THE BALANCED SCORECARD AND DIFFERENT BUSINESS MODELS IN THE TEXTILE INDUSTRY - A CASE STUDY PDF

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THE BALANCED SCORECARD AND DIFFERENT BUSINESS MODELS IN THE TEXTILE INDUSTRY – A CASE STUDY Klarissa Lueg, Aarhus University, Denmark Rainer Lueg, Aarhus University, Denmark ABSTRACT This case study is applicable both as an exam question and as a case study for class discussion. It allows for a broa...

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THE BALANCED SCORECARD AND DIFFERENT BUSINESS MODELS IN THE TEXTILE INDUSTRY - A CASE STUDY Klarissa Lueg, Rainer Lueg International Journal of Strategic Management

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THE BALANCED SCORECARD AND DIFFERENT BUSINESS MODELS IN THE TEXTILE INDUSTRY – A CASE STUDY Klarissa Lueg, Aarhus University, Denmark Rainer Lueg, Aarhus University, Denmark

ABSTRACT This case study is applicable both as an exam question and as a case study for class discussion. It allows for a broad discussion of most topics covered in both undergraduate and graduate courses in strategy or management accounting. Due to its breadth, the teacher can easily adjust the required level of sophistication to the prior knowledge of students. Some issues are also of interest to students from entrepreneurship. The case deals with a succession in a family company in the Scandinavian textile industry. It gives an introduction of different, equally profitable strategies and then addresses the topics of business model change, strategic control (Balanced Scorecard), and incentive systems on the level of the family company. The case study enables students to demonstrate a reflective application of their knowledge and encourages them to make feasible suggestions that fit the complex and emotional setting of a succession in a family company. Strategy; business model; management accounting; entrepreneurship; case study; teaching notes; family; succession; Balanced Scorecard; benchmarking; incentives; textile industry; Scandinavia.

1.

BACKGROUND

The Copenhagen+based textile company FRÆSER is a mid+size player in the Scandinavian market which produces clothes (sweaters, pants, dresses, shirts, T+shirts and socks). The company is fully equity financed and has a pre+tax return on sales of 10%. The company was founded in 1930 by the tailor Niels FRÆSER, who passed it on to his only son Knut in 1984. Knut, also a tailor, expanded the business from the Copenhagen area to all of Scandinavia. Under his management, the company grew profitable, expanding full+time employee equivalents from 50 to 500. Now, Knut plans to retire in March 2012 and therefore he wants to hand the company over to his only child Linda, who recently obtained her Bachelor of Science degree in Management. Thereby, she will be the first employee in FRÆSER’s history who holds an academic degree. The family is very proud of their heritage and local roots and clings strongly to them. FRÆSER’s products do not focus on the latest trends in fashion but on a frugal, timeless Scandinavian style, outstanding durability and long life of the garment. This has created a very loyal customer base among middle class families, who appreciate the pricing below high+quality branded products, but who are also willing to pay for the superior quality compared to no+name brands. FRÆSER’s business model differs substantially from most other fashion companies in the industry. The average company designs garments, outsources their production, and then sells the garments to retailers. FRÆSER starts by buying synthetic fibres, yarn and cloth dye. All garments are completely designed and manufactured by FRÆSER in Scandinavia at unionised wages, and there is no outsourcing of any kind. This loyalty to Scandinavian craftsmanship is another major focus of FRÆSER’s marketing. Finally, all products are sold in fully+owned, standardised no+frills retail outlets. These are located close to motorways or main distributor roads around all large and mid+size cities. The trucks in the logistic network are also owned by the company—a contractor does the shipping by sea.

2.

THE TWO STRUCTURES OF THE TEXTILE INDUSTRY

After Knut established himself as the successor of his father in the 1990s, globalization was the most recent buzzword, and many companies in the textile industry began to build global supply chains by outsourcing almost their entire value chain. It was the fad of the decade to strip textile companies to their very core, meaning that they only kept providing a strong brand. Production moved to unrelated suppliers

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to the opening Eastern Europe or the Far East, and the vast majority of final products were sold to independent retailers. Up