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T4- Part B – Case Study

BVS – Fleet maintenance case – May 2013

REPORT To: BVS Board From: Management Accountant Date: 23 May 2013

Review of issues facing BVS Contents 1.0 Introduction 2.0 Terms of reference 3.0 Prioritisation of the issues facing BVS 4.0 Discussion of the issues facing BVS 5.0 Ethical issues and recommendations on ethical issues 6.0 Recommendations 7.0 Conclusions Appendices Appendix 1 SWOT analysis Appendix 2 PEST analysis Appendix 3 Evaluation of the Government contract Appendix 4 Customer profitability analysis Appendix 5 Proposal for tyre pressure checking service Appendix 6 Forecast alternative share prices Appendix 7 Part (b) - Presentation and graph on the range of share prices for flotation 1.0 Introduction BVS is an unlisted company, which was formed following an MBO on 1 April 2010. The company has grown considerably since its formation and is currently responsible for servicing and maintaining its customers’ fleet vehicles, totalling over 82,000 vehicles. Its sales revenue has grown from €84.0 million in BVS’s first year of operation, following the MBO, to a forecast of €122.9 million in the current year ended 31 March 2013, growth of almost 45%. BVS follows the generic strategy of differentiation according to Porter. BVS is trying and succeeding to grow its business as well as meeting the demands of its customers in respect of the quality and range of services it offers. In the real world there are many fleet maintenance companies including BT plc, the UK’s main telecommunications provider. BT plc’s fleet maintenance subsidiary company has many large fleet maintenance contracts including one with the AA to service all of its roadside breakdown and recovery vehicles.

Note: This report is far more comprehensive than would be expected from a candidate in exam conditions. It is more detailed for teaching purposes.


There are two main issues facing BVS, which concern trying to retain the government contract and customer profitability analysis. The possible loss of the government contract will impact on the achievement of the company’s 5-year plan. The nature of the fleet maintenance industry is constantly evolving. For example, by 2015 vehicle manufacturers will need to abide by the Euro V1 emissions standards and BVS cannot afford to stand still and needs to be pro-active towards change. 2.0 Terms of reference I am the Management Accountant appointed to write a report to the BVS Board which prioritises, analyses and evaluates the issues facing BVS and makes appropriate recommendations. I have also been asked to prepare a presentation on the range of share prices for flotation. This is included in Appendix 7 to this report. 3.0 Prioritisation of the issues facing BVS 3.1 Top priority – Contract for government vehicles The top priority is the need to re-tender for this large contract with the government of BVS’s home country. BVS currently services 20,800 vehicles with total revenue of €34.5 million. Losing this contract will have long-term implications on its workshops utilisation levels, the cost of outsourcing and will also affect the potential share price when BVS is listed. So this is a key contract to do everything possible to try to retain. However, the profitability of the contract needs to be considered as a significant revenue reduction is required to win the tender. 3.2 Second priority – Customer profitability analysis This is considered to be the second priority as BVS needs to ensure that all categories of customer are profitable and that some customers should not be “subsidising” other customers. Whilst this is an operational, rather than a strategic issue, it is key to the long-term success of BVS. It is important that overhead costs are controlled and accurately charged to customers to ensure that BVS’s prices reflect the cost of servicing different categories of customer. 3.3 Third priority – Proposal for tyre pressure checking service The third priority is considered to be the proposal to launch a new tyre checking service to its customers. The proposal is to recruit an additional 110 employees in the first year and is risky if the take up for this new service does not achieve the forecast level. This new service will enable customers who select this service to reduce their vehicles’ fuel consumption and carbon emissions. 3.4 Fourth priority – Flotation plans for BVS The flotation of BVS will not take place until early in 2015/16, but this is a strategic issue and the actions taken now will have an impact on BVS’s share price at flotation. This issue is important but less urgent than the customer profitability and the tyre pressure checking service proposal. However, it is important for Board members, who are shareholders of BVS, to understand that the decisions they make on the above three priority issues will have an impact on BVS’s share price at flotation.


A SWOT analysis summarising the strengths, weaknesses, opportunities and threats facing BVS is shown in Appendix 1. A PEST analysis is shown in Appendix 2. 4.0 Discussion of the issues facing BVS 4.1 Overview BVS has grown considerably since it was formed following the MBO in April 2010. It is clearly meeting the needs of its fleet customers as it has not lost any customers to date and has grown the number of vehicles it maintains from 47,500 to a forecast figure of 82,100 at end March 2013. The major issue facing BVS is the possible loss of the government contract to service and maintain 20,800 vehicles in its home country. The loss of this contract would impact on outsourced cost levels and workshop utilisation levels. It is important that BVS prepares a new tender price which will give it the best opportunity to retain this contract but will allow it to remain a profitable contract, albeit at a much lower level of profits. Customer profitability is another key area for BVS’s management team to concentrate on. It seems that growth in customer numbers and growth in vehicle numbers has taken priority over the level of profitability each customer delivers. Additionally BVS needs to review its overhead cost allocations to ensure that all of the contracts with its existing customers are profitable. Otherwise it may be better to re-negotiate prices or lose customers if they are not profitable. BVS’s management have perhaps been too focussed on growth and now is the time to consolidate its position to ensure that the company’s good reputation for quality and range of services is maintained or enhanced. 4.2 – Contract for government vehicles BVS has been asked to re-tender for this government contract and to reduce the price by between 5% and 8% compared to current levels. The lower the price that BVS tenders, the more likely it is to retain this large contract for 20,800 vehicles. BVS has only one chance of tendering for this contract and must ensure that its tender takes all of the factors into account. This contract is very profitable currently with an overall margin of 9.5% and it also increases workshop utilisation levels.

