its customers’ confidence. Perhaps a competition or a
promotional campaign at each of the Zubinos shops should happen as part of the promotion of
its new totally ethical stance.
In real life, Costa Coffee makes much PR out of its ethical stance and retails only Fair Trade
coffee. However, research has shown that for the additional premium that customers are willing
to pay, the additional cost of procuring Fair Trade supplies is only 10% of this premium price.
Therefore, over 90% of the premium charged does not go to the Fair Trade farmers. This in itself
is highly unethical. However, the procurement of Fair Trade produce has a significant financial
effect on the producers of the crops and has enabled many to make a living from farming, so
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While more could be done globally to raise prices for the benefit of Fair Trade farmers, they are
already much better off than they used to be.
5.7 Coffee machines
Zubinos has sold its customers coffee machines which it now knows have a design fault. It
would be good business practice to advertise this fault and offer a replacement machine, rather
than waiting for customers to return the faulty machines. The Zubinos management team needs
to negotiate with the manufacturer to ascertain whether Zubinos continues to replace customers’
faulty machines at its own expense, or whether the design fault is the responsibility of the
manufacturer. However, it is in Zubinos interests not to damage customer relations and as a
gesture of goodwill, the replacement of faulty machines is more likely to engender customer
loyalty. It is in Zubinos interests to have the machines working, as it makes its profit on the sale
of coffee supplies, not on the machines themselves.
6.0
Recommendations
6.1
Zubinos Light meal boxes
It is recommended that Zubinos selects supplier DTY as a supplier of Zubinos Light meal boxes
as it meets Zubinos high standards of food quality and cleanliness of food preparation areas. As
DTY has the ability to increase its capacity to 8,000 boxes a day, perhaps there is scope in the
contract negotiations to reduce the cost per box down from £2⋅00 per box to £1⋅80 per box when
volumes increase. Therefore it is recommended that a sliding scale of charges is agreed with
DTY depending on volumes produced.
It is recommended that the current suppliers of Zubinos Light meal boxes are handled as
follows:
•
Supplier ART supplying at £1⋅20 per box should be given a rolling 12 month contract at
this fixed rate
•
Supplier BBK should have the contract terminated at the end of the 6 month contract
period as it does not meet Zubinos quality standards. If it is possible to reduce the
quantity procured sooner or cancel the contact on the grounds of quality issues, then this
should be done as soon as possible.
In summary, the quality of the food offered to customers is key to the continued success of this
new innovative product and it is recommended that the two top quality suppliers, ART and DTY
are selected.
6.2
Accept the GF franchising proposal
It is recommended that Zubinos should accept the GF franchising proposal as this would give
Zubinos an excellent opportunity to expand the number of Zubinos shops in the fastest possible
time, and at a reduced business risk.
Zubinos has limited management expertise and limited equity and loan finance. The current 5
year plan assumes that by 2010 it will have 75 shops operational, which is quite a challenging
target to achieve and also to manage.
By selecting the franchising route, expansion is financed by the franchisees and Zubinos takes
just the agreed level of franchise fees. However, it should allow for faster expansion. The GF
proposal states that it has over 30 franchisees ready to open franchised outlets and this speed
of operation is not unusual in the franchise business.
The GF proposal is for 180 franchised shops by 2010, but would mean a reduced number of
Zubinos operated shops, to around 50. However, totalled together would mean 250 Zubinos
shops using the franchising route rather than the current plan of 75. Furthermore the GF
proposal is for 120 additional franchised shops in 2011, which far exceeds the number of owned
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and operated shops that Zubinos could achieve if it were financing the expansion programme
itself.
Overall, franchising is the recommended way forward to achieve rapid expansion. It is also
recommended that Zubinos uses GF, rather than choosing to manage the franchise business
itself, as it has no franchising skills and GF has a proven track record, being an international
franchising company.
Therefore, recommend that Zubinos select to franchise with GF, but negotiate the level of fees
payable to be less than the 2% of ongoing revenues.
6.3
Luis Zubino’s planned leave
It is recommended that an experienced senior manager is recruited on a short term contract to
fill the role of MD in Luis Zubino’s absence. If the manager proves to be good in the role, his
skills should be retained in a different Zubinos senior management role after Luis Zubino returns
to work.
6.4
Human resource issues
It is recommended that an employee share scheme is introduced as soon as possible, so as to
motivate key employees and retain their skills within the business.
It is recommended that the Balanced Scorecard approach is used as a motivational tool and that
as many senior staff as possible are involved in its introduction and setting of key performance
measures.
It is also recommended that the use of EU immigrant labour is stopped as these employees do
not provide the high level of customer service that Zubinos customers expect and which Zubinos
needs to provide in order to maintain customer satisfaction.
