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N.B.: 1) Attempt any Four cases
CASE : 01
COOKING LPG LTD
DETERMINATION OF WORKING CAPTIAL
Introduction
Cooking LPG Ltd, Gurgaon, is a private sector firm dealing in the bottling and supply of domestic LPG for household consumption since 1995. The firm has a network of distributors in the districts of Gurgaon and Faridabad. The bottling plant of the firm is located on National Highway – 8 (New Delhi – Jaipur), approx. 12 kms from Gurgaon. The firm has been consistently performing we.” and plans to expand its market to include the whole National Capital Region.
The production process of the plant consists of receipt of the bulk LPG through tank trucks, storage in tanks, bottling operations and distribution to dealers. During the bottling process, the cylinders are subjected to pressurized filling of LPG followed by quality control and safety checks such as weight, leakage and other defects. The cylinders passing through this process are sealed and dispatched to dealers through trucks. The supply and distribution section of the plant prepares the invoice which goes along with the truck to the distributor.
Statement of the Problem :
Mr. I. M. Smart, DGM(Finance) of the company, was analyzing the financial performance of the company during the current year. The various profitability ratios and parameters of the company indicated a very satisfactory performance. Still, Mr. Smart was not fully content-specially with the management of the working capital by the company. He could recall that during the past year, in spite of stable demand pattern, they had to, time and again, resort to bank overdrafts due to non-availability of cash for making various payments. He is aware that such aberrations in the finances have a cost and adversely affects the performance of the company. However, he was unable to pinpoint the cause of the problem.
He discussed the problem with Mr. U.R. Keenkumar, the new manager (Finance). After critically examining the details, Mr. Keenkumar realized that the working capital was hitherto estimated only as approximation by some rule of thumb without any proper computation based on sound financial policies and, therefore, suggested a reworking of the working capital (WC) requirement. Mr. Smart assigned the task of determination of WC to him.
Profile of Cooking LPG Ltd.
1) Purchases : The company purchases LPG in bulk from various importers ex-Mumbai and Kandla, @ Rs. 11,000 per MT. This is transported to its Bottling Plant at Gurgaon through 15 MT capacity tank trucks (called bullets), hired on annual contract basis. The average transportation cost per bullet ex-either location is Rs. 30,000. Normally, 2 bullets per day are received at the plant. The company make payments for bulk supplies once in a month, resulting in average time-lag of 15 days.
2) Storage and Bottling : The bulk storage capacity at the plant is 150 MT (2 x 75 MT storage tanks) and the plant is capable of filling 30 MT LPG in cylinders per day. The plant operates for 25 days per month on an average. The desired level of inventory at various stages is as under.
• LPG in bulk (tanks and pipeline quantity in the plant) – three days average production / sales.
• Filled Cylinders – 2 days average sales.
• Work-in Process inventory – zero.
3) Marketing : The LPG is supplied by the company in 12 kg cylinders, invoiced @ Rs. 250 per cylinder. The rate of applicable sales tax on the invoice is 4 per cent. A commission of Rs. 15 per cylinder is paid to the distributor on the invoice itself. The filled cylinders are delivered on company’s expense at the distributor’s godown, in exchange of equal number of empty cylinders. The deliveries are made in truck-loads only, the capacity of each truck being 250 cylinders. The distributors are required to pay for deliveries through bank draft. On receipt of the draft, the cylinders are normally dispatched on the same day. However, for every truck purchased on pre-paid basis, the company extends a credit of 7 days to the distributors on one truck-load.
4) Salaries and Wages : The following payments are made :
• Direct labour – Re. 0.75 per cylinder (Bottling expenses) – paid on last day of the month.
• Security agency – Rs. 30,000 per month paid on 10th of subsequent month.
• Administrative staff and managers – Rs. 3.75 lakh per annum, paid on monthly basis on the last working day.
5) Overheads :
• Administrative (staff, car, communication etc) – Rs. 25,000 per month – paid on the 10th of subsequent month.
• Power (including on DG set) – Rs. 1,00,000 per month paid on the 7th Subsequent month.
• Renewal of various licenses (pollution, factory, labour CCE etc.) – Rs. 15,000 per annum paid at the beginning of the year.
• Insurance – Rs. 5,00,000 per annum to be paid at the beginning of the year.
• Housekeeping etc – Rs. 10,000 per month paid on the 10th of the subsequent month.
• Regular maintenance of plant – Rs. 50,000 per month paid on the 10th of every month to the vendors. This includes expenditure on account of lubricants, spares and other stores.
• Regular maintenance of cylinders (statutory testing) – Rs. 5 lakh per annum – paid on monthly basis on the 15th of the subsequent month.
• All transportation charges as per contracts – paid on the 10th subsequent month.
• Sales tax as per applicable rates is deposited on the 7th of the subsequent month.
6) Sales : Average sales are 2,500 cylinders per day during the year. However, during the winter months (December to February), there is an incremental demand of 20 per cent.
7) Average Inventories : The average stocks maintained by the company as per its policy guidelines :
• Consumables (caps, ceiling material, valves etc) – Rs. 2 lakh. This amounts to 15 days consumption.
• Maintenance spares – Rs. 1 lakh
• Lubricants – Rs. 20,000
• Diesel (for DG sets and fire engines) – Rs. 15,000
• Other stores (stationary, safety items) – Rs. 20,000
8) Minimum cash balance including bank balance required is Rs. 5 lakh.
9) Additional Information for Calculating Incremental Working Capital During Winter.
• No increase in any inventories take place except in the inventory of bulk LPG, which increases in the same proportion as the increase of the demand. The actual requirements of LPG for additional supplies are procured under the same terms and conditions from the suppliers.
• The labour cost for additional production is paid at double the rate during wintes.
• No changes in other administrative overheads.
• The expenditure on power consumption during winter increased by 10 per cent. However, during other months the power consumption remains the same as the decrease owing to reduced production is offset by increased consumption on account of compressors /Acs.
• Additional amount of Rs. 3 lakh is kept as cash balance to meet exigencies during winter.
• No change in time schedules for any payables / receivables.
• The storage of finished goods inventory is restricted to a maximum 5,000 cylinders due to statutory requirements.
Suppose you are Mr.Keen Kumar, the new manager. What steps will you take for the growth of Cooking LPG Ltd.?
CASE : 2
M/S HI-TECH ELECTRONICS
M/s. Hi – tech Electronics, a consumer electronics outlet, was opened two years ago in Dwarka, New Delhi. Hard work and personal attention shown by the proprietor, Mr. Sony, has brought success. However, because of insufficient funds to finance credit sales, the outlet accepted only cash and bank credit cards. Mr. Sony is now considering a new policy of offering installment sales on terms of 25 per cent down payment and 25 per cent per month for three months as well as continuing to accept cash and bank credit cards.
Mr. Sony feels this policy will boost sales by 50 percent. All the increases in sales will be credit sales. But to follow through a new policy, he will need a bank loan at the rate of 12 percent. The sales projections for this year without the new policy are given in Exhibit 1.
Exhibit 1 Sales Projections and Fixed costs
Month Projected sales without instalment option Projected sales with instalment option
January Rs. 6,00,000 Rs. 9,00,000
February 4,00,000 6,00,000
March 3,00,000 4,50,000
April 2,00,000 3,00,000
May 2,00,000 3,00,000
June 1,50,000 2,25,000
July 1,50,000 2,25,000
August 2,00,000 3,00,000
September 3,00,000 4,50,000
October 5,00,000 7,50,000
November 5,00,000 15,00,000
December 8,00,000 12,00,000
Total Sales 48,00,000 72,00,000
Fixed cost 2,40,000 2,40,000
He further expects 26.67 per cent of the sales to be cash, 40 per cent bank credit card sales on which a 2 per cent fee is paid, and 33.33 per cent on instalment sales. Also, for short term seasonal requirements, the film takes loan from chit fund to which Mr. Sony subscribes @ 1.8 per cent per month.
Their success has been due to their policy of selling at discount price. The purchase per unit is 90 per cent of selling price. The fixed costs are Rs. 20,000 per month. The proprietor believes that the new policy will increase miscellaneous cost by Rs. 25,000.
The business being cyclical in nature, the working capital finance is done on trade – off basis. The proprietor feels that the new policy will lead to bad debts of 1 per cent.
(a) As a financial consultant, advise the proprietor whether he should go for the extension of credit facilities.
(b) Also prepare cash budget for one year of operation of the firm, ignoring interest. The minimum desired cash balance & Rs. 30,000, which is also the amount the firm has on January 1. Borrowings are possible which are made at the beginning of a month and repaid at the end when cash is available.
CASE : 3
SMOOTHDRIVE TYRE LTD
Smoothdrive Tyre Ltd manufacturers tyres under the brand name “Super Tread’ for the domestic car market. It is presently using 7 machines acquired 3 years ago at a cost of Rs. 15 lakh each having a useful life of 7 years, with no salvage value.
After extensive research and development, Smoothdrive Tyre Ltd has recently developed a new tyre, the ‘Hyper Tread’ and must decide whether to make the investments necessary to produce and market the Hyper Tread. The Hyper Tread would be ideal for drivers doing a large amount of wet weather and off road driving in addition to normal highway usage. The research and development costs so far total Rs. 1,00,00,000. The Hyper Tread would be put on the market beginning this year and Smoothdrive Tyrs expects it to stay on the market for a total of three years. Test marketing costing Rs. 50,00,000, shows that there is significant market for a Hyper Tread type tyre.
As a financial analyst at Smoothdrive Tyre, Mr. Mani asked by the Chief Financial Officer (CFO), Mr. Tyrewala to evaluate the Hyper-Tread project and to provide a recommendation or whether or not to proceed with the investment. He has been informed that all previous investments in the Hyper Tread project are sunk costs are only future cash flows should be considered. Except for the initial investments, which occur immediately, assume all cash flows occur at the year-end.
Smoothedrive Tyre must initially invest Rs. 72,00,00,000 in production equipments to make the Hyper Tread. They would be depreciated at a rate of 25 per cent as per the written down value (WDV) method for tax purposes. The new production equipments will allow the company to follow flexible manufacturing technique, that is both the brands of tyres can be produced using the same equipments. The equipments is expected to have a 7-year useful life and can be sold for Rs. 10,00,000 during the fourth year. The company does not have any other machines in the block of 25 per cent depreciation. The existing machines can be sold off at Rs. 8 lakh per machine with an estimated removal cost of one machine for Rs. 50,000.
Operating Requirements
The operating requirements of the existing machines and the new equipment are detailed in Exhibits 11.1 and 11.2 respectively.
Exhibit 11.1 Existing Machines
• Labour costs (expected to increase 10 per cent annually to account for inflation) :
(a) 20 unskilled labour @ Rs. 4,000 per month
(b) 20 skilled personnel @ Rs. 6,000 per month.
(c) 2 supervising executives @ Rs. 7,000 per month.
(d) 2 maintenance personnel @ Rs. 5,000 per month.
• Maintenance cost :
Years 1-5 : Rs. 25 lakh
Years 6-7 : Rs. 65 lakh
• Operating expenses : Rs. 50 lakh expected to increase at 5 per cent annually.
• Insurance cost / premium :
Year 1 : 2 per cent of the original cost of machine
After year 1 : Discounted by 10 per cent.
Exhibit 11.2 New production Equipment
• Savings in cost of utilities : Rs. 2.5 lakh
• Maintenance costs :
Year 1 – 2 : Rs. 8 lakh
Year 3 – 4 : Rs. 30 lakh
• Labour costs :
9 skilled personnel @ Rs. 7,000 per month
1 maintenance personnel @ Rs. 7,000 per month.
• Cost of retrenchment of 34 personnel : (20 unskilled, 11 skilled, 2 supervisors and 1 maintenance personnel) : Rs. 9,90,000, that is equivalent to six months salary.
• Insurance premium
Year 1 : 2 per cent of the purchase cost of machine
After year 1 : Discounted by 10 per cent.
The opening expenses do not change to any considerable extent for the new equipment and the difference is negligible compared to the scale of operations.
Smoothdrive Tyre intends to sell Hyper Tread of two distinct markets :
1. The original equipment manufacturer (OEM) market : The OEM market consists primarily of the large automobile companies who buy tyres for new cars. In the OEM market, the Hyper Tread is expected to sell for Rs. 1,200 per tyre. The variable cost to produce each Hyper Tread is Rs. 600.