The contract overall generates forecast operating profit of €3.261 million, which for 20,800 vehicle is equal to an average profit of €157 per vehicle. The overall margin, including repairs and tyres is a net operating margin of 9.5%. This is shown in Appendix 3. Therefore there is scope to reduce the re-tender price up to 8% and still remain profitable, albeit at a much lower level of profit. Should BVS give in to the pressure from its home government and be forced to cut its margins and should it tender a lower price to retain the contract? Alternatively BVS could simply let the contract be terminated.

If it were to tender a lower price, how low should BVS tender to be confident of securing the contract? There is only one opportunity to win the tendering process and all will depend on submitting the lowest price. The possible use of information that Annika Larsen, the Finance Director, has received from a contact in the government procurement department is not an acceptable way of conducting


business and is discussed in the Ethics section below. Furthermore this information may not be reliable and should not be used as a basis for preparing a reduced tender price. The current operating profit is €3.261 million, which is a 9.5% margin. Therefore, there is scope to reduce revenues by the indicated 5% to 8% overall. However, the margin on vehicle servicing which represents revenues of €11.086 million currently only achieves a margin of 3.9%. So a reduction of even the minimum of 5% would result in this major part of the contract being loss-making. If this were to occur, then all the ongoing work to service 20,800 vehicles would be generating an operating loss and would be subsidised by the repair work and tyre replacement elements of the contract. Is this acceptable to BVS’s management? Should BVS knowingly enter a loss making contract so that it can make such a small level of profit on repairs and tyres only? Would it be possible for BVS to contract only for the vehicle repairs and tyre replacement business? This is extremely unlikely; almost certainly the government department would be looking for a single supplier to manage its fleet maintenance, and therefore BVS needs to consider how low to tender in order to win the contract in its entirety. This is a major contract for 20,800 vehicles, the second largest customer after JAR, BVS’s previous parent company. The JAR contract will need to be re-negotiated at the end of the 5 year period and if the government contract and the JAR contract were both to be lost, then this would have a major impact on the company, its ability to become listed and the potential share price at flotation. For the long-term success of BVS, it should do everything possible to retain the government contract as long as the overall contract generates a positive margin. However, this price reduction could have implications on BVS’s other customers if any of them were to discover the extent of the contract renewal discount given to the government contract. This could have long-term implications on BVS’s profitability. Therefore, it is essential that all contract negotiations and the final contract price (if the contract is renewed with BVS) should remain confidential. If the contract were lost, then BVS would be likely to incur a higher outsourced workshop charge of €33.00 per hour rather than the current €32.00 per hour. The outsourced workshops currently undertake 1,390,000 hours of work, including the government contract of 216,000. Therefore the net hours of 1,174,000 would cost BVS €1.00 more per hour. This alone would increase BVS’s costs by €1.174 million. Furthermore, if the contract were to be lost, the utilisation levels at each of BVS’s 120 workshops would fall from 91.0% to only 66.6% based on an average reduction of 2,704 hours of work at each workshop. This is shown in Appendix 3. However, this could be increased by outsourcing less work for BVS’s other customers. BVS has one opportunity to submit a tender at a lower price to try to retain the contract. The indicated reduction is between 5% and 8%. At a price reduction of 5%, the margin overall would fall to €1.5 million, resulting in a margin of 4.7%, which is still good for a contract of this size. However at the top end of the indicated reduction required, at 8% reduction in revenue, the contract margin would fall to only €0.5 million, which is a very small margin of only 1.6%. To be assured of having some success in retaining this contract, a tender close to the maximum suggested price reduction of 8% reduction would need to be made. There is also the concern that if BVS wins the contract back this year and maintains a very small margin, then next year the government could seek a further price reduction. This would not then be possible as the contract could then be loss-making. Therefore it is suggested that if BVS tenders a low price that it tries to secure a fixed price for a 2 or 3 year contract period if this can be negotiated. Against this erosion of the margin is the concern that BVS would be trying to boost its revenues and profits and confidence for a future flotation. The loss of this major contract would impact on BVS’s possible P/E ratio and also on investors’ confidence.


The impact of not re-tendering for this contract is huge and has 3 main impacts:

1. Loss of operating profit on the current contract of €3.261 million. 2. Higher cost of outsourcing of €1.174 million. 3. Lower utilisation level at owned workshops.

The financial impact on profitability of losing the contract is €4.435 million as shown in Appendix 3. This comprises the loss of gross margin from the current contract of €3.261 million as well as the higher cost of outsourcing of €1.174 million.