It is recommended that Anita Wiseman attempts to “introduce” a positive company culture that
does not encourage working long hours.
Additionally, more customer surveys should be undertaken to ascertain what Zubinos current
customer service is perceived to be and to identify areas for improvement.
6.5
New 2006 shop openings
It is strongly recommended that the 2 shops purchase at £2⋅2 million does NOT proceed. It is
recommended that all new shop openings are in rented premises to reduce the amount of
capital expenditure required.
If suitable rental sites cannot be found in the targeted town/city that Zubinos plans to expand
into, then Zubinos should select suitable rental sites in the next town/city scheduled for
expansion. The company should NOT buy any additional premises as this is not a good use of
its limited loan facility.
6.6
Other recommendations
It is recommended that Maria Todd should not pursue her current changes in suppliers to save
operating costs as this is likely to compromise on quality. As it is quality that is Zubinos main
area of differentiation, it should not reduce the level of product quality. Furthermore, it is
recommended that Zubinos should offer 100% Fair Trade coffee and the current policy of
reducing the amount of Fair Trade coffee procured should be stopped immediately.
It is recommended that the Zubinos Board is strengthened and more external experienced
managers are recruited. It is recommended that an IT Director be appointed to ensure that the
growing Zubinos business has the IT solutions to cope with its planned high growth.
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It is recommended that the Zubinos shareholders start to plan the way in which KPE would exit
in 2009. It will be necessary to start preparing plans for an AIM flotation, if this is the planned
route, as early as 2007. It is recommended that Zubinos should put in place the required
management structure and IT systems over the next 2 years in order to start the process for
KPE to exit in 2009.
It is recommended that operating costs, and particularly capital expenditure, are closely
controlled as the current forecast cost overruns on capital expenditure has far reaching effects
on the amount of loan capital available to achieve the agreed 5-year plan expansion plans. It is
recommended that operating costs should be carefully controlled but that short-term savings are
not made at the expense of long-term objectives and by offering lower quality food and drink
products. Capital expenditure needs to be better managed so that the cost of each new Zubinos
opening does not escalate, as this would have an impact on the amount of financing required to
achieve the agreed roll-out plans. Any cost overruns on one new shop should be saved on other
shop fitting costs and also Zubinos cannot afford to keep increasing the specifications just
because bigger and better refrigeration units are available. There are some capital expenditure
items that Zubinos needs to agree are beyond its limited budget.
It is recommended that Zubinos negotiates a deal with the manufacturer of the coffee machines
to replace all machines sold to date if they become faulty. Zubinos should actively try to notify
customers of the fault and offer replacement machines to try to pre-empt customer complaints
over broken machines.
It is recommended that no dividends are paid over the next few years, depending on what has
been specifically agreed with KPE when it invested in 2005. The reason for paying no dividends
is that cash can be retained in the business to finance the planned expansion.
7.0
Conclusions
The Zubinos business has already grown very rapidly and the business is profitable and cash
generating. It has attracted the attention of the global franchising company GF who has offered
a very attractive franchising proposal, which could give the company a huge chance to expand
its business via the use of franchisees.
The Zubinos management team needs to be strengthened in order for the planned growth in the
5-year plan to be achieved. It is likely that KPE would wish to exit in 2009 or 2010 by a flotation
on AIM and this process needs to be planned.
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Appendix 1
SWOT analysis for Zubinos
Strengths
•
High growth in revenues and profits
achieved since launch of Zubinos in
2001
•
Cash generating business
•
Has attracted KPE to invest in the
company
•
Has achieved plan in 2005
•
Innovative management team
•
Management team is highly motivated
and most own shares in Zubinos
•
Significant shareholding by Zubino
family holdings
•
Successful launch of Zubinos Light
meal boxes
Weaknesses
•
Far too dependant on a few key managers
•
Gap in the management team when Luis Zubino
goes on his 3 month leave
•
Weak financial systems
•
Poor forecasting and control
•
Lack of IT solutions
•
Not building the company’s infrastructure up (HR
and IT resources) for the planned high growth
•
Inexperienced management team
•
Reduced staff morale due to longer opening hours
•
Not procuring 100% Fair Trade coffee which could
harm the company’s PR initiatives
•
Control of Zubinos is not with the Zubinos family
•
Luis Zubino is both Chairman and Managing
Director
•
Poor stock control
•
Has the Zubinos management team got the skills to
achieve the agreed 5-year plan?