2. The replacement market : The replacement market consists of all tyres purchased after the automobile has left the factory. This markets allows higher margins and Smoothdrive Tyre expects to sell the Hyper Tread for Rs. 1.500 per tyre. The variable costs are the same as in the OEM market.
Smoothdrive Tyre expects to raise prices by 1 percent above the inflation rate.
The variable costs will also increase by 1 per cent above the inflation rate. In addition, the Hyper Tread project will incur Rs. 2,50,000 in marketing and general administration cost in the first year which are expected to increase at the inflation rate in subsequent years.
Smoothdrive Tyre’s corporate tax rate is 35 per cent. Annual inflation is expected to remain constant at 3.25 per cent. Smoothdrive Tyre uses a 15 per cent discount rate to evaluate new product decisions.
The Tyre Market
Automotive industry analysts expect automobile manufacturers to have a production of 4,00,000 new cars this year and growth in production at 2.5 per year onwards. Each new car needs four new tyres (the spare tyres are undersized and fall in a different category) Smoothdrive Tyre expects the Hyper Tread to capture an 11 per cent share of the OEM market.
The industry analysts estimate that the replacement tyre market size will be one crore this year and that it would grow at 2 per cent annually. Smoothdrive Tyre expects the Hyper Tread to capture an 8 per cent market share.
You also decide to consider net working capital (NWC) requirements in this scenario. The net working capital requirement will be 15 per cent of sales. Assume that the level of working capital is adjusted at the beginning of the year in relation to the expected sales for the year. The working capital is to be liquidated at par, barring an estimated loss of Rs. 1.5 crore on account of bad debt. The bad debt will be a tax-deductible expenses.
As a finance analyst, prepare a report for submission to the CFO and the Board of Directors, explaining to them the feasibility of the new investment.
CASE : 4
COMPUTATION OF COST OF CAPITAL OF PALCO LTD
In October 2003, Neha Kapoor, a recent MBA graduate and newly appointed assistant to the Financial Controller of Palco Ltd, was given a list of six new investment projects proposed for the following year. It was her job to analyse these projects and to present her findings before the Board of Directors at its annual meeting to be held in 10 days. The new project would require an investment of Rs. 2.4 crore.
Palco Ltd was founded in 1965 by Late Shri A. V. Sinha. It gained recognition as a leading producer of high quality aluminum, with the majority of its sales being made to Japan. During the rapid economic expansion of Japan in the 1970s, demand for aluminum boomed, and palco’s sales grew rapidly. As a result of this rapid growth and recognition of new opportunities in the energy market, Palco began to diversify its products line. While retaining its emphasis on aluminum production, it expanded operations to include uranium mining and the production of electric generators, and finally, it went into all phases of energy production. By 2003, Palco’s sales had reached Rs. 14 crore level, with net profit after taxes attaining a record of Rs. 67 lakh.
As Palco expanded its products line in the early 1990s, it also formalized its caital budgeting procedure. Until 1992, capital investment projects were selected primarily on the basis of the average return on investment calculations, with individual departments submitting these calculations for projects falling within their division. In 1996, this procedure was replaced by one using present value as the decision making criterion. This change was made to incorporate cash flows rather than accounting profits into the decision making analysis, in addition to adjusting these flows for the time value of money. At the time, the cost of capital for Palco was determined to be 12 per cent, which has been used as the discount rate for the past 5 years. This rate was determined by taking a weighted average cost Palco had incurred in raising funds from the capital market over the previous 10 years.
It had originally been Neha’s assignment to update this rate over the most recent 10-year period and determine the net present value of all the proposed investment opportunities using this newly calculated figure. However, she objected to this procedure, stating that while this calculation gave a good estimate of “the past cost” of capital, changing interest rates and stock prices made this calculation of little value in the present. Neha suggested that current cost of raising funds in the capital market be weighted by their percentage mark-up of the capital structure. This proposal was received enthusiastically by the Financial Controller of the Palco, and Neha was given the assignment of recalculating Palco’s cost of capital and providing a written report for the Board of Directors explaining and justifying this calculation.
To determine a weighted average cost of capital for Palco, it was necessary for Neha to examine the cost associated with each source of funding used. In the past, the largest sources of funding had been the issuance of new equity shares and internally generated funds. Through conversations with Financial Controller and other members of the Board of Directors, Neha learnt that the firm, in fact, wished to maintain its current financial structure as shown in Exhibit 1.
Exhibit 1 Palco Ltd Balance Sheet for Year Ending March 31, 2003
Assets Liabilities and Equity
Cash
Accounts receivable
Inventories
Total current assets
Net fixed assets
Goodwill
Total assets Rs. 90,00,000
3,10,00,000
1,20,00,000
5,20,00,000
19,30,00,000
70,00,000
25,20,00,000
Accounts payable
Short-term debt
Accrued taxes
Total current liabilities
Long-term debt
Preference shares
Retained earnings
Equity shares
Total liabilities and equity shareholders fund
Rs. 8,50,000
1,00,000
11,50,000
1,20,00,000
7,20,00,000
4,80,00,000
1,00,00,000
11,00,000
25,20,00,000
She further determined that the strong growth patterns that Palco had exhibited over the last ten years were expected to continue indefinitely because of the dwindling supply of US and Japanese domestic oil and the growing importance of other alternative energy resources. Through further investigations, Neha learnt that Palco could issue additional equity share, which had a par value of Rs. 25 pre share and were selling at a current market price of Rs. 45. The expected dividend for the next period would be Rs. 4.4 per share, with expected growth at a rate of 8 percent per year for the foreseeable future. The flotation cost is expected to be on an average Rs. 2 per share.
Preference shares at 11 per cent with 10 years maturity could also be issued with the help of an investment banker with an investment banker with a per value of Rs. 100 per share to be redeemed at par. This issue would involve flotation cost of 5 per cent.
Finally, Neha learnt that it would be possible for Palco to raise an additional Rs. 20 lakh through a 7 – year loan from Punjab National Bank at 12 per cent. Any amount raised over Rs. 20 lakh would cost 14 per cent. Short-term debt has always been usesd by Palco to meet working capital requirements and as Palco grows, it is expected to maintain its proportion in the capital structure to support capital expansion. Also, Rs. 60 lakh could be raised through a bond issue with 10 years maturity with a 11 percent coupon at the face value. If it becomes necessary to raise more funds via long-term debt, Rs. 30 lakh more could be accumulated through the issuance of additional 10-year bonds sold at the face value, with the coupon rate raised to 12 per cent, while any additional funds raised via long-term debt would necessarily have a 10 – year maturity with a 14 per cent coupon yield. The flotation cost of issue is expected to be 5 per cent. The issue price of bond would be Rs. 100 to be redeemed at par.
In the past, Palco had calculated a weighted average of these sources of funds to determine its cost of capital. In discussion with the current Financial Controller, the point was raised that while this served as an appropriate calculation for external funds, it did not take into account the cost of internally generated funds. The Financial Controller agreed that there should be some cost associated with retained earnings and need to be incorporated in the calculations but didn’t have any clue as to what should be the cost.
Palco Ltd is subjected to the corporate tax rate of 40 per cent.
From the facts outlined above, what report would Neha submit to the Board of Directors of palco Ltd ?
CASE : 5
ARQ LTD
ARQ Ltd is an Indian company based in Greater Noida, which manufactures packaging materials for food items. The company maintains a present fleet of five fiat cars and two Contessa Classic cars for its chairman, general manager and five senior managers. The book value of the seven cars is Rs. 20,00,000 and their market value is estimated at Rs. 15,00,000. All the cars fall under the same block of depreciation @ 25 per cent.
A German multinational company (MNC) BYR Ltd, has acquired ARQ Ltd in all cash deal. The merged company called BYR India Ltd is proposing to expand the manufacturing capacity by four folds and the organization structure is reorganized from top to bottom. The German MNC has the policy of providing transport facility to all senior executives (22) of the company because the manufacturing plant at Greater Noida was more than 10 kms outside Delhi where most of the executives were staying.
Prices of the cars to be provided to the Executives have been as follows :
Manager (10) Santro King Rs. 3,75,000
DGM and GM (5) Honda City 6,75,000
Director (5) Toyota Corolla 9,25,000
Managing Director (1) Sonata Gold 13,50,000
Chairman (1) Mercedes benz 23,50,000
The company is evaluating two options for providing these cars to executives
Option 1 : The company will buy the cars and pay the executives fuel expenses, maintenance expenses, driver allowance and insurance (at the year – end). In such case, the ownership of the car will lie with the company. The details of the proposed allowances and expenditures to be paid are as follows :
a) Fuel expense and maintenance Allowances per month
Particulars Fuel expenses Maintenance allowance
Manager
DGM and GM
Director
Managing Director
Chairman Rs. 2,500
5,000
7,500
12,000
18,000 Rs. 1,000
1,200
1,800
3,000
4,000
b) Driver Allowance : Rs. 4,000 per month (Only Chairman, Managing Director and Directors are eligible for driver allowance.)
c) Insurance cost : 1 per cent of the cost of the car.
The useful life for the cars is assumed to be five years after which they can be sold at 20 per cent salvage value. All the cars fall under the same block of depreciation @ 25 per cent using written down method of depreciation. The company will have to borrow to finance the purchase from a bank with interest at 14 per cent repayable in five annual equal instalments payable at the end of the year.
Option 2 : ORIX, The fleet management company has offered the 22 cars of the same make at lease for the period of five years. The monthly lease rentals for the cars are as follows (assuming that the total of monthly lease rentals for the whole year are paid at the end of each year.
Santro Xing Rs. 9,125
Honda City 16,325
Toyota Corolla 27,175
Sonata Gold 39,250
Mercedes Benz 61,250
Under this lease agreement the leasing company, ORIX will pay for the fuel, maintenance and driver expenses for all the cars. The lessor will claim the depreciation on the cars and the lessee will claim the lease rentals against the taxable income. BYR India Ltd will have to hire fulltime supervisor (at monthly salary of Rs. 15,000 per month) to manage the fleet of cars hired on lease. The company will have to bear additional miscellaneous expense of Rs. 5,000 per month for providing him the PC, mobioe phone and so on.
The company’s effective tax rate is 40 per cent and its cost of capital is 15 per cent.
Analyse the financial viability of the two options. Which option would you recommend ? Why ?
Attempt all Cases.
Case 1: PROMOTING THE PROTÉGÉ
The die was cast. Prem Nath Divan, executive chairman of Vertigo, the country’s largest engineering project organization, decided to switch tracks for a career in academics. Divan was still six years short of the company’s retirement age of 65. His premature exit was bound to create a flutter at the Vertigo board. Having joined Vertigo as a management trainee soon after college, he had gradually risen through the hierarchy to take a board position as the marketing director of the firm at 32. He had become the president five years later and the youngest chairman of the company at 45. But, by the time he was 50, the whizkid had acquired a larger than life image of a role model for younger managers and a statesman who symbolized the best and brightest face of Indian management.
On his wife’s suggestion that it would be wise to discuss the move with one of his trusted colleagues before making a formal announcement of his intention to seek premature retirement, Divan called on Ramcharan Saxena, a solicitor who has been on the Vertigo board for over a decade. Sexena was surprised at Divan’s plan. But he was unfazed. “If that is what you want to do for the rest of your life, we can only wish you well”, he told him. “The board will miss you. But the business should go on. We should get down to the task of choosing a successor. The sooner it is done, the better.
“I think the choice is quite obvious, “said Divan, “Ranjan Warrior. He is good and …” Divan was taken aback to see Saxena grimace. “You don’t have anything against him, do you?” he asks him. “No, no,” said Saxena, “He is good. A financial strategist and a visionary. His conceptual skills have served the company well. But he has always had staff role with no line experience. What we need is someone from operations. Like Richard Crasta.”
“Richard known things inside out alright”, said Divan, “But he is just a doer. Not fire in the belly. Vertigo needs someone who understands the value of power and known how to use it. Like me. Like Ranjan.”