It is possible that some of the cost of owned workshops could be reduced by not outsourcing as much work from BVS’s other customers’ vehicles, so as to increase the workshop utilisation levels at the 120 owned workshops. However, this would not happen overnight and therefore, due to the fixed cost nature of the workshops, these managed workshops fixed costs will still be incurred. This emphasises that all steps should be taken to retain this government contract as it would have a huge impact on the company, its profits, its utilisation levels and therefore the ability to prepare the company for flotation in 2015/16. 4.3 - Customer profitability analysis It is important for BVS to deliver a high quality service, but it is also necessary for BVS to maintain its competitive position. BVS needs to position itself as a differentiator on quality of service in this industry as this is a major source of competitive advantage and is one of Porter’s generic strategies. BVS also needs to make an adequate return for its shareholders, who are a key player using Mendelow’s framework, and need to be kept satisfied. Therefore, it is important that BVS has a reliable costing system to ensure that the various services it offers its customers provide value for money not only for BVS’s customers but also for BVS itself. Annika Larsen has provided some basic ABC analysis showing the relevant costs and benefits for three categories of customer i.e. large, medium and small. These are summarised in the table below and full workings are shown in Appendix 4.

All figures are per average customer Large fleet customer

2001+

vehicles

Medium fleet customers

31 to 2,000

vehicles

Small fleet customer

30 or fewer

vehicles

€’000 €’000 €’000

Sales revenue 4,906.0 1,253.0 28.0

Contribution to other costs 770.2 182.9 3.9

Total cost allocation using cost drivers 492.7 122.0 4.8

Net profit / (loss)

277.5

60.9

(0.9)

Net profit percentage

5.7%

4.9%

(3.3)%


There is a concern that this analysis shown in Appendix 4 shows that the small fleet customers, with 30 or fewer vehicles, are shown to be loss making with an average loss of €(922) per customer which is negative (3.3)%. However, much depends on the suitability and accuracy of the cost drivers. Using the range of cost drivers, the customer profitability analysis (CPA) in Appendix 4, shows that large customers with a fleet size of 2,001 or more vehicles are the most profitable with an average margin of €277,515 per customer, which is a net profit margin of 5.7%.

Medium size customers appear to be profitable, but not as much as the larger customers, with medium customers providing a profit margin of 4.9% compared with the 5.7% for the large customers. The average medium sized customer generates a profit after finance costs of €60,918. However, before any action is taken such as renegotiation of prices with small customers, BVS needs to ensure that the cost drivers are correct. These would need to be further investigated. Additionally, the choice of what management actions could be taken to address the potentially loss-making customers with a small number of vehicles in their fleets include reviewing the cost drivers, reducing the costs incurred or renegotiating prices with small customers. The number of days of customer support and billing and accounts administration is proportionately higher (as a percentage of revenues) for small fleet size customers. Is this an accurate and suitable measure for these cost categories? The cost of finance is charged to customer categories based on each customer’s category for its cash operating cycle. However, this may vary between customers with some paying earlier or later than others. This currently shows a high cost for small fleet size customers, as they appear to pay 23 days later than medium fleet size customers with a net cash operating cycle of 23 days (net of BVS’s payments to suppliers). What actions can be taken to speed up payment? Perhaps a penalty for late payment could be introduced or the introduction of a reward for faster payments. The cost category of “other fixed costs” used a cost driver of €160 per vehicle. This is a large cost item and it is suggested that further analysis work is undertaken to break these costs into a wider range of cost drivers. This cost item may be unfair to the category for small customers. It should be noted that no matter how accurate or not the ABC data is, small customers do still make a reasonable contribution to overhead costs (at 14.0%), even though this is lower than the contribution percentage earned of 15.7% and 14.6% for the other two types of customer. Should BVS lose a lot of small customers, then it may well be that the only savings in overhead costs are those of finance costs, which would not compensate for the lost contribution from small customers. If, after further investigation, the small fleet size category of customers is proved to be loss-making, then BVS would need to review whether some, or all, of these customers contracts should be renewed or whether higher revenues are required to justify a reasonable level of profitability for BVS. However, there is a need to take into account workshop utilisation levels and the volume of work that small fleet customers generate. Perhaps BVS should have a criterion for new customers based on a minimum of 20 vehicles. 4.4 – Proposal for tyre pressure checking service This is an innovative proposal which would allow BVS’s customers to reduce their fleets’ fuel consumption and also reduce their carbon emissions.

The proposal is to charge customers €300 per year per vehicle for this service. This service will generate fuel savings of €420 per year (and greater savings as fuel prices rise) and therefore customers could achieve a cost saving of €120. This saving represents a massive 40% of the revenue paid to BVS for this new innovative service.