Opportunities
•
Growth in revenues and margins
following successful launch of Zubinos
Light meal boxes
•
Franchising opportunities – the GF
proposal or for Zubinos to franchise the
business itself
•
Improved management team following
the temporary recruitment of an
experienced manager to take Luis
Zubinos place while he is on 3 month’s
leave
•
Expansion into Europe
•
Possible flotation in 4 years time on
AIM or MBO to give KPE an exit route
•
New product innovations
•
Longer opening times generating higher
revenues
•
Improved IT systems to reduce
wastage
•
Better staff motivation if an employee
share ownership scheme were to be
introduced
Threats
•
Increasing competition
•
Poor customer service resulting in a loss of
customer loyalty as a result of the use of more EU
immigrant employees
•
Legal action pending about noise nuisance, which
could generate adverse publicity
•
Possible loss of business following changes in
types of coffee procured (less Fair Trade coffee)
•
Reduced Fair Trade coffee could lead to poor PR
and loss of customers who believe in the Fair Trade
ideals
•
The need to continue to meet financial targets in
order to avoid KPE getting more involved in the
day-to-day management of the business
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Appendix 2
PEST analysis
Political/Legal
•
Sensitive issue over the high use of EU immigrant employees and the adverse publicity
that could follow if these employees do not have their short-term contracts renewed
•
Noise nuisance issues and pending legal claim against Zubinos
Economic
•
Growing market place
•
Not price sensitive
•
Success of new Zubinos Light meal boxes
•
Expansion into cities in UK that have been tested by market research to be able to sustain
the number of coffee shops present
Social
•
Current trend for coffee shops that has grown in last 10 years
•
Industry worth total revenues of over £1 billion in the UK in 2005
•
Meeting place for people
•
Meeting demand for low calorie meals by providing Zubinos Light meal boxes
•
Coffee shop culture and European street café culture permeating through all areas of the
UK successfully
•
Much room for expansion in the UK and overseas
•
There is the question of how many coffee shops are sustainable in the longer term in the
UK – there will be a move for the industry to consolidate within the next 10 years with a
wave of take-overs, like in the sports club market place 5 years ago
Technological
•
Zubinos has been successful to date with little use of IT systems and high technology
•
There is the opportunity to continue to use technology to increase revenues and control
costs
•
Sales of Zubinos products on Internet
•
Improved site selection, in the UK and overseas, using sophisticated market research and
traffic statistics.
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Appendix 3
Balanced scorecard performance measures
It is recommended that Zubinos adopts the Balanced Scorecard approach and below are
suggested performance measures that should be monitored for each of the four criteria:
Innovation:
•
% spend on new products launched within 12 months (data captured at source)
•
Number of new products launched per month/per year
•
% of total revenue that new products represent
•
Number of new customers into Zubinos shops (done by random sampling)
•
Number of ideas generated by Zubinos staff for new products
•
Number of new suppliers
Financial:
•
Average spend per customer
•
% spend on each category of products for example coffee products
•
Margin per product category
•
% increase in revenue and operating profits per shop
•
Capital spend per new Zubinos shop
•
Operating margin per shop
•
Net margin
Quality:
•
Number of deliveries on time
•
Number of stock shortages
•
Number of returned goods to suppliers
•
Survey of customers on perceived quality of Zubinos’ products
Customer service:
•
Customer throughput
•
Number (and analysis) of customer complaints
•
Survey of customers on perceived level of customer service
•
Waiting time to serve customers
•
Average number of people in queue during peak times (can be counted by use of IT
solutions using cameras or pressure pad systems to judge people waiting)
•
Number of orders correctly served to customers (by market research)
•
Number of repeat customers
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Appendix 4
Evaluation of Zubinos Light meal boxes
First, an evaluation of revenues and gross margins achieved to date on Zubinos Light meal
boxes:
Per Box
Revenue
Costs:
Supplier ART
Supplier BBK
Gross margin
Current
capacity
£
3⋅00
4,000
Number of days
per month
Zubinos Light
are in demand
20
1⋅20
1⋅60
2,000
2,000
20
20
Monthly
Annualised
£
240,000
£
2,880,000
48,000
64,000
128,000
53⋅3%
1⋅60
1,536,000
Proposed supplier change from BBK to DTY:
Per Box
Revenue
Costs:
Supplier ART
Supplier DTY
Gross margin
Forecast
capacity
£
3⋅00
5,000
Number of days
per month
Zubinos Light are
in demand
20
1⋅20
2⋅00
2,000
3,000
20
20
Monthly
£000
300,000
48,000
120,000
132,000
44⋅0%
1⋅32
Annualised
£000
3,600,000
1,584,000
If the cheaper option of CCV is chosen for the balance of 3,000 meal boxes per day, then
Zubinos could save £0.90 per meal box. This could generate an additional annual gross margin
of almost £650,000 but it could limit Zubinos ability to continue to generate the current level of
demand if the food quality produced by CCV is below expectations.