“That is just the problem, “said Saxena. “Prem, let me tell you something. Ranjan is a man in your own image. Everyone known that he is your protégé. And are never popular. He has generated a lot of resentment among senior Veritigo executives and there would be a revolt if he were to succeed you. An exodus is something we can’t afford to have on our hands. We should think of someone else in the interest of stability to top management.” Divan could not believe what he heard. He had always prided himself on his hands – on style and thought he had his ear to the ground. “How could I lose touch?” he wondered, somewhat shaken.
“When you are the boss, people accept your authority without question,” continued Saxena. “In any case, you have been successful at Vertigo and it is difficult to argue with success. But the moment you announce your intention to leave, the aura begins to fade away. And in deciding on your successor, the board will seek your opinion, with due regard to your judgment. The board member must do what in their view is right for the company. Having said that, may I also mention that if there is a showdown in the boardroom, you could always choose to stay on ? We would like it. Or we could bring in an outsider.”
“I have finalized my career plans and there is no question of staying on beyond six months from now,” said Divan. “The board is scheduled to meet next month. Let us shelve the matter till then. In the meantime, I rely on you, Ram, to keep this discussion between the two of us.”
“Of course yes,” said Saxena.
On his way home, Divan thought about the matter in detail. Bringing an outsider would undo all his life’s work at Vertigo. There were considerations like cuture and compatibility which were paramount. The chairman had to be an inside man. “Richard lacks stature, “Divan said to himself. “Ranjan is the one I have been grooming, but heavens, the flip side of it all had missed me completely. There is no way I can allow a split at the top just before I quit. I must leave on a high note in my own interest. I must find a way out of he imminent mess.”
Question:
1. What should Divan do?
Case 2: PREJUDICES IN WORKPLACES : REAL OR PERCEIVED ?
Manjula Srivastav had been head of marketing for the last four years at Blue Chips, a computer products firm. The company’s turnover had increased by two – and a half times during the period and its market share in a number of precuts had also moved up marginally. What was creditable was that all this had happened in an environment in which computer prices had been crashing.
Although she had a talent for striking an instant report with people – particularly with the company’s dealers – Srivastav often found herself battling against odds, as she perceived it, as far as her relationships with her subordinates and peers in the company were concerned. Srivastav had to fight male prejudice all the way. She found it unfair that she had to prove herself regularly at work and she used to make her displeasure on that score quite obvious to everyone.
Six months ago, Blue Chips had been taken over by an industrial group which had a diversity of business interests and was, more importantly, flush with funds. The change of ownership had led to a replacement of the managing director, but it had not affected the existing core management team. Anand Prakash, the new managing director, had his priorities clear. “Blue Chips will go international,” he had declared in the first executive committee meeting, “and exports will be our first concern.”
Prakash had also brought in Harish Naik as his executive assistant with special responsibility for exports. Naik had been seconded to Srivastav for five weeks as a part of a familiarization programme. Much to her surprise, he had been appointed, within two months, as the vice president (exports), with compensation and perks higher than her own. Srivastav had made a formal protest to Prakash who had assured her that he was aware of her good work in the company and that she would have an appropriate role once the restructuring plan he was already working on would by put into effect.
One morning, as she entered the office and switched on her workstation, a message flashed on her screen. It was from Prakash. “Want to see you sometime today regarding restructuring. Will 2.30 be convenient?” It went.
Later at his office, Prakash had come straight to the point. He wanted to create a new post called general manager (public affairs) in the company. “With your excellent background in customer relations and connections with the dealer network, you are the ideal material for the job,” he said, “and I am offering it to you.” Srivastav was quick to react. “There is very little I can contribute in that kind of job,” she said. “I was in fact expecting to be promoted as vice president (home marketing).” Prakash said that the entire gamut of marketing functions would be looked after by Naik who would have boardroom responsibility for both domestic and export sales. “If you continue in marketing, you will have to be reporting to Naik which I thought may not be fair to you. In any case, we need someone who is strong in marketing to handle public affairs. Let me assure you that the new post I am offering will in no way diminish your importance in the company. You will in fact be reporting to me directly.”
“You are being unfair and your are diminishing my importance in the company,” reported Srivastav. “You know that I am a hardcore marketing professional and you also know I am the best. Why then am I being deprived of a rightful promotion in marketing? Tell me,” she asked pointedly, “would you have done this to a male colleague?”
“That is a hypothetical question,” said Prakash. “But I can’t think of any other slot for you in the restructuring plan I want to implement except what I am offering.”
“If the reason why you are asking me to handle this fancy public affairs business of yours,” said Srivastav, “is that you can’t think of any other slot for me, then I would have second thoughts about continuing to work for this company.”
“May I reiterate,” Said Prakash, “that I value your role and its is precisely because of this that I am delegating to you the work I have been personally handling so far? May I also state that I am upgrading the job not only because it is important but also because it should match your existing stature in the organization?”
“I need to think about this. I will let you know tomorrow,” said Srivastav and left the office.
What should she do?
Case 3: MECHANIST’S INDISCIPLINED BEHAVIOUR
Dinesh, a machine operator, worked as a mechanist for Ganesh, the supervisor. Ganesh told Dinesh to pick up some trash that had fallen from Dinesh’s work area, and Dinesh replied, “I won’t do the janitor’s work.”
Ganesh replied, “When you drop it, you pick it up”. Dinesh became angry and abusive, calling Ganesh a number of names in a loud voice and refusing to pick up the trash. All employees in the department heard Dinesh’s comments.
Ganesh had been trying for two weeks to get his employees to pick up trash in order to have cleaner workplace and prevent accidents. He talked to all employees in a weekly departmental meeting and to each employee individually at least once. He stated that he was following the instructions of the general manager. The only objection came from Dinesh.
Dinesh has been with the company for five years, and in this department for six months. Ganesh had spoken to him twice about excessive alcoholism, but otherwise his record was good. He was known to have quick temper.
This outburst by Dinesh hurt Ganesh badly. Ganesh told Dinesh to come to the office and suspended him for one day for insubordination and abusive language to a supervisor. The decision was within company policy, and similar behaviors had been punished in other departments.
After Dinesh left Ganesh’s office, Ganesh phoned the HR manager, reported what he had done, and said that he was sending a copy of the suspension order for Dinesh’s file.
Questions:
1. How would you rate Dinesh’s behaviour? What method of appraisal would you use?
2. Do you assess any training needs of employees? If yes, what inputs should be embodied in the training programme?
Case 4: RISE AND FALL
Jagannath (Jaggu to his friends) is an over ambitious young man. For him ends justify means.
With a diploma in engineering. Jaggu joined, in 1977, a Bangalore-based company as a Technical Assistant. He got himself enrolled as a student in an evening college and obtained his degree in engineering in 1982. Recognizing as Engineer-Sales in 1984.
Jaggu excelled himself in the new role and became the blue-eyed boy of the management. Promotions came to him in quick succession. He was made Manager-Sales in 1986 and Senior Manager-Marketing in 1988.
Jaggu did not forget his academic pursuits. After being promoted as Engineer-Sales, he joined an MBA (part-time) programme. After completing MBA, Jaggu became a Ph.D. scholar and obtained his doctoral degree in 1989.
Functioning as Senior Manger-Marketing, Jaggu eyed on things beyond his jurisdiction. He started complaining against Suresh the Section Head and Prahalad the Unit Chief (both production) with Ravi, the EVP (Executive – Vice President). The complaints included delay in executing orders, poor quality and customer rejections. Most of the complaints were concocted.
Ravi was convinced and requested Jaggu to head the production section so that things could be straightened up there. Jaggu became the Section head and Suresh was shifted to sales.
Jaggu started spreading his wings. He prevailed upon Ravi and got sales and quality under his control, in addition to production. Suresh, an equal in status, was now subordinated to Jaggu. Success had gone to Jaggu’s head. He had everything going in his favor-position, power, money, and qualification. He divided workers and used them as pawns. He ignored Prahalad and established direct link with Ravi. Unable to bear the humiliation, Prahalad quit the company. Jaggu was promoted as General Manager. He became a megalomaniac.
Things had to end at some point. It happened in Jaggu’s life too. There were complaints against him. He had inducted his brother – in – law, Ganesh, as an engineer. Ganesh was by nature corrupt. He stole copper worth Rs. 5 lakh and was suspended. Jaggu tried to defend Ganesh but failed in his effort. Corruption charges were also leveled against Jaggu who was reported to have made nearly Rs. 20 lakh for himself.
On the new-year day of 1993, Jaggu was reverted back to his old position- sales. Suresh was promoted and was asked to head production. Roles got reversed. Suresh became boss to Jaggu.
Unable to swallow the insult, Jaggu put in his papers.
Back home, Jaggu started his own consultancy claiming himself as an authority in quality management. He poached on his previous company and picked up two best brains in quality.
Fro 1977 to 1993, Jaggu’s career graph had a steep rise and a sudden fall. Whether there would be another hump in the curve is a big question.
Questions:
1. Bring out the principles of promotion that were employed in promoting Jaggu.
2. What would you do if you were (i) Suresh, (ii) Prahalad or (iii) Ravi?
3. Bring out the ethical issues involved in Jaggu’s behaviour.
Note: Solve any 4 Cases Study’s
CASE: I Playing to a new beat: marketing in the music industry
Good old fashioned rock ‘n’ roll could be dead. If a mobile phone ringtone in the shape of the vocalizations of the animated Crazy Frog dominates the billboard charts for months on end, then it could well signal the death knell for the industry, and how it operates. If this ubiquitous amphibian’s aurally annoying song, converted from a mobile phone ringtone, outsold even mainstay acts such as Oasis and Coldplay, why should music companies invest millions in cultivating fresh musical talent, hoping for them to be the next big thing, when their efforts can be beaten by basic synthesizer music? The industry is facing a number of challenges that it has to address, such as strong competition, piracy, changing delivery formats, increasing cost pressures, demanding pri-madonnas and changing customer needs. Gone are the days when music moguls were reliant on sales from albums alone, now the industry trawls for revenue from a variety of sources, such as ringtones, merchandising, concerts, and music DVDs, leveraging extensive back catalogues, and music rights from advertising, movies and TV programming.
The music industry is in a state of flux at the moment. The cornerstone of the industry—the singles chart—has been facing terminal decline since the mid-1990s. Some retailers are now not even stocking singles due to this marked freefall. Some industry commentators blame the Internet as the sole cause, while others point to value differences between the price of an album and the price of a single as too much. Likewise, some commentators criticize the heavy pre-release promotion of new songs, the targeting of ever-younger markets by pop acts, and the explosion of digital television music channels as root causes of the single’s demise. The day when the typical record buyer browses through rows of shelves for a much sought-after band or song on a Saturday afternoon may be thing of the past.
Long-term success stories for the music industry are increasingly difficult to develop. The old tradition of A&R (which stands for ‘Artists & Repertoire’) was to sign, nurture and develop musical talent over a period of years. The industry relied on continually feeding the system with fresh talent that could prove to be the next big thing and capture the public imagination. Now corporate short-term thinking has enveloped business strategies. If an act fails to be an immediate hit, the record label drops them. The industry is now characterized by an endless succession of one-hit wonders and videogenic artist churning out classic cover songs, before vanishing off the celebrity radar. Four large music labels now dominate the industry (see Table 1), and have emerged through years of consolidation.
Table 1 The ‘big four’ music labels
Universal Music Sony BMG
The largest music label, with 26 per cent of global music market share; artists on its roster include U2, Limp Bizkit, Mariah Carey and No Doubt Merger consolidated its position; artists on its roster include Michael Jackson, Lauryn Hill, Westlife, Dido, Outkast and Christina Aguilera
Warner Music EMI
Third biggest music group; artists on its roster include Madonna, Red Hot Chili Peppers and REM Artists on its roster include the Rolling Stones, Coldplay, Norah Jones, Radiohead, and Robbie Williams
The ‘big four’ labels have the marketing clout and resources to invest heavily in their acts, providing them with expensive videos, publicity tours and PR coverage. This clout allows their acts to get vital airplay and video rotation on dedicated TV music channels. Major record labels have been accused of offering cash inducements of gifts to radio stations and DJs in an effort to get their songs on playlists. This activity is known in the industry as ‘radio payola’.