This is an example of market development using the Ansoff growth vector matrix. In the real world, ATS Euromaster launched this type of tyre pressure service in 2012 to help its fleet customers to reduce their fuel costs and to cut their carbon footprint. The proposal generates a positive NPV of €0.611 million over a 3 year period. This is shown in Appendix 5. However, the proposal is highly dependent on several key assumptions. One of the major assumptions concerns the number of customers which choose to take up this service. The NPV assumes that an average of 12,000 of BVS’s customers’ vehicles will take this service in Year 1. This is a challenging target for year 1 and could be affected or delayed by the need to have telemetric devices fitted in all of the vehicles that use the service. What if the assumption of an average of 12,000 vehicles in Year 1 is incorrect? BVS’s current customer base includes servicing for 82,100 vehicles. However, this includes the government contract for 20,800 vehicles which is unlikely to take up this extra service due to the government needing to reduce its costs. This leaves a vehicle base of 61,300 vehicles including JAR’s vehicles. Therefore 12,000 vehicles represents just under 20% of the remaining number of BVS’s customers’ vehicles. BVS is proposing to recruit 110 new employees who will be dedicated to this new service and not involved in normal workshop vehicle servicing work. The cost of these 110 employees is a large fixed cost of €2.9 million. This is a huge increase to BVS’s cost base but if this service is to be offered, then these employees would need to be recruited and trained before the launch of this new service. Perhaps BVS could recruit only half of these proposed employees and outsource the remaining tyre pressure checks or use some of BVS’s existing employees based at workshops to undertake the remaining volumes of tyre pressure checks, at the launch of this service. This would allow it to wait and see how successful it is before recruiting more employees. Appendix 5 also shows the NPV for the proposal based on the breakeven number of vehicles. The breakeven number of vehicles required in Year 1, assuming vehicle take-up does grow at 30% each year, is just over 10,000 vehicles. This is 2,000 lower than the forecast number. Therefore, if the take-up for this new service is much lower, at say only 6,000 vehicles, then BVS would make a loss. The NPV is very sensitive to vehicle take-up due to the fixed cost nature of the employees required to deliver this weekly tyre check service across 3 countries. The proposal appears to omit costs in respect of sales and marketing costs or perhaps an introductory discount to try to get customers to take up this new service. Perhaps customers could be offered a month’s trial for free. Another risk of this proposal is that the manpower and other forecast costs of undertaking this service may not be accurate as they are based on a limited trial only. The service is complex as it requires BVS to locate each of the vehicles (using data from the telematic devices) and to get an employee to each of the vehicles every week. This service is logistically complex. What if the tyre checks are not undertaken each week? What if the tyres need changing and this delays the vehicle operationally? There are many operational and logistical facets to be discussed with customers affecting this new service which need to be resolved before the service is launched. In principle, the proposal is acceptable to BVS and also to its customers as both would benefit. The customer would save fuel costs and reduce its carbon emissions. BVS would operate a new profitable value added service. It is also another feature that ties customers into BVS. Sensitivity analysis on the NPV calculation in Appendix 5 shows that if only 10,000 customers’ vehicles took this service in Year 1 with a 30% rise in vehicles each year, then the NPV would be zero, i.e. breakeven. Therefore it is suggested that a further extended trial is launched prior to going fully operational with this service across all 3 countries. Perhaps only 40 to 50 new employees could be recruited


initially to operate this service in just BVS’s home country until the number of customer vehicles that take-up this service is known with greater certainty. Currently BVS employs a total of 724 workshop employees and therefore recruiting a further 110 employees would be a huge increase of 15% to BVS’s skilled employee numbers. It is suggested that this new service is rolled out slower and fewer people are recruited for this new service initially. 4.5 – Flotation plans for BVS When BVS was formed in April 2010 the shareholders, including the private equity investor PIE, bought shares at €5.00 each. The initial investment totalled €2.0 million comprising €0.8 million from the 4 shareholders and €1.2 million from PIE. The company has been hugely successful and is considering a flotation on the Alternative Investment Market stock exchange during 2015/16, which is only in around 2 years time. The growth of the company and its profitability will enable the company to become listed and this would give PIE an exit route. This is usual for private equity investors. However after the company becomes listed, many changes are possible. The range of possible share prices at flotation is shown in Appendix 6 and is summarised below:

€77.50 per share based upon a P/E of 4.0. This share price includes the reduced profitability from the government contract assuming this contract is won at the lowest tender price of an 8% discount which would generate €0.500 pre-tax.

€96.88 per share based upon a P/E of 5.0. This share price includes the reduced profitability from the government contract assuming this contract is won at the lower tender price.

€65.80 per share based on a lower P/E of 4.0. This share price assumes that the government contract is terminated and the cost of outsourcing is increased by €1 per hour.

Note: Appendix 6 shows the alternative share prices for BVS based on a discount for the government contract of 8%. However, if a candidate had adjusted BVS’s post-tax profit for any of the other possible ranges of discounts (5%, 6% or 7%) then these would have been acceptable for full marks. These additional ranges of possible share prices for BVS are shown in Appendix 6.

The private equity investor, PIE, would wish to maximise the P/E ratio and the level of profits prior to flotation to maximise its profit from its investment in BVS. Therefore it would wish to do everything possible to retain the government contract and also to boost profitability prior to listing. BVS has a 5-year loan which is due for repayment at end March 2015. After flotation BVS would have access to a wider choice of debt instruments and also cheaper debt. It could choose to have a higher proportion of debt (a higher gearing ratio) in order to gain tax relief on debt finance. BVS could use the increased debt finance to fund expansion by acquiring a competitor or by acquiring one (or more) of the companies it currently outsources to. Alternatively, with the large volume of work, it could expand organically by opening more owned workshops.


Ownership of the company will change after flotation, as PIE which currently owns 60% of the company, will have exited and sold its shares. If the entire 60% of the company were to be bought by a competitor, BVS could be acquired. Therefore, if the current shareholders wish to gain majority control, they would need to finance the purchase of at least 10% of the 400,000 shares that PIE will wish to dispose of. Therefore if they were to collectively buy 40,000 + 1 shares, this could cost the existing 4 directors around €3.9 million (if the share price were to be as high as €96.88 per share). One or more of the current shareholders may wish to sell their shares and leave the company, having made a substantial profit during the 5 years since the MBO. For the company to continue to operate successfully it is essential that the existing 4 directors and shareholders do not sell their shares and exit the company soon after flotation.