It is recommended that DTY is chosen, despite the reduced gross margin, as it is the higher
quality ingredients used by DTY that should help Zubinos to generate the highest total sales and
profitability in the medium term.
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Appendix 5
Evaluation of GlobalFranch franchising proposal
2007
£ million
2008
£ million
2009
£ million
2010
£ million
2011
£ million
Total Franchise income
1⋅1
4⋅2
9⋅7
19⋅6
36⋅3
Less: Franchise fees payable by
Zubinos to GF
1⋅0
2⋅4
4⋅7
8⋅7
15⋅2
Net pre-tax cash flows
0⋅1
1⋅8
5⋅0
10⋅9
21⋅1
Not
known
Adjustment for reduced profits from Zubinos operated shops:
5 year plan – end year number of
coffee shops operated by Zubinos
36
48
60
75
36
40
40
Not
restricted
Reduced number of Zubinos
operated coffee shops
- end year
0
8
20
Not
restricted
Not
known
- average
0
2
14
117
133
152
161
Not
known
Reduced number of coffee shops
operated by Zubinos if GF proposal
accepted
Pre-tax profit per coffee shop
operated by Zubino
£000
£ million
Reduction in pre-tax profit for
reduced number of shops
£ million
£ million
£ million
£ million
Not
known
£ million
0
(0⋅3)
(2⋅1)
Not
restricted
Not
known
Net pre-tax profit after adjustment
for the GF proposal
0⋅1
1⋅5
2⋅9
10⋅9
21⋅1
Net post tax profit after adjustment
for the GF proposal
0⋅1
1⋅1
2⋅2
8⋅3
16⋅0
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Appendix 6 (page 1)
Alternative valuations of Zubinos
1. P/E ratio
NOTE: Any suitable P/E ratio could be used, as the P/E ratio of 16 is not given in the May 2006
unseen material.
If the market P/E ratio is assumed to be 16, this should be reduced by 40% (as Zubinos is not
listed) = 9⋅6. Based on 2005 earnings of £897,000 and a P/E of 9⋅6 = £8⋅6 million (£8⋅60 per
share). The P/E ratio of 9⋅6 could be applied to the 5 year plan profit figures as follows:
2008
£ million
5⋅6
2009
£ million
8⋅2
2010
£ million
11⋅0
-0⋅5
-0⋅5
-0⋅5
-1⋅2
-1⋅8
-2⋅5
Estimated post tax operating profits
3⋅9
5⋅9
8⋅0
Valuation based on P/E ratio of 9⋅6 £ million
37⋅4
56⋅6
76⋅8
Value per share
£37⋅4
£56⋅6
£76⋅8
5 year plan pre-tax operating profit
Less estimated finance costs (assumed entire £5
million KPE loan at 10% has been taken up by
2008)
Less tax (at 24%)
£ per share
If the GF franchising proposal is accepted, then the planned post tax operating profits would be
as follows:
2008
£ million
2009
£ million
2010
£ million
Estimated post tax operating profits (as above)
3⋅9
5⋅9
8⋅0
Net post tax profit after adjustment for the GF
proposal
Estimated post tax operating profits including GF
franchising revenues, adjusted for the reduced
number of shops operated by Zubinos
1⋅1
2⋅2
8⋅3
5⋅0
8⋅1
16⋅3
Valuation based on P/E ratio of 9⋅6 £ million
48⋅0
77⋅8
156⋅5
Value per share
£48⋅0
£77⋅8
£156⋅5
£ per share
Note: In reality, the P/E ratio would change as the level of the franchised number of shops
increased, but for the purpose of simplicity in this answer, it has been assumed to stay at 9⋅6.
However, any alternative realistic P/E ratio could be used by candidates to achieve full marks.
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Appendix 6 (page 2)
Alternative valuations of Zubinos
2.
Net assets
This is not a good way to value a going concern business, but it is worth noting that assets are
worth £5⋅4 million at the end of 2005.
3.
Discounted cash flows
The data to prepare a valuation on the basis of discounted cash flows is not available and
therefore this valuation method cannot be used.
Examiners note:
A wide range of additional calculations could have been provided here for additional
marks including an evaluation of the sale of coffee machines, an updated cash forecast
for 2006 or an updated 5 year plan. However, in respect of the 5 year plan, any material
changes would need to be approved by the Zubinos Board and KPE and it is unlikely that
it would be approved if the cash flows generated or the forecast profitability were
materially lower.
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