Consumer have flocked to the Internet, to download, to stream, to ‘rip and burn’ copyrighted music material. The digital music revolution has changed the way people listen, use and obtain their favourite music. The very business model that has worked for decades, buying a single or album from a high-street store, may not survive. Music executives are left questioning whether the Internet will kill the music business model has been fundamentally altered. According to the British Phonographic Industry (BPI), it estimated that 8 million people in the UK are downloading music from the Internet—92 per cent of them doing so illegally. In 2005 alone, sales of CD singles fell by a colossal 23 per cent. To put the change into context, the sales of digital singles increased by 746.6 per cent in 2005. Consumers are buying their music through different channels and also listening to their favourate songs through digital media rather than through standard CD, cassette or vinyl. The emergence of MP3 players, particularly the immensely popular Apple iPod, has transformed the music landscape even further. Consumers are now downloading songs electronically from the Internet, and storing them on these digital devices or burning them onto rewritable CDs.
Glossary of online music jargon
Streaming: Allows the user to listen to or watch a file as it is being simultaneously downloaded. Radio channels utilize this technology to transmit their programming on the Internet.
‘Rip n burn’: Means downloading a song or audio file from the Internet and then burning them onto rewritable CDs or DVD.
MP3 format: MP3 is a popular digital music file format. The sound quality is similar to that of a CD. The format reduces the size of a song to one-tenth of its original size allowing for it to be transmitted quickly over computer networks.
Apple iPod: The ‘digital jukebox’ that has transformed the fortunes of the pioneer PC maker. By the end of 2004 Apple is expected to have sold 5 million units of this ultra-hip gadget. It was the ‘must-have item’ for 2003. The standard 20 GB iPod player can hold around 5000 songs. Other hardware companies, such as Dell & Creative Labs, have launched competing devices. These competing brands can retail for less than £75.
Peer-to-peer networks (P2P): These networks allow users to share their music libraries with other net users. There is no central server, rather individual computers on the Internet communicating with one another. A P2P program allows users to search for material, such as music files, on other computers. The program lets users find their desired music files through the use of a central computer server. The system works lime this; a user sends in a request for a song; the system checks where on the Internet that song is located; that song is downloaded directly onto the computer of the user who made the request. The P2P server never actually holds the physical music files—it just facilitates the process.
The Internet offers a number of benefits to music shoppers, such as instant delivery, access to huge music catalogues and provision of other rich multi-media material like concerts or videos, access to samples of tracks, cheaper pricing (buying songs for 99p rather than an expensive single) and, above all, convenience. On the positive side, labels now have access to a wider global audience, possibilities of new revenue streams and leveraging their vast back catalogues. It has diminished the bargaining power of large retailers, it is a cheaper distribution medium than traditional forms and labels can now create value-laden multimedia material for consumers. However, the biggest problem is that of piracy and copyright theft. Millions of songs are being downloaded from the Internet illegally with no payment to the copyright holder. The Internet allows surfers to download songs using a format called ‘MP3’, which doesn’t have inbuilt copyright protection, thus allowing the user to copy and share with other surfers with ease. Peer to peer (P2P) networks such as Kazaa and Grokster have emerged and pose an even deadlier threat to the music industry—they are enemies that are even harder to track and contain. Consumers can easily source and download illegal copyrighted material with considerable ease using P2P networks (see accompanying box).
P2P Networks used for file sharing
Kazaa
Gnutella
Grokster
Morpheus
eDonkey
Imesh
Bearshare
WinMX
A large number of legal download sites have now been launched, where surfers can either stream their favourite music or download it for future use in their digital libraries. This has been due to the rapid success of small digital medial players such the Apple iPod. The legal downloading of songs has grown exponentially. A la carte download services and subscription-based services are the two main business models. Independent research reveals that the Apple’s iTunes service has over 70 per cent of the market. Highlighting this growing phenomenon of the Internet as an official channel of distribution, new music charts are now being created, such as the ‘Official Download Chart’. Industry sources suggest that out of a typical 99p download, the music label get 65p, while credit card companies get 4p, leaving the online music store with 30p per song download. These services may fundamentally eradicate the concept of an album, with customers selecting only a handful of their favourite songs rather than entire standard 12 tracks. These prices are having knock-on consequences for the pricing of physical formats. Consumers are now looking for a more value-laden music product rather than simply 12 songs with an album cover. Now they are expecting behind the scenes access to their favourite group, live concert footage and other content-rich material.
Big Noise Music is an example of one of the legitimate downloading sites running the OD2 system. The site is different in that for every £1 download, 10p of the revenue goes to the charity Oxfam.
The music industry is ferociously fighting back by issuing lawsuits for breach of copyright to people who are illegally downloading songs from the Internet using P2P software. The recording industry has started to sue thousands of people who illegally share music using P2P. They are issuing warnings to net surfers who are P2P software that their activities are being watched and monitored. Instant Internet messages are being sent to those who are suspected of offering songs illegally. In addition, they have been awarded court orders so that Internet providers must identify people who are heavily involved in such activity. The music industry is also involved heavily in issue advertising campaigns, by promoting anti-piracy websites such as www.pro-music.org to educate people on the industry and the impact of piracy on artists. These types of public awareness campaigns are designed to illustrate the implications of illegal downloading.
Small independent music labels view P2P networks differently, seeing them as vital in achieving publicity and distribution for their acts. These firms simply do not have the promotional resources or distribution clout of the ‘big four’ record labels. They see P2P networks as an excellent viral marketing tool, creating buzz about a song or artist that will ultimately lead to wider mainstream and commercial appeal. The Internet is used to create communities of fans who are interested in their music, providing them access to free videos and other material. It allows independent acts the opportunity to distribute their music to a wider audience, building up their fan base through word of mouth. Savvy unsigned bands have sophisticated websites showcasing their work, and offering free downloads as well as opportunities for audio-philes to purchase their tunes. Alternatively major labels still see that to gain success one has to get a video on rotation on MTV and that this in turn encourages greater airplay on radio stations, ultimately leading to increased purchases.
Table 2 The major legitimate online music provider
Name Details Pricing
Apple iTunes Huge catalogue of over 750,000 songs; compatible with Apple’s very hip iPod system; offers free single of the week and other exclusive material 79p per track, £7.99 per album
Napster The now-legitimate website offers over 1,000,000 songs; offers several streaming radio stations too Subscription based—subscribers pay £9.99 a month to stream any of the catalogue, plus another 99p to download on to a CD
Sony Connect over 300,000 songs from the major labels; excellent sound quality but compatible only with Sony products due to proprietary file formats From 80p- £1.20 per track, and £8- £10 per album
Bleep.com Small catalogue of 15,000 songs with a focus on independent music labels; high-quality downloads due to media files used 99p per track, £6.99 per album
Wippit UK-based service; 175,000 songs to download; gives a selection of free tracks every month From 30p to £1 to download; alternatively, users can subscribe to the service for £50 a year to gain access to 60,000 songs
OD2 System, used by:Mycokemusic.com HMV.com
MSN.com
TowerRecord.co.uk
Big Noise Music These online sites use the OD2 system for music downloads; they look after encryption, hosting, royalty management and the entire e-commerce system; provides access to nearly 350,000 tracks from 12,000 recording artists Varying product bundles, typically 99p for track download, and 1p for streaming
For traditional music retailers the retailing landscape is getting more competitive, with multiple channels of distribution emerging due to the Internet and large supermarket chains now selling music CDs. Supermarkets are becoming one of the main channels of distribution through which consumers buy music. These supermarkets are stocking only a limited number of the best-selling music titles, limiting the number of distribution outlets for new and independent music. Only charts hits and greatest hits collections will make it on to the shelves of such outlets.
Now consumers can buy albums from traditional Internet retailers such as Amazon.com, and also on websites that utilize access to grey markets such as cdwow.co.uk, as well as through legitimate download retailers. This has left traditional music retail operations with a severe conundrum: how can they entice more shoppers into their stores? The accompanying box highlights where typical shoppers source their music at present.
Where do people buy their music?
Music stores (like HMV, Virgin Megastore) 16 per cent
Chains (like Woolworth, WHSmith) 16 per cent
Supermarkets (like Tesco, Asda) 21.6 per cent
Mail order 3.9 per cent
Internet sales (like Amazon.com) 7 per cent
Downloads Not yet measured
The issue of online music retailers using parallel importing, such as CDWOW (www.cdwow.co.uk) is a concern. These retailers are taking advantage of worldwide price discrepancies for legitimate music CDs, sourcing them in low-cost countries like Hong Kong and exporting them into European countries. Prices for music in these markets are considerably lower than the market that they are exporting to, and they don’t even charge for international delivery. Yet technological improvements have led to revenue opportunities for the industry. Development such as online radio, digital rights management, Internet streaming, tethered downloads (locked to PC), downloads (burnable, portable), in-store kiosks, ring-tones, mobile message clips and games soundtracks are great potential revenue sources. In an effort to unlock this potential the major labels have digitized their entire back catalogues. In the wake of these dramatic environmental changes the industry has had to radically adapt. The ‘big four’ music labels are consolidating even further, developing a digital music strategy, and re-evaluating their entire traditional business model. Mobile phones are seen as the next primary channel of distribution for digital music. High penetration levels in the market for mobile phones and the inherent mobility advantages make this the next crucial battlefield for the music industry.
The Internet may emerge as the primary channel of distribution for music, and the music industry is going to have to adapt to these changes. The move towards the online distribution of entertainment is still in its infancy, with more investment into the telecommunications infrastructure, such as greater Internet access, increased access to broadband technology, 3G technology and changing the way people shop for music will undoubtedly take time. The digital revolution will fundamentally change the way people purchase and consume their musical preferences. In forthcoming years the digital format will become more mainstream, leading to a proliferation of channels of distribution for music. However, as with most new channels of technology, catalogue shopping, Internet shopping likewise, and ‘video never really killed the radio star’… but will the Internet kill the record store?
Questions:
1. Discuss the micro and macro forces that are affecting the music industry.
2. Based on this analysis, what strategic options would you recommend for both music publishers and music retailers in the current marketing environment?
3. Discuss the advantages and disadvantages associated with online distribution from a music label’s perspective.
CASE: II The Sudkurier
The Sudkurier is a regional daily newspaper in south-western Germany. On average 310,000 people in the area read the newspaper regularly. The great majority of those readers subscribe to its home delivery service, which puts the paper on their doorsteps early in the morning. On the market for the last 35 years, the Sudkurier contains editorial sections on politics, the economy, sports, local news, entertainment and features, as well as advertising. The newspaper is financially independent and its staff is free of any political affiliation. Management at the Sudkurier would like to bring the paper into line with the current needs of its readers. For this purpose, the management team is considering the use of market research.
Management would like to have information about the following.
1. What newspaper or other media are the Sudkurier’s main competitors?
2. Do most readers read the Sudkurier for the local news, sports and classified ads, and should these sections therefore be expanded at the expense of the sections on politics and the economy?