5.0 Ethical issues and recommendations on ethical issues 5.1 Range of ethical issues facing BVS There are a range of ethical issues that will be discussed and recommendations made, including the following:

1. Annika Larsen, the Finance Director, has received information from a contact in the government procurement department about possible competitor tender prices. The ethical dilemma is whether this information should be used or ignored.

2. Unauthorised use of workshop space.

5.2 – The use of information obtained about the tender price for the Government contract 5.2.1 Why this is an ethical issue This is an ethical issue for 3 reasons: 1. It is not acceptable business practice to use any known contacts to try to find out about the

level of competitor tenders. 2. The Finance Director would be in breach of her accounting body’s Ethics Code if she were

to pass this information onto the Sales Director. 3. BVS should not attempt to use any information gained in this way to affect the level of its

tender. This information compromises BVS’s management methods and it should not use the information at all. Furthermore, the information could turn out to be incorrect or unreliable. 5.2.2 Recommendations for this ethical issue It is recommended that the Finance Director should NOT communicate the information that she has received to the Sales Director. The information that has been given to Annika Larsen was that no other tenders from BVS’s competitors have been received which have a price reduction of more than 6%. This information should be ignored totally. It is further recommended that BVS should establish a code of conduct for all employees and that all employees should be trained in ethical ways of conducting business.


5.3 – Unauthorised use of workshop space 5.3.1 Why this is an ethical issue This is an ethical issue for 3 reasons: 1. It is not fair for the seven workshop managers to be so harshly punished for allowing these

vehicles to be serviced, which are owned by employees, without a reminder being sent to all employees that this is not acceptable practice.

2. Leo Willems email stating that termination of an employee’s contract of employment for

using workshop space is considered to be too harsh a reaction for a first offence. 3. It is also unethical for BVS’s employees to have used workshop facilities and for BVS to

have procured and paid for parts and tyres when there was a rule stating that this was no longer acceptable practice. All employees should be reminded of this rule that personal vehicles should not be serviced on BVS premises.

5.3.2 Recommendations for this ethical issue It is recommended that Carmen Kemp, HR Manager, speaks to Leo Willems and asks that he agrees that no adverse comments should be recorded on the 7 workshop managers’ personnel records in respect of the employee’s vehicle servicing at these 7 workshops. This will therefore not affect these 7 workshops managers from potentially earning a bonus this year, assuming there are no further instances of allowing employee vehicles to be serviced using workshop time and materials. It is further recommended that Carmen Kemp sends an email to all employees, including workshop managers, reminding them that they are NOT entitled to undertake servicing of personal vehicles at all using company owned workshops at any time. Carmen Kemp should remind employees that they currently receive a share of BVS’s profits based on the PRP scheme and that it is unethical for them to use company workshop space and use company owned spares and tyres for their personal use. It is, in effect, stealing and this must be stopped immediately. The email should advise all employees that any further breach, effective immediately, will result in disciplinary action and that this will result in no bonus payable in the year. However, the email should clearly state that contracts of employment will not be terminated, unless there are repeated instances of breaking this company rule concerning servicing of employees own vehicles. 6.0 Recommendations 6.1 – Contract for government vehicles 6.1.1 Recommendation It is recommended that BVS should try to retain this contract, albeit at a much lower level of profitability. Really BVS does not have any choice but to re-tender for this major contract. As the company nears flotation, the loss of this key customer could affect investors’ confidence in BVS and reduce the P/E ratio that the company could be valued at. It is recommended that BVS should offer the maximum suggested price reduction of 8% lower than the current contract price to ensure that it stands the best possibility of retaining this large contract. It could, perhaps, tender at just below 8% at say, 7.8% lower than the contract price, to allow a little room for negotiation if required. However, it should try to negotiate to secure a 2 or 3 year contract at this reduced revenue level, perhaps linked to inflation increased each year.


The recommended tendered price is therefore €31.747 million if the revenue reduction is 8%. It is recommended that the opening tender is at a 7.8% reduction which is €31.815 million. 6.1.2 Justification BVS should try to retain the contract for several reasons as this is still a profitable contract and enables BVS to maintain a high level of utilisation at its managed workshops. It will also allow BVS to continue to pay its outsourced workshops at a cost per hour of €32 with no increase. Furthermore, it improves future investors’ confidence in the company. The forecast profit for this contract is €0.500 million even if the reduced revenue of €31.747 million, an 8% reduction, is accepted by the government. 6.1.3 Actions to be taken 1. Initial tender at 7.8% reduction of current revenues, resulting in a tender price of €31.815

million which is forecast to achieve a margin of €0.569 million. 2. Perhaps negotiate the reduction, if necessary, to 8% to retain the contract, which is a

revised price of €31.747 million. 3. Try to negotiate at least a 2 year contract at this tender price. 4. Ask the government to agree to a confidentiality clause to ensure the price reduction is kept