3. Should the Sudkurier’s layout be modernized?
4. Do mostly lower levels of society read the Sudkurier?
5. Into what political category do readers and non-readers the Sudkurier?
6. Which suppliers of products and services consider the Sudkurier especially appropriate for their advertising?
7. What advertising or information dot the readers think is missing from the Sudkurier?
You are an employee of the Sudkurier who has been instructed to obtain the requested information and to prepare your findings for the decision-makers. You are in the fortunate position of receiving regular reports about the people’s media use from the Arbeitsgemeinschaft Media-Analyse e.V. Relevant excerpts from the most recent survey are shown here as Tables 3 and Table 4
Table 3 Media analysis of readership structure
Range in Circulation Area (1) Readers per edition of SUDKURIER National
average
in %
RANGE Total in %
in % Absolute
Total 53.5 310,000 100.0 100.0
Gender Men 55.5 150,000 49.0 47.2
Women 51.6 160,000 51.0 52.8
Age Groups 14-19 years 51.8 20,000 8.0 7.2
20-29 years 41.0 50,000 15.0 19.1
30-39 years 52.1 50,000 16.0 16.4
40-49 years 61.8 50,000 16.0 15.2
50-59 years 61.1 60,000 19.0 16.5
60-69 years 53.6 40,000 13.0 13.5
70 years and older 57.4 40,000 13.0 12.2
Educational
Level Secondary school without apprenticeship 49.4 60,000 18.0 17.6
Secondary school with apprenticeship 50.8 100,000 31.0 39.6
Continuing education without Abitur 60.8 110,000 36.0 27.0
Abitur, university preparation, university/college 49.7 50,000 15.0 15.8
Occupation Trainee, pupil, student 44.7 40,000 11.0 11.0
Full-time employee 54.6 160,000 50.0 51.7
Retire, pensioner 57.3 70,000 23.0 21.8
Unemployed 52.4 50,000 16.0 15.5
Occupation of main wage earner Self-employed, mid- to large business/Freelancer 63.8 20,000 5.0 3.1
Self-employed, small business,/Farmer 59.9 30,000 10.0 7.1
Managers and civil servants 58.6 30,000 9.0 8.7
Other employees and civil servants 49.3 120,000 40.0 42.9
Skilled staff 57.6 100,000 32.0 32.5
Unskilled staff 38.7 10,000 4.0 5.6
Net Household Income/month 4500 and more 62.7 100,000 31.0 23.9
3500-4500 52.7 60,000 19.0 20.8
2500-3500 54.9 80,000 26.0 25.9
to 2500 44.1 70,000 23.0 29.3
Number of wage earners 1 earner 45.4 100,000 33.0 40.4
2 earner 56.5 130,000 41.0 42.6
3 earner 62.7 80,000 25.0 16.9
Household Size 1 Person 41.8 50,000 14.0 17.9
2 Persons 55.5 90,000 29.0 31.8
3 Persons 59.5 70,000 22.0 22.4
4 Persons and more 54.8 110,000 35.0 27.9
Children in Household Children less than 2 years of age 52.7 10,000 4.0 3.8
2 to less than 4 years 38.4 10,000 4.0 5.4
4 to less than 6 years 45.8 10,000 5.0 5.2
6 to less than 10 years 43.8 20,000 8.0 8.5
10 to less than 14 years 54.1 30,000 10.0 9.2
14 to less than 18 years 57.7 50,000 16.0 13.7
No children under 14 54.9 250,000 79.0 77.4
No children under 18 53.6 210,000 67.0 68.1
Driving Licence yes 55.2 250,000 80.0 73.0
no 47.3 60,000 20.0 27.0
Private Automobile 55.5 270,000 86.0 80.0
Garden own garden 60.4 240,000 76.0 57.0
without garden 39.8 70,000 23.0 43.0
Housing own house 62.1 180,000 58.0 46.0
own apartment 45.9 10,000 3.0 3.0
rent house or apartment 44.7 120,000 38.0 49.0
Electrical Appliances Freezer/Deep freeze 59.6 200,000 62.0 51.0
Last Holiday Journey Within the last 12 months 55.1 190,000 62.0 n.a.
1-2 years ago 51.0 40 ,000 14.0 n.a.
More than two years ago 48.6 50 ,000 16.0 n.a.
Never 55.4 30 ,000 9.0 n.a.
Last Holiday Destination Germany 57.4 70 ,000 23.0 n.a.
Austria, Switzerland, South Tyrol 48.7 60 ,000 20.0 n.a.
Elsewhere in Europe 53.4 130,000 42.0 n.a.
Country outside Europe 51.4 20 ,000 5.0 n.a.
Did not travel 56.4 30 ,000 9.0 n.a.
1) Entire circulation area 310 ,000 readers per edition
Example:
53.5% of people older than 14 years in the circulation of the Sudkurier daily
55.5% of all men older than 14 years and 51.6% of women older than 14 read the Sudkurier daily; that is 150 ,000 men and 160 ,000 women.
Table 4 Reader behavior
What purchasing information is used?
Media purchasing information
for medium and long-term acquisition
(11 product areas; Basis: total population)
Daily newspaper 61%
Posters on the street 9 %
Leaflets 36 %
Television 24%
Radio 13%
Magazines 27 %
Free newspapers 49% Credibility of advertising in the media
Advertising in… is generally believable and reliable
(Basis: broadest user group in each case)
Regional newspaper 49%
Television 30%
Public radio 20%
Privately-owned radio 14 %
Magazines 15%
Free newspaper 23%
Advertising in… is most informative
(Basis: broadest reading group)
Regional newspapers (subscription) 62 %
Television 47%
Public Radio 29%
Privately-owned radio 26%
Magazines 27 %
Free newspapers 36 % Time spent reading daily newspaper
(Basis: broadest user group)
less than 15 minutes 7 %
15-24 minutes 21 %
25-34 minutes 28 %
35-65 minutes 34 %
more than 65 minutes 10 %
I often consult/depend on advertising in…
(Basis: broadest user group in each case)
Regional newspapers (subscription) 27 %
Television 11%
Public Radio 89%
Privately-owned radio 6%
Magazines 7 %
Free newspapers 18 %
Source: Regional Press Study, Gfk-Medienforschung Contest-Census
Questions:
1. Explain how you will methodically go about compiling the requested information covered in the seven questions for management. Include in your explanation an estimate of the expense involved in obtaining the information.
2. Develop a 10-question questionnaire for the purpose of making a survey.
CASE: III Unilever in Brazil: marketing strategies for low-income customers
After three successful years in the Personal Care division of Unilever in Pakistan, Laercio Cardoso was contemplating attractive leadership positioning China when he received a phone call from Robert Davidson, head of Unilever’s Home Care division in Brazil, his home country. Robert was looking for someone to explore growth opportunities in the marketing of detergents to low-income consumers living in the north-east of Brazil and felt that Laercio had the seniority and skills necessary for the project. Though he had not been involved in the traditional Unilever approach to marketing detergents, his experience in Pakistan had made him acutely aware of the threat posed by local detergent brands targeted at low-income consumers.
At the start of the project—dubbed ‘Everyman’—Laercio assembled an interdisciplinary team and began by conducting extensive field studies to understand the lifestyle, aspirations and shopping habits of low-income consumers. Increasing detergent use by these consumers was crucial for Unilever given that the company already had 81 per cent of the detergent powder market. But some in the company felt that it should not fight in the lower cost structures struggled to break even. How could Laercio justify diverting money from a best-selling brand like Omo to invest in a lower-margin segment?
Consumer behavior
The 48 million people living in the north-east (NE) of Brazil lag behind their south-eastern (SE) counterparts on just about every development indicator. In the NE, 53 per cent of the population live on less than two minimum wages versus 21 per cent inn the SE. In the NE, only 28 per cent of households own a washing machine versus 67 per cent in the SE. Women in the NE scrub clothes in a washbasin or sink using bars of laundry soap, a process that requires intense and sustained effort. They then add bleach to remove tough stains and only a little detergent powder in the end, primarily to make the clothes smell good. In the SE, the process is similar to European or North American standards. Women mix powder detergent and softener in a washing machine and use laundry soap and bleach only to remove the toughest stains.
The penetration and usage of detergent powder and laundry soap is the same in the NE and the SE (97 per cent). However, north-easterners use a little less detergent (11.4 kg per years versus 12.9 kg) and a lot more soap (20 kg versus 7 kg) than south-easterners. Many women in the NE view washing clothes as one of the pleasurable routine activities of their week. This is because they often do their washing in a public laundry, river or pond where they meet and chat with their friends. In the SE, in contrast, most women wash clothes alone at home. They perceive washing laundry as a chore and are primarily interested in ways to improve the convenience of the process.
People in the NE and SE differ in the symbolic value they attach to cleanliness. Many poor north-easterners are proud of the fact that they keep themselves and their families clean despite their low income. Because it is so labour intensive, many women see the cleanliness of clothes as an indication of the dedication of the mother to her family, and personal and home cleanliness is a main subject of gossip. In the SE, where most women own a washing machine, it has much lower relevance for self-esteem and social status. Along with price, the primarily low-income consumers of the NE evaluate detergents on six key attributes (Figure 1 provides importance ratings, the range of consumer expectations, and the perceived positioning of key detergent brands on each attribute).
Competition
In 1996 Unilever was a clear leader in the detergent powder category in Brazil, with an 81 per cent market share, achieved with three brands: Omo (one of Brazil’s favourate brands across all categories) Minerva (the only brand to be sold as both detergent powder and laundry soap with a more hedonistic ‘care’ positioning) and Campeiro (Unilever’s cheapest brand). Proctor & Gamble, which had recently entered the Brazilian market, had 15 per cent of the market with three brands (Ace, Bold and the low-price brand Pop). Other competitors were smaller companies (see Figure 2).
The Brazilian fabric wash market consists of two categories: detergent powder and laundry soap. In 1996 detergent was a US$106 million (42,000 tons) market in the NE. In 1996 the NE market for laundry soap bars was as large as the detergent powder market (US$102 million for 81,250 tons). The NE market for laundry soap is much easier to produce than powdered laundry detergent. Laundry soap is a multi-use product that has many home and personal care uses. Table 5 provides key information on all powder and laundry soap brands (packaging, positioning, key historical facts, and financial and market data).
Table 5
Brand Packaging Positioning Key Data
OMO Cardboard pack:
1 kg & 500g. Removes stains with low quantity of product when used in washing machines, thus reducing the need for soap or bleach. S: 55.20
WP: 3.00
FC: 1.65
PKC: 0.35
PC: 0.35
Minerva Cardboard pack:
1 kg & 500g. S: 17.60
WP: 2.40
FC: 1.40
PKC: 0.35
PC: 0.30
Campeiro Cardboard pack:
1 kg & 500g. S: 6.05
WP: 1.70
FC: 0.90
PKC: 0.35
PC: 0.20
Ace Cardboard pack:
1 kg & 500g
Bold Cardboard pack:
1 kg & 500g.
Pop Cardboard pack:
1 kg & 500g.
Invicto Cardboard pack:
1 kg & 500g.
Minerva Plastic pack with 5 bars of 200g.
Bem-te-vi Plastic pack with 5 bars of 200g or single bar of 200g.
Figure 1 & 2 Market Share and wholesale Price of Major Brands in the Laundry Soap and Detergent Powder Categories in the Northeast in 1996
Decisions
Robert Davidson, head of Unilever’s Home Care Division in Brazil, and Laercio Cardoso, head of the ‘Everyman’ research project aided at understanding the low-income consumer segment, must re-examine Unilever’s strategy for low-income consumers in the NE region of Brazil and make three important decisions.
1. Go/no go. Should Unilever divert money from its premium brands to invest in a lower-margin segment of the market? Does Unilever have the right skills and structure to be profitable in a market in which even small local entrepreneurs struggle to break even? In the long run, what would Unilever gain and what would it risk losing?
2. Marketing and branding strategy. Unilever already has three detergent brands with distinct positionings. Does it need to develop a new brand with a new value proposition or can it reposition its existing brands or use a brand extension?
3. Marketing mix. What price, product, promotion and distribution strategy would allow Unilever to deliver value to low-income consumers without cannibalizing its own premium brands too heavily? Is it just a matter of price?
Product
Unilever could produce a product comparable to Campeiro, its cheapest product, but would it deliver the benefits that low-income consumers wanted? Alternatively, Unilever could use Minerva’s formula but it might be too expensive for low-income consumers. If they could eliminate some ingredients, Unilever’s scientists could develop a third formula that would cost about 10 per cent more than Campeiro’s formula. The difficulty would be in determining which attributes to eliminate, which to retain and which, if any would actually need to be improved relative to both existing brands.
Larger packages would reduce the cost per kilo but could price the product out of the weekly budget range of the poorest consumers. Unilever could use a plastic sachet, which would cost 30 per cent of the price of traditional cardboard boxes, but market research data had shown that low-income consumers were attached to boxes and regarded anything else as good for only second-rate products. One solution might be to launch multiple types and sizes.
Price
Priced significantly above Campeiro and Minerva soap, the product would be out of reach for the target segment. Priced too low, it would increase the cost of the inevitable cannibalization of existing Unilever brands. Should Unilever use coupons or other means to reduce the cost of the product for low-income consumers? Or should it change the price of Omo, Minerva
and Campeiro?
Promotion
In the low-income segment, lower margins meant that volume had to be reached very quickly for the product to break even. It was therefore crucial to find a radical ‘story’, one that would immediately put the new brand on the map. What would be the objective of the communication? What should be the key message? Low-income consumers might be reluctant to buy a product advertised ‘for the low-income people’ especially as products with that kind of message are typically of inferior quality. On the other hand, using the classic aspirational communication of most Brazilian brands could confuse consumers and lead to unwanted cannibalization.
In regular detergent markets Unilever had established that the most effective allocation of communication expenditure was 70 cent above-the-line (media advertising) and 30 per cent below-the-line (trade promotions, events, point- of-purchase marketing). The advantages of using primarily media advertising are its low cost per contact and high reach because almost all Brazilians, irrespective of income, are avid television watchers. One alternative would be to use 70 per cent below-the-line communication. At US$0.05 per kg, this plan would require only one-third of the cost of a traditional Unilever communication plan. On the other hand, it would lower the reach of communication, increase the cost of per contact, and make a simultaneous launch in all north-eastern cities more difficult to organize.
Distribution
Unilever did not have the ability to distribute to the approximately 75,000 small outlets spread over the NE, yet access to these stores was key because low-income consumers rarely shopped in large supermarkets like Wal-Mart or Carrefour. Unilever could rely on its existing network of generalist wholesalers who supplied its detergents and a wide variety of products to small stores. These wholesalers had national coverage and economies of scale but did not directly serve the small stores where low-income consumers shopped, necessitating another layer of smaller wholesalers, which increased their cost to US$0.10 per kg. Alternatively, Unilever could contract with dozens of specialize distributors who would get exclusive rights to sell the new Unilever detergent. These specialized distributors would have a better ability to implement point of purchase marketing and would cost less ($0.05 per kg).
Question:
1. Describe the consumer behaviour differences among laundry products’ customers in Brazil. What market segments exists?
2. Should Unilever bring out a new brand or use one of its existing brands to target the north-eastern Brazilian market?
3. How should the brand be positioned in the marketplace and within the Unilever family of brands?
Case 4 Ryanair: the low fares airlines
The year 2004 did not begin well for Ryanair. On 28 January, the airline issued its first profits warning and ended a run of 26 quarters of rising profits. On that day, when the markets opened, the company was worth €5 billion. By close of business, its value had shrunk to worth €3.6 billion, as its share price plunged from worth €6.75 to €4.86. Investors were dismayed by the airline’s admission that it was facing ‘an enormous and sudden reduction of 25 to 30 per cent in yields’ (i.e. average fare levels) in the first quarter of 2004 (the last fiscal quarter of 2004). This was on top of an earlier fall of 10 to 15 per cent in the first nine months.
In April 2004, Chief Executive Michael O’Leary forecast a ‘bloodbath’, an ‘awful’ 2004/2005 winter for European airlines, amid continuing fare wars, with a shakeout among the many budget airlines. ‘We will be helping to make it awful,’ warned Mr O’Leary, as he announced an 800,000 free seats giveaway. The most difficult markets were predicted to be Germany and the UK regions where many new carriers, which were ‘losing money on an heroic scale’, had entered the arena. O’Leary anticipated that the company’s 2004 profits would decline by 10 per cent, while 2005 profits would increase by up to 20 per cent with a 5 per cent drop in yields. However, if yields were to fall by as much as 20 per cent, the 2005 outcome would be break-even, at best.
Yet, by 31 May 2005, on Ryanair’s 20th birthday, the carrier was able to announce record results for the year ended 31 March 2005. Both passenger volumes and net profits grew year on year by 19 per cent to 27.6 million from 23.1 million and €268.9 from €226.6 million respectively. The all- important passenger yield figure (revenue per passenger) grew by 2 per cent, partially offsetting the 14 per cent yield decline in 2003/2004. Ancillary revenues were 40 per cent higher, rising faster than passenger volumes, which resulted in total revenues rising by 24 per cent to €1.337 billion. Operating costs rose 25 per cent, fractionally more than revenue growth, due principally to higher fuel costs. The 2005 results announcement was followed by a 3.4 per cent jump in the company’s share price, to close to €6.46 on the day.
Ryanair’s adjusted after-tax margin for the full year at 20 per cent compared very to figures for Aer Lingus, British Airways, easyJet, Lufthansa, Southwest and Virgin, with margins of 8, 1, 3, minus 5, 7, .1 per cent respectively (2003/2004 results). Despite the dire warnings and the temporary dip in fiscal 2004, Ryanair had arguably come through its crisis with flying colours. How did it manage this?
Overview of Ryanair
Ryanair, Europe’s first budget airline, with 229 routes across 20 countries at of May 2005, is one of the world’s most profitable, fastest-growing carriers. Founded in 1985 by the Ryan family as an alternative to the then state monopoly carrier Aer Lingus, Ryanair started out as a full-service airline. After accumulating severe financial losses, finally, in 1990/91, the company came up with a survival plan, spearhead by Michael O’Leary and the Ryans, to transform itself into a low-fares no-frills carrier, based on the model pioneered by Southwest Airlines, the Texas-based operator. Ryanair, first floated on the Dublin Stock Exchange in 1997, is quoted on the Dublin and London Stock exchanges and on NASDAQ, where it was admitted to the NASDAQ-100 in 2002. In June 2005, Ryanair’s market capitalization stood €5 billion, the second highest carrier in the world, next to Southwest Airlines, and ahead of airlines with vastly greater turnover—such as Lufthansa with capitalization at €4.7 billion, British Airways at €4.3 billion and Air France/KLM at €3.5 billion. Its market capitalization was nearly four times that of easyJet, its UK-based budget airline rival. This was despite easyJet’s higher turnover, similar passenger volumes and a slightly larger fleet.
Ryanair’s fares strategy
Ryanair’s core strategy entails offering the lowest fares, and the airline claims that it generally makes its lowest fares widely available by allocating a majority of seat inventory to its two lowest fare categories. In fact, was Ryanair, originally styled as the ‘low-fares airline’, actually becoming a ‘no-fares airline’? Half of Ryanair’s passenger will be flying for free by 2009, pledged Michael O’Leary in an interview with a German newspaper. He said that ticket prices would fall by an average 5 per cent a year over the next five years, as passenger numbers grew by five million annually. One analyst speculated that Ryanair pronouncement on free seats ‘is designed to put the wind up potential competitors in the hotly contested German market. Of course, a balance must be struck between low fares to attract customers and a sufficient yield to ensure viability.
An integral part of the low fares strategy is revenue enhancement through ancillary activities, increasingly used to subsidize airfares in order to improve Ryanair margins to compensate for falls in fare yields. These include on-board sales, charter flights, travel reservations and insurance, car rentals, in-flight television advertising, and advertising outside its air-craft, whereby a corporate sponsor pays to paint an aircraft, whereby a corporate sponsor pays to paint an aircraft with its logo. Advertising on Ryanair’s popular website also provides ancillary income. Despite the abolition of duty-free sales on intra-EU travel in 1999, Ryanair’s revenue from duty-paid sales and ancillary services has continued to rise. In 2005, ancillary revenues comprised 18.3 per cent of total operating revenue, up from 16.1 per cent the year before, and the ambition is to grow at twice the rate of increase in its passenger traffic. The company has outlined plans to continue raising ancillary revenues through further penetration of existing products and the introduction of new ones, especially on-board entertainment and gaming products/services. Ryanair is also considering entering the highly competitive mobile phone market and has been in talks with various UK operators with a view to forming a joint venture.
Its low fares policy notwithstanding, Ryanair was able to realize a 2 per cent growth in yields in fiscal 2005. This is attributable to a number of favourable factors in the competitive landscape. Underlying passenger growth volumes returned in the industry as a whole, reducing the intensity of competition. Mainstream European operators like British Airways, Lufthansa and Air France/KLM were increasingly abandoning the short-haul sector, preferring to concentrate their growth on more lucrative long-run haul routes. Moreover, these airlines reacted to the massive price rise in the cost of aviation fuel by introducing a fuel surcharge on their fares. For example, the surcharge levied by British Airways equated to 22 per cent of an average Ryanair fare.
Another favourable factor was the failure of the threat of new entrants to materialize. Michael O’Leary’s prophecy of a 2004/2005 winter bloodbath in the European airline industry had been based on the forecast of many new entrants into the budget airlines sector, thus intensifying overcapacity. While new rivals continued to enter the fray, at any one time large numbers were also dying off. Autumn 2004 saw the demise of a number of budget airlines—for example, Volare, an Italian low-fare and charter operator, and V-Bird, a Dutch-owned carrier. Yet, new entrants were still launching. However, it was agreed that the industry could not sustain the some 47low-fares airlines operating as of the end of November 2004, Michael O’Leary predicted that the anticipated shake-out would be accelerated by rising oil prices. ‘Many of our competitor airlines who were losing money heroically when fuel was US$25 a barrel are doomed the longer it stays at US$50. We anticipate there will be further airline casualties as the perfect storm of declining fares and record high oil prices force loss-making carriers out of the industry.
Low fares require cost savings
To quote Michael O’Leary, ‘Any fool can sell low air fares and lose money. The difficult bit is to sell the lowest air fares and make profits. If you don’t make profits, you can’t lower your air fares or reward your people invest in new aircraft or take on the really big airlines like BA and Lufthansa.’
According to the company, its no-frills service allows it to prioritize features important to its clientele, such as frequent departures, advance reservations, baggage handling and consistent on-time services. Simultaneously, it eliminates non-essential extras that interfere with the reliable, low-cost delivery of its basic flights. The eliminated extras include advance seat assignments, in-flight meals, multi-class seating, access to a frequent-flyer programme, complimentary drinks and amenities. In 1997, Ryanair dropped its cargo services, at an estimated annual cost of IR£400,000 in revenue. Without the need to load and upload cargo, the turnaround time of an aircraft was reduced from 30 to 25 minutes, according to the company. It claims that business travellers, attracted by frequency and punctuality, comprise 40 per cent of its passengers, despite often less conveniently located airports and the absence of pampering.
In conjunction with the elimination of non-essential extras, the organization of its operations enables the airline to minimize costs, based on five main sources.
1. Fleet commonality (Boeing 737s, like Southwest Airlines): this results in lower maintenance and staff training costs. In 2005, the company negotiated a new Boeing deal that takes down its per-seat costs for all post-January 2005 deliveries to rock-bottom levels. This deal not only establishes a platform for growth; a younger fleet also enables further cost reductions through lower fuel utilization and maintenance costs.
2. Contracting out of aircraft cleaning, ticketing, baggage handling and other services, other than at Dublin Airport; this is more economical and flexible, while it entails less aggravation in terms of employee relations.
3. Airport charges and point-to-point route policy: Ryanair uses secondary airports that are less congested, motivated to offer better deals and have fewer delays, resulting in increased punctuality and shorter turnaround times.
4. Staff costs and productivity: productivity-based pay schemes and non-unionized staff.
5. Marketing costs; Ryanair was the first airline to reduce and finally eliminate travel agents’ fees. In January 2000, Ryanair launched its www.ryanair.com website. This has had the effect of saving money on staff costs, agents’ commissions and computer reservation charges, while significantly contributing to growth. In 2005, Internet sales accounted for 97 per cent of all bookings. Ryanair supplements its advertising with the use of free publicity to highlight its position as the low fares champion, by attacking various constituencies that threaten its cost structure. These include EU regulators, airport authorities, politicians and trade unions. Its per passenger marketing costs of 60c are considered to be the lowest across the European airline sector.
The year 2005 saw enormous volatility in the price of oil, and the global airline industry faced losses of US$6 billion. Ryanair, which had been unhedged with respect to oil prices since September 2004, announced on 1 June that it was hedging 75 per cent of its fuel needs for the October 2005 to March 2006 period, at a price of US$47 a barrel. At times, in previous weeks, the price had stood at US$53-plus per barrel. At the end of June, the price had hit US$60 and analysts were predicting it would rise to US$70-plus in the coming months.
Low costs contribute to a low break-even load factor of 62 per cent, so the airline can make money even if it fills fewer seats than other budget competitors with higher costs and higher break-even load factors. For example, easyJet’s break-even load factor is 73 per cent, while that of Virgin Express is 83 per cent. Table 6 shows Ryanair’s operating cost structure.