confidential. 5. Not allow any “inside information” to affect BVS’s tender price. 6.2 – Customer profitability analysis 6.2.1 Recommendation It is recommended that in principle BVS should try to increase the profitability for all customer categories to be in line with the 5.7% apparently achieved with large fleet customers. Therefore, it is recommended that the cost drivers are reviewed and the “other fixed cost” cost driver, which is currently set at €160 per vehicle, is further broken down into smaller cost types with more specific cost drivers. After further analysis it is recommended that if small fleet size customers are proved to be loss-making, then contracts should be either terminated at contract renewal date or renegotiated at higher revenues. It is also recommended that the cash operating cycle should be speeded up to reduce finance costs and incentives or action taken to get debtor days down. It is recommended that Annika Larsen writes to all small fleet size customers advising that from 1 September, vehicle repairs will not be undertaken or vehicle bookings accepted until outstanding debts over 30 days are settled. The current cash operating cycle averaging 23 days for small customers is net of the average trade payables days of 52 days and is therefore currently 75 days. This is unacceptably long.


6.2.2 Justification BVS should not allow its small fleet size customers to be loss making if the CPA analysis is correct. The BVS management team have an obligation to ensure value for money on behalf of BVS’s shareholders Whilst it is recognised that all customers are making a contribution to overhead costs a review of the ABC cost drivers is required to ensure that they are accurate, especially for the “other fixed costs” category which may need to be broken down further. The rationale is that BVS does not want to lose any customers, particularly considering its planned flotation. Due to the loss-making situation for small fleet customers, it is justified that BVS should negotiate higher prices. BVS would need to be able to justify to its small fleet customers why any increase in prices would be reasonable. In the meantime improved control of debtor days is required to bring the cash operating cycle to zero, i.e. trade debtors should not exceed the average trade payables of 52 days. 6.2.3 Actions to be taken 1. Review of cost drivers, especially the “other fixed costs”. 2. Negotiate higher revenues for small fleet customers when contracts are due for renewal. 3. Chase for earlier payment from trade debtors, especially small fleet customers. 4. Individual customers should be chased for outstanding payment especially when their

vehicles are booked for future work. Perhaps a warning could be given stating that no new work will be undertaken by BVS when trade debtors for small customers exceed a specified level or number of debtor days.

6.3 – Proposal for tyre pressure checking service 6.3.1 Recommendation It is recommended that the proposal to offer a new tyre pressure checking service is accepted but that an extended trial is undertaken in BVS’s home country only. It is further recommended that only 40 to 50 new employees are recruited initially and not the forecast number of 110 employees due to the risk of the unknown number of vehicles that may take this new service. 6.3.2 Justification The proposal for this new service generates a positive NPV of €0.611 million based on a forecast of 12,000 vehicles in Year 1 and growth in vehicle numbers of 30% each year. However, these assumptions are highly subjective and the fixed costs of new employees could result in a breakeven or even a negative NPV if these vehicle numbers prove to be incorrect. Therefore, it is recommended that the proposal should be further trialled before being fully launched and the number of new employees to be recruited should be limited to 40 to 50 employees initially to reduce BVS’s fixed costs. Furthermore, the logistical aspects of the service would need to be trialled further to resolve any operational problems. This proposal could generate much positive publicity for BVS as this service could save its fleet customers both money and reduce carbon emissions. This is a key area of focus for fleet managers now.


6.3.3 Actions to be taken 1. It is recommended that BVS continues to trial the service for a further 6 months that Carmen

Kemp, HR Manager, helps manage the process to recruit 50 or 60 new employees for this new service.

2. It is recommended that Phillip Beck, Sales and Customer Support Director, writes to all of

BVS’s customers to launch the extended trial of this service and assesses the interest from its customers.

3. Customers are offered a free month’s trial for this new service and that BVS monitors fuel

costs by vehicle and demonstrates to customers the savings that can be achieved. 4. Financing for the investment cost of €0.500 million needs to be put in place. Perhaps this

investment is to be funded from cash generated from operations or maybe from a new bank loan.

5. Depending on the number of vehicles that take-up this new service, further employees are

recruited and trained. 6.4 – Flotation plans for BVS 6.4.1 Recommendation It is recommended that BVS try to retain the government contract if possible to maintain investor confidence so that the P/E ratio at listing is as high as possible. It is recommended that the 4 existing shareholders decide whether they wish to buy shares at flotation to gain a majority shareholding. It is further recommended that new loan finance is sought to repay the existing loan which is due for repayment in March 2015. 6.4.2 Justification The forecast share price at a P/E ratio of 5.0 could be as high as €96.88 per share based on an 8% discount being accepted for the renewal of the government contract. At this high price it will cost the existing shareholders around €3.9 million to buy enough shares to gain a majority shareholding. It is possible that the shareholders could secure debt finance to buy these shares but this does hold personal risks for them. However, it allows the current shareholder to control the company and to prevent BVS from a hostile take-over. The current shareholders need to consider acquiring more shares at flotation in order to gain control over BVS and to stop a competitor acquiring the company. It is recommended that the 4 founding Directors be retained in the company, due to their personal skills and their knowledge. It is recommended that funds generated from the flotation are used to acquire some of its competitor’s workshops or for BVS to expand organically to operate more owned workshops and be less reliant on outsourced workshop space. Alternative share prices at flotation for different levels of discount for the Government contract renewal are shown in Appendix 6. 6.4.3 Actions to be taken 1. The 4 existing directors need to decide if they would collectively wish to own more shares to

gain a majority shareholding after flotation.


2. All efforts should be put into winning new business and retaining the government contract in

order to boost the share price at listing. 3. Negotiations with PIE concerning the timing of their exit and what support they may wish to

offer after flotation. 4. Annika Larsen to identify new sources of loan finance for March 2015 when the current loan

is due for repayment. 7.0 Conclusions BVS is a growing business and needs to continue to meet or exceed the agreed 5-year business plan to keep the private equity investor, PIE, satisfied. It is recommended that all efforts are put into trying to retain the government contract and that the tender price should be submitted at the indicated maximum reduction level of 8% lower than current prices. It is important that BVS continues to innovate and meet its customers’ expectations and therefore the tyre pressure checking service proposal should be approved but not on a full scale yet until the demand can be more accurately assessed. BVS should only recruit around 50 more employees at present until the demand is confirmed. The future looks promising for BVS but improved management information and costing is required to ensure that the category of small fleet customers are not loss-making, as shown by the current CPA analysis.


Appendix 1 SWOT analysis

Strengths

Experienced and motivated senior management team following the MBO

High growth experienced

No loss of customers to date

Profitable company

Reputation for high quality of work

Use of PRP to incentivise employees

PIE equity investor and experience it brings to BVS

5-year maintenance agreement for JAR’s fleet

Good support from BVS’s 5 outsourced suppliers

Weaknesses

Customer profitability analysis highlighting loss- making category of small fleet customers

Unauthorised use of BVS managed workshop space

How to manage employee reaction to the use of workshop space for their own vehicles if this was “accepted practice”

Increasing reliance on outsourced suppliers – can they cope with BVS’s expansion and provide the required level of quality work

Dependent on key customers (especially JAR and the government contract)

No dividends paid to date

Opportunities

Proposal for tyre checking service to help customers reduce their vehicles’ fuel consumption

Retaining the government contract

Future listing of BVS

To increase revenues and profitability following the CPA analysis

Threats

Possible loss of major contract for 20,800 government vehicles

Lower level of profits if government contract is retained

Loss of any other existing customers

Competitors

Need to maintain a high quality of service

Higher cost of outsourcing if the government contract is lost

Dependent on outsourced workshops – they could “steal” BVS’s customers

Outsourced workshops' quality of work could affect BVS’s reputation

Note: The above SWOT analysis is detailed for teaching purposes. However, in exam conditions a SWOT containing fewer bullet points, which cover the main issues from the case and the unseen material, is expected.


Appendix 2 PEST analysis

Political/Legal

Increased government legislation on vehicle safety features.

Increased pressure on BVS’s customers to reduce carbon emissions for their fleet vehicles.

Economic

Loss of government contract due to government cost cutting.

Current economic environment putting all companies under pressure to reduce costs.

BVS’s customers try to lower their fleet operating costs.

Need to control wage rates with pressure to keep fixed price servicing costs down.

New service to check tyre pressure to reduce vehicle fuel consumption.

Increased cost of fuel requiring vehicles to perform their best to maximise fuel consumption.

Social

Increased awareness of environmental damage by vehicles and pressure on fleet mangers to reduce carbon emissions.

Employees managing to cope with the expansion of BVS and the number of vehicles that it maintains.

Technological

Use of new technology to help BVS’s customers manage their fleet operating costs (FLIS IT system).

Use of telematic devices to improve driving performance.

Use of telematic devices to locate vehicles to undertake weekly tyre pressure checks.

Use of new technology for fault diagnosis.


Appendix 3

Evaluation of the Government contract

(A) Alternative tenders for contract:

Revenue Revenue Tender Costs Operating

profit Operating profit %

reduction price

€'000 €'000 €'000 €'000 €'000 %

5% 34,507 1,725 32,782 31,246 1,536 4.7%

6% 34,507 2,070 32,437 31,246 1,191 3.7%

7% 34,507 2,415 32,092 31,246 846 2.6%

8% 34,507 2,761 31,746 31,246 500 1.6%

Recommended tender:

7.8%

34,507

2,692

31,815

31,246

569

1.8%

(B) To not re-tender for this contract - impact on BVS operating profit:

€'000

Loss of current operating profit from contract 3,261

Increased hourly cost of outsourced work: Hours

Current 1,390,000

Government contract 216,000

Net hours 1,174,000 €1.00 1,174

Total impact on BVS operating profit each year

4,435

(B) To not re-tender for this contract - impact on BVS workshops utilisation levels:

Average hours at owned workshops per workshop 2,704 24.4%

Total hours available at each workshop per workshop 11,100 Planned utilisation level 91% 10,101

New level of hours utilised without government contract 7,397 66.6%

Therefore without this contract utilisation will fall from 91% to

66.6%


Appendix 3

Evaluation of the Government contract Workings based on the operating profit margin % on current contract: (Note data on Revenue, costs and margin is given in the unseen material)

Revenue

Costs

Operating


€'000 €'000 €'000

Fixed price vehicle servicing 11,086 10,650 436 3.9% Vehicle repairs 11,024 9,811 1,213 11.0% Tyre replacement 12,397 10,785 1,612 13.0%

Total 34,507 31,246 3,261 9.5%

Note: The current margin on “Fixed price vehicle servicing” is only 3.9% which will result in a loss-making element to this contract if revenue is reduced by 5% or more.