Table 6 Ryanair consolidated profit and loss accounts
Operating revenues
Scheduled revenues
Ancillary revenues
Year ended 31 March 2005
€000
Year ended 31 March 2004
€000
1,128,116 924,566
208,470 149,658
Total operating revenues—continuing operations
1,336,586
1,074,224
Operating expenses
Staff costs 140,997 123,624
Depreciation and amortization 98,703 98,130
Other operating expenses
Fuel and oil 265,276 174,991
Maintenance, materials and repairs 37,934 43,420
Marketing and distribution costs 19,622 16,141
Aircraft rentals 33,471 11,541
Route charges 135,672 110,271
Airport and handling charges 178,384 147,221
other 97,038 78,034
Total operating expenses 1,007,097 803,373
Operating profit before exceptional costs and goodwill 329,489 270,851
Profit for the year 266,741 206,611
Customer service
The airline’s claims of attention to customer service are encompassed in its Passenger Charter, which embraces a number of doctrines:
• Sell the lowest fares at all times on all routes and match competitors’ special offers.
• Allow flight and name changes with requisite fee
• Strive to deliver on-time performance
• Provide information to passengers regarding commercial and operational conditions
• Provide complaint response within seven days
• Provide prompt refunds
• Eliminate overbooking and involuntary denial of boarding
• Publish monthly service statistics
• eliminate lost or delayed luggage
• Ryanair will not provide refreshments or meals or accommodation to passengers facing delays; any passenger who wish to avail themselves of such services will be asked to pay for them directly to the service provider
• Ryanair facilitates wheelchair passengers travelling in their own wheelchair; where passengers require a wheelchair, Ryanair directs those passengers to a third-party wheelchair supplier at the passenger’s own expense; Ryanair is lobbying the handful of airports that do not provide a free wheelchair service to do so.
The company has confirmed that it would introduce a number of cost-cutting new features on its flights. For instance, the Ryanair fleet would heretofore be devoid of reclining seats, window blinds, headrests, seat pockets and other ‘non-essentials’. Leather seats instead of cloth ones would allow faster turnaround times since leather is quicker and easier to clean. More controversially, Michael O’Leary hoped eventually to wean passengers off checked-in luggage, eliminating the need for baggage handling, suitcase holding areas and lost property. In 2004, Ryanair had one of the lowest baggage allowances of any major airline, at 15 kg a person, and charged up to €7 for every additional kilo, one of the highest surcharges in European aviation.
Successive Annual Reports cite-on-time performance (defined as up to 15 minutes after scheduled time in UK Civil Aviation Authority statistics) and baggage handling as of key importance to customers. On punctuality, Ryanair claims to be the most punctual airline between Dublin and London. On baggage handling, Ryanair claims less than one bag lost per 1000 carried, better than even the best US airline, Alaska Airlines, with 3.48 bags per 1000 lost, and considerably better than its role model Southwest Airlines with 5.00 per 1000 lost.
Tables 7and 8, and Figure 3 provide some independent comparisons of Ryanair with other airlines on punctuality and customer perceptions.
Reporting airport/airline Origin/ destination % early to No. of 15minutes Average delay flights
flights late (minutes) unmatched
Birmingham—Ryanair Dublin 180 88 6 0
Birmingham—Aer Lingus Dublin 299 89 7 2
Birmingham—MyTravel Dublin 4 50 20 0
Heathrow—Aer Lingus Dublin 785 71 16 2
Heathrow—bmi British Midland Dublin 432 71 14 0
Stansted—Ryanair Dublin 727 79 11 1
Gatwick—British Airways Dublin 180 82 9 0
Gatwick—Ryanair Dublin 298 87 8 2
Heathrow— bmi British Midland Brussels 354 73 13 1
Heathrow— British Airways Brussels 452 84 9 2
Heathrow— bmi British Midland Palermo 8 25 37 0
Heathrow—Alitalia Milan(Linate) 174 63 15 0
Heathrow— British Airways Milan(Linate) 178 80 10 0
Heathrow— bmi British Midland Milan(Linate) 172 68 13 0
Heathrow—Alitalia Milan (Malpensa) 298 48 24 0
Heathrow— British Airways Milan (Malpensa) 180 80 10 0
Stansted— Ryanair Bergamo 172 76 10 0
Stansted— easyJet Bologna 60 70 14 0
Stansted— easyJet Milan(Linate) 60 42 39 0
Stansted— easyJet Rome (Ciampio) 120 76 12 0
Stansted— Ryanair Rome (Ciampio) 356 79 9 0
Stansted— easyJet Edinburgh 327 60 20 0
Stansted— easyJet Nice 120 70 24 0
Stansted— Virgin Express Nice 1 0 184 0
Stansted— Ryanair Montpellier 59 76 14 2
Stansted— Ryanair Prestwick 562 87 6 4
Stansted— easyJet Glasgow 276 87 8 0
Glasgow—Aer Lingus Dublin 176 80 9 4
Glasgow—bmi British Midland Dublin 2 100 0 0
On punctuality, it must be borne in mind that one is not necessarily comparing like with like when contrasting figures for congested Heathrow with Stansted or Luton, even if all serve London. Also not counted in the statistics were cancelled flights. Ryanair has been known to ‘consolidate’ passengers by transferring them from their original flight to later or alternative routing without any notice, if passengers were unfortunate enough to have originally been booked on a low seat occupancy flight. Ryanair has announced that it would ignore European Commission proposals stipulating that passengers whose flight has been cancelled and who have to wait for an alternative flight should be provided with care while waiting, stating ‘we do not, and never will offer refreshments’.
Clouds on the horizon?
Despite its winning performance in its 2005 results, a number of issues faced Ryanair
• While the competitive threat of new budget carriers had not emerged, some of the mainstream carriers were becoming quasi-budget airlines on short-haul routes. An important instance of this was Aer Lingus, the national state-owned airline of Ireland, operating domestic and international services, with a fleet of 30 aircraft. The events of 11 September 2001 were particularly traumatic for Aer Lingus, as the airline teetered on the verge of bankruptcy. In late 2001, the choice was to change, or to be taken over or liquidated. Led by a determined and focused chief executive and senior management team, the company set about cutting costs. By the end of 2002, Aer Lingus had turned a 2001 €125 million loss into a €33 million profit, and it improved still further in 2003 with a net profit of €69.2 million. In essence. Aer Lingus claimed that it had transformed itself into a low-fares airline, and that it matched Ryanair fares on most routes, or that it was only very slightly higher. The airline’s chief operating officer said that “Aer Lingus no longer offers a gold-plated service to customers, but offers a more practical and appropriate service…it clearly differentiates itself from no-frills carriers. We fly to main airports and not 50 miles away. We assign seats for passengers, we beat low fares competitors on punctuality, even though we fly to more congested airports, and we always fulfil our commitment to customers—unlike no frills carrier. While Aer Lingus had been an early adopter, other mainstream airlines like British Airways and Air France/KLM were also converting short-haul intra-European routes to the value model offered by Aer Lingus.
• Further source of pressure came from the EU. A decision from the EU Commission in February 2004 ruled that had been receiving illegal state subsidies for its base airport at publicly owned Charleroi Airport (styled ‘Brussels South’ by Ryanair). Of course, it was not only the Charleroi decision but also the precedent it could set that was of concern. Other deals with public airports would come under scrutiny, although the vast majority of the airline’s slots were at private airports. Also, it was estimated that Ryanair would have to repay €2.5 million and €7 million to Charleroi’s regional government. Ryanair appealed the decision, but also threatened to initiate state aid cases and complaints against every other airline flying into any state airports offering concessions and discounts. Airport fees comprised 19 per cent of Ryanair’s operating costs and were deemed to be an inherent part of the airline’s low-cost model. Thus, Ryanair warned that there was no mid-cost alternative model. Nevertheless, two months after the Charleroi verdict, Ryanair confirmed that it had agreed a new deal there. It would keep flying all its 11 routes from Charleroi, continuing existing airports and handling charges until the airport, which accommodated 1.8 million passengers a year at the time, reached two million passengers a year. The EU Commission was not readily convinced and initiated an investigation of the new settlement.
On another regulatory matter, the EU had devised fresh rules to cover overbooking that results in boarding denials to passengers by air-lines. Air travellers bumped off overbooked flights by EU airlines would receive automatic compensation of between €250 and €600. Compensation might also be claimed when flights are cancelled for reasons that are the carrier’s responsibility, provided the passengers have not been given two weeks’ notice or offered alternative flights. Ryanair declared that the new rules would not impact its operations, as it did not overlook its flights, and had the fewest number of cancellations and the best punctuality record in Europe. It suggested that, it the EU is serious, it should just outlaw the practice of over-booking entirely.
A few days prior to the EU decision on Charleroi, on 30 January 2004, at the Central London County Court, a disabled man won a landmark case against Ryanair after it charged him £18 (€25) for a wheelchair he needed at Stansted to get from the check-in desk to the aircraft. The passenger was awarded £1336 (€2400) in compensation from Ryanair, as the UK-based Disability Commission said it may launch a class action against the airline on behalf of 35 other passengers. Ryanair’s immediate reaction was to levy 70c a flight on all customers using the affected airports. In December 2004, the decision against Ryanair was upheld on appeal, although it was somewhat mitigated when the Court of Appeal decided that Stansted Airport was also answerable and had to pay half of Ryanair’s liability for damages, with interest. In response, Ryanair’s lawyer suggested that the 50:50 split in liability was unclear and unexplained, and ‘could well have been delivered by King Solomon’.
Also in 2004, a disgruntled Ryanair passenger set up a website inviting complaints about the airline. Ryanair moved to have the website shut down in early 2005, on the grounds that it contained material that is ‘untrue, unfounded, malicious and deeply damaging to the good name and trading reputation of Ryanair’, and that the name and appearance of the site, which resembled that of Ryanair’s home website could be construed as ‘abusive registration’. However, the site has reappeared under an ISP provider in Canada, and its number of hits has increased since the incident was reported in the British satirical magazine Private Eye.
• On another front, Ryanair was in dispute against the British Airports Authority (BAA), as it filed a writ at the High Court in London for alleged ‘monopoly abuse’ at Stansted. Michael O’Leary warned that the action was only the first skirmish in what would become ‘the mother and father of a war’. The Chief Executive of the BAA announced that he did not intend to negotiate further reductions to Ryanair’s deeply discounted deal on landing charges at Stansted, due to finish in March 2007. The average charge per passenger would rise form £3 to £5 at the airport, whose capacity utilization was now so high that it was running out of slots at peak times. Meanwhile, Michael O’Leary was scathing about ‘grandiose plans’ to build a second runway at Stansted at cost of £4 billion, ‘when the cost of a runway and even a terminal should run no more than £400 million.
• As if these issues were not enough, a number of Dublin-based Ryanair pilots were planning to establish their own association, the Ryanair European Pilots Association with links to the British Airline Pilots Association (BALPA), the Irish Airline Pilots Association (IALPA) and the European Cockpit Association. In November 2004, these pilots, supported by IALPA, took a complaint about victimization against Ryanair to the Irish Labour Court. Ryanair could potentially face a compensation bill of £44 million if 170 victimization claims brought by its Dublin-based pilots were to be upheld. The company had out-lined various consequences to pilots if they joined a trades union: possible redundancy when the existing 737-200 fleet was phased out, no share options or pay increases, non promotions and no payment for future recurrent training. The airline declared its determination to keep out trades unions and to take a case to the High Court to prove that legislation attempting to force companies to negotiate with unions was unconstitutional. A ruling favourable to the pilots in February 2005 by the Irish Labour Relations Commission, ordering that Ryanair had to attend a hearing dealing with the pilot’ complaints, was dismissed by Michael O’Leary: ‘It is no surprise that the brothers have found in favour of the brothers. We will fight them on the beaches, in the fields, and in the valleys,’ he said. Meanwhile, the airline is also fighting a number of legal challenges, including proceedings against IALPA, accusing it of conducting an organized campaign of harassment and intimidation of Ryanair pilots through a website, warning them off flying the airline’s new aircraft. Indeed, the carrier claims that specific threats issued on the website are being investigated by the Irish police. In April 2005, Ryanair abandoned an experiment in paid-for in flight entertainment, after passengers were reluctant to rent the consoles at the £5 required to receive the service. Apparently, market research discovered passengers are unwilling to invest on such short flights, with the ideal being six-hour flights to longer-haul holiday destinations. When the experiment was launched in November 2004, Michael O’Leary hailed the move as ‘the next revolution of the low-fares industry…we expect to make enormous sums of money’.
Questions:
1. How does Ryanair’s pricing strategy account for its successful performance to date? Would you suggest any changes to Ryanair’ pricing approach? Why/why not?
2. Is the ‘no-fares’ strategy a useful approach for Ryanair in the short term? In the long term?
3. Do the issues facing Ryanair threaten its low-fares model?
Case V LEGO: the toy industry changes
How times have changed for LEGO. The iconic Danish toy maker, best known for its LEGO brick, was once the must-have toy for every child. However, LEGO has been facing a number of difficulties since the late 1990: falling sales, falling market share, job losses and management reshuffles. Once vote ‘Toy of the Century’ and with a history of uninterrupted sales growth, it appears LEGO has fallen victim to changing market trends. Today’s young clued-up consume is far more likely to be seen surfing the web, texting on their mobile phone, listening to their MP3 player or playing on their Game Boy than enjoying a LEGO set. With intensifying competition in the toy market, the challenge for LEGO is to create aspirational, sophisticated, innovative toys that are relevant to today’s tweens.
History
In 1932 Ole Kirk Christiansen, a Danish carpenter, established a business making wooden toys. He named the company ‘LEGO’ in 1934, which comes from Danish words ‘leg godt’, meaning ‘play well’. Later, coincidentally, it was discovered that in Latin it means, ‘I put together’. The LEGO name was chosen to represent company philosophy, where play is seen as integral to a child’s successful growth and development. In 1947 the company began to make plastic products and in 1949 it launched its world-famous automatic building brick. Ole Kirk Christiansen was succeeded by his son Godtfred in 1950, and under this new leadership the LEGO group introduced the revolutionary ‘LEGO System of Play’, which focused on the importance of learning through play. The company began exporting in 1953 and soon developed a strong international reputation.
The LEGO brick, with its new interlocking system, was launched in 1958. During the 1960s LEGO began to use wheels, small motors and gears to give its products the power of motion. LEGOLAND was established in Billund in 1968, as a symbol of LEGO creativity and imagination. Later, in the 1990s, two new parks were opened in Britain and California. LEGO figures were introduced in 1974, giving the LEGO brand a personality. The 1980s saw the beginning of digital development, with LEGO forming a partnership with Media Laboratory at the Massachusetts Institute of Technology in the USA. This resulted in the launch of LEGO TECHNIC Computer and paved the way for LEGO robots. LEGO introduced a constant flow of new products in the 1990s, and placed greater focus on intelligence and behaviour. The new millennium saw LEGO crowned the ‘Toy of the Century’ by Fortune magazine and the British Association of Toy Retailers. LEGO is currently the fourth largest toy manufacturer in the world after Mattel, Hasbro and Bandai, with a presence in over 130 countries.
Challenges for the traditional toy market
A number of environmental shifts have been affecting the toy market over the past decade. Some of these are described below.
• Kids getting older younger. By the time most kids reach the age of eight they have outgrown the offerings of the traditional toy market. A central factor in children abandoning toys earlier in their lack of free time to play. Children today have a lot more scheduled activities and, with greater emphasis on academic achievement, a lot more time is spent studying. Faced with more media and entertainment choices these sophisticated and technologically savvy consumers are favouring electronic, fashion, make-up and lifestyle products. The most susceptible group to this age compression are ‘tweens’—children between the ages of 8 and 12—a US$5 billion market, accounting for 20 per cent of the US$20.7 billion traditional toy industry.
• Intensifying competition from the electronic and games market. As noted above, today’s young consumer is far more likely to be seen surfing the web, texting on their mobile phone, listening to their MP3 player or playing on their Game Boy than enjoying a LEGO set. A survey by NPD Funworld, in 2003, found that tween boys who played video game spent approximately 40 per cent less time playing with action figures when compared with the previous year. Handheld toys with a video and gaming element suit the mobile lifestyle of today’s tween. As demand for these more sophisticated toys increases, traditional toy makers are facing more direct competition with the electronic and video games market.
• Fickleness of young consumers. The toy market today is very fashion-driven, leading to shorter product life cycles. Toy manufacturers are facing increasing pressure to develop a competency in forecasting market changes and improving their speed of response to those changes. In an effort to get a share of the huge revenues generated by the latest hot toy, many toy manufacturers have left themselves more vulnerable to greater earnings volatility.
• Power of the retail sector. Consolidation in the retail sector and the expansion of many retail chains has placed enormous pressure on the profit margins of traditional toy makers. Major retailers can exert tremendous power over their suppliers because of the vast quantities they buy. Many retailers insert a clause in their supplier contracts that gives them a certain percentage of profit regardless of the retail price.
Traditional toy makers are struggling to keep up with these environmental changes. It appears no one is safe, when even the world-renowned LEGO brand can fall victim to changing market trends. The cracks first began to show in 1998, when LEGO made a loss for the first time in its history. This began a major reversal in the fortunes of a company that had become accustomed to decades of uninterrupted sales growth (see Table 9). Ironically, it is the success of LEGO that may ultimately have paved the way for its downfall.
Table 9 : LEGO financial information
LEGO financial information (Mdkk) 2004 2003 2002 2001 2000
Income statement
Revenue 6704 7196 10006 9475 8379
Expenses (6601) ( 8257) (9248) (8554) (9000)
Profit/(loss) before special items, financial income and expenses and tax 103 (1061) 868 921 (621)
Impairment of fixed assets ( 723) ( 172) - - -
Restructuring expenses ( 502 ( 283) - ( 122) ( 191)
Operating profit/(loss) (1122) (1516) 868 799 ( 812)
Financial income and expenses ( 115) 18 ( 251) ( 278) ( 280)
Profit/(loss) before tax (1237) (1498) 617 521 (1092)
Profit/(loss) on continuing activities (1473) (953 ) 348 420 ( 788)
Profit/(loss) discontinuing activities ( 458) 18 (22) (54) (75)
Net profit/(loss) for the year (1931) (935) 326 366 (863)
Employees:
Average number of employees (full-time), continuing activities 5569 6542 6659 6474 6570
Average number of employees (full-time), discontinuing activities 1725 1756 1657 1184 1328
What went wrong for LEGO
According to Kjeld Kirk Kristiansen, owner of the business and grandson of its founder, following many years of success the LEGO culture had become ‘inward looking’ and ‘complacent’ and had failed to keep pace with the changes taking place in the toy market. This lack of environmental sensitivity was evident in the US market in 2003, where LEGO failed to predict demand for its Bionicle figures, resulting in two of its best-selling products from this range being out of stock in the run-up to Christmas. It appeared nothing had been learned from the previous year, when also in the run-up to Christmas the much sought-after Hogwarts Castle sets were out of stock across the UK.
LEGO had also become over-dependent on licences in the 1990s, for products such as Star Wars and Harry Potter, as its main source of growth. This left LEGO vulnerable to the faddishness of these products: the years in which Star Wars and Harry Potter films were released coincided with profitable years for LEGO, while losses were reported in the intervening years.
The diversification of the brand into the manufacture of items such as clothing, bags and accessories was another mistake for LEGO. The company over-complicated its product portfolio and it ran close to over-stretching the LEGO brand. Kristiansen, resumed leadership in 2004 to guide the company out of crisis, is quoted as saying ‘LEGO was so busy chasing the fashion of the day it took its eye off its core brand.’
He phasing-out of its long-established pre-school Duplo brand, to be replaced by LEGO Explore, was another error. Parents were left confused, with many believing the larger-size Duplo brick had been discontinued. This error resulted in a loss of revenues from the pre-school market in 2003. Adult fans of LEGO (AFOLs) were also left disgruntled when LEGO changed the colour of its new building bricks so that they no longer matched the colour of the old bricks.
While other toy manufacturers have moved production to low-cost destinations such as China, LEGO has been reluctant to follow suit. Today it still manufactures the bulk of its product in Billund and Switzerland. The reasons posited for the company’s reluctance to move include a strong sense of loyalty to Billund, where one-quarter of the residents work at the LEGO factory, and concerns that a move would affect its brand image. While its loyalty to these sites is admirable, and brand image worries understandable, the question is whether its long-term future is viable without such a move.
A new direction for LEGO
In an attempt to turn around its fortunes LEGO has developed a number of new marketing strategies. These include the following.
• A back-to-basics strategy is seeing LEGO refocus on its core brick-based product range and place more emphasis on its key target group—younger children. In 2003, LEGO relaunched its classic range of brick-based products and many new product lines have centred on eternal themes such as Town, Castle, Pirates and Vikings. LEGO has reinstated the Duplo brand and introduced the Quarto brand, which consists of larger bricks for children under two. Other new lines include LEGO Sports, born from strategic alliances with the National Hockey League and US National Basketball Association. While the traditional audience of LEGO has always been young boys it has introduced a new range, ‘Clikits’, a social toy developed specifically for a female audience. Clikits consists of pretty pastel-coloured bricks, which provide numerous options to create jewellery and fashion accessories.
• LEGO has admitted to over-diversifying its brand. In response to this, LEGO has withdrawn many of its manufacturing lines, instead opting to outsource these to third parties via licensing deals. LEGO is also selling its LEGOLAND parks in a bid to refocus efforts on its core product and improve its financial situation.
• In an attempt to create a story-based, multi-channel, LEGO has engaged in a number of licensing deals, with varying degrees of success, but more importantly it is now developing its own intellectual property. The Bionicle range, launched in 2001, was the first time LEGO has created a story from the start as the basis for a new product range. The Bionicles combine physical snap-together kits with an online virtual world. This toy brand has also been extended into entertainment in the form of comics, books and a Miramax movie: Bionicle: Mask of light. The range has proved a major success for LEGO and, building on this success, it has developed Knights Kingdom.
• Sub-brands that LEGO has neglected, including Mindstorms and LEGO TECHNIC, both aimed at older children and enjoyed by some adults, are being given more attention. With so many adult fans of LEGO, efforts are also being made to further engage the adult market. The company is currently considering whether to market its management training tool, entitled LEGO Serious Play, to a wider adult audience.
• LEGO has overhauled its packaging, and the style and tone of its advertising. The emphasis is now being placed on the LEGO play an educational experience as opposed to product detail. The strap-line ‘play on’ was introduced in January 2003 to accompany the change. The slogan draws its inspiration from the company’s five core values: creativity, imagination, learning, fun and quality. LEGO is also making greater use of more interactive communication tools to promote its products, which it is believed will encourage consumers to interact more with the brand. 2005 has seen LEGO invite fans on a tour of the company. Here they are given the opportunity to meet new product developers, designers and toolmakers, and learn about the company’s history, culture and values.
• LEGO is also taking steps to reverse its insular culture. In an attempt to build a more market-driven organization, it is spending more time consulting children, parents, retailers and AFOLs. The company established the LEGO Vision Lab in 2002 to examine how the future will look to children and their families. A variety of sources are being used to make assessments of future worldwide family patterns, including anthropology, architecture, consumer patterns and awareness, culture, philosophy, sociology and technology.
• Plagued by supply-chain inefficiencies LEGO has improved production time from concept to the retailer’s shelf. An example of this is the Duplo Castle, which was developed in nine months.
Conclusion
Having taken its eye off the ball, LEGO is fighting back with a new customer-focused strategic approach. Continuous improvement, in response to changing market trends, is now key if LEGO is to ward off the many challenges it still faces. It is still involved in many licence agreements, making it vulnerable to this cyclical market. Its back-to-basics strategy has been widely praised but it remains to be seen if LEGO can balance this with its increasing activity in software. With children’s growing appetite for video games with a more violent content, can LEGO satisfy this target group while still remaining true to its wholesome ‘play well’ brand values? Will LEGO succeed in its attempts to target young girls and its desire to target a more adult audience? Will it succeed in its attempts to reduce costs and improve efficiencies? Will CEO Jorgen Vig Knudstorp succeed where his predecessors have failed? Only in the fullness of time will these questions be answered but one thing is for sure: no brand, no matter how powerful, can afford to become complacent in an increasingly competitive business environment.
Questions:
1. Why did LEGO encounter serious economic difficulties in the late 1990s?
2. Conduct a SWOT analysis of LEGO and identify the company’s main sources of advantage.
3. Critically evaluate the LEGO turnaround strategy.
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