Appendix 4

Customer profitability analysis

Per customer

Large fleet customer

2001 + vehicles

Medium fleet

customer

31 – 2000 vehicles

Small fleet customer

30 or fewer

vehicles

€ € €

Revenue 4,906,000 1,253,000 28,000

Contribution % before the following cost items 15.7% 14.6% 14.0%

Contribution before the following cost items:

770,242

182,938

3,920

Customer support 9,000 4,500 300

Billing and administration 12,900 10,320 1,290

Cost of finance 53,227 0 212

Other fixed costs 417,600 107,200 3,040

Total costs 492,727 122,020 4,842

Net profit

277,515

60,918

-922

Net profitability % 5.7% 4.9% -3.3%


Appendix 5 Proposal for tyre pressure checking service

Evaluation of the proposal based on assumptions given:

Year 0 Year 1 Year 2 Year 3

Vehicles Growth at 30% 12,000 15,600 20,280

€'000

€'000

€'000

€'000

Revenue at €300 per vehicle 3,600 4,680 6,084

Cash out flows:

Investment costs -500

Per vehicle per year

Manpower costs €240 -2,900 -3,744 -4,867

Travel costs €30 -360 -468 -608

Net cash flows -500 340 468 609

DR 12% 1.000 0.893 0.797 0.712

DCF -500 304 373 434

NPV 611

Notes: The above figures exclude:

The savings in customers carbon emissions = 320,000 kg per vehicle per year.

The cost of installing telematic devices. (To be incurred by the customer).

The customers fuel savings.

Breakeven point for the proposal:

Year 0 Year 1 Year 2 Year 3

Vehicles Growth at 30% 10,022 13,029 16,937

€'000 €'000 €'000 €'000

Revenue at €300 per vehicle 3,007 3,909 5,081

Cash out flows:

Investment costs -500

Per vehicle per year

Manpower costs €240 -2,900 -3,127 -4,065

Travel costs €30 -301 -391 -508

Net cash flows -500 -194 391 508

DR 12% 1.000 0.893 0.797 0.712

DCF -500 -173 311 362

NPV 0


Appendix 6

Forecast alternative share prices (Based on 8% price reduction for the Government contract)

Calculation of amended post-tax profits for P/E valuation:

With government contract:

Pre-tax change

Post-tax profit

€ million

€ million

Original forecast of post-tax profit

9.70

Less: Original post-tax value of the government contract -3.30 -2.30 Plus: Recommended value of the government contract based on 8% price reduction

0.50

+0.35

Total revised post-tax profit with government contract

7.75

Without government contract:

Pre-tax change

Post-tax profit

€ million

€ million

Original forecast of post-tax profit

9.70

Less: Original post-tax value of the government contract

-3.30

-2.30

Less: Additional cost of outsourcing if government contract not renewed (€1 x 1,174,000 hours)

-1.17

-0.82

Total revised post-tax profit without government contract

6.58

For P/E valuation ONLY post tax profit is relevant

P/E

Post tax profit

Market capitalisation

Number of shares

Forecast share price

€ million € million €

April 2010

5.00

P/E 4.0

4.0

7.75

31.00

400,000

77.50

P/E 5.0

5.0

7.75

38.75

400,000

96.88

Loss of government contract at P/E of 4.0

4.0

6.58

26.32

400,000

65.80


Appendix 6

Forecast alternative share prices (Based on 5%, 6% and 7% price reduction for the Government contract)

Revenue Revenue Tender Costs Operating


Profit after Tax

reduction price

€'000 €'000 €'000 €'000 €'000 % €’000

5% 34,507 1,725 32,782 31,246 1,536 4.7% 1,075

6% 34,507 2,070 32,437 31,246 1,191 3.7% 834

7% 34,507 2,415 32,092 31,246 846 2.6% 592

8% 34,507 2,761 31,746 31,246 500 1.6% 350

P/E valuation at different levels of price reduction for Government contract: At 5% price reduction P/E Forecast share price € 4.0 84.75 5.0 105.95 At 6% price reduction P/E Forecast share price € 4.0 82.34 5.0 102.93 At 7% price reduction P/E Forecast share price € 4.0 79.92 5.0 99.90


Appendix 7

Part (b) – Presentation and graph on the range of share prices for flotation

Share price when company was formed in April 2010 was €5.00 and share price at flotation is forecast to vary between €65.80 and €96.88 per share.

If BVS were to lose the large government contract this would damage business confidence and increase outsourcing costs and this would result in a lower P/E ratio and a lower share price of €65.80 per share.

PIE investor will sell its 60% stake in the company and control will change and some of the existing shareholders may choose to sell their shares and leave the company

External financing will be more accessible when BVS is listed and cheaper, which could help it to expand by acquisition

Recommendation – Maximise profits and try to retain government contract in the short-term to gain maximum confidence in BVS so as to achieve a higher P/E ratio at flotation. This will necessitate trying to retain the government contract, even at a lower level of profitability, based on tendering an 8% price reduction.

BVS - Range of possible share prices at flotation

5.00

77.50

96.88

65.80

0.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

April 2010 P/E 4.0 P/E 5.0 Loss of

government

contract at P/E

of 4.0

Sh

are

pri

ce € p

er

sh

are

End of answer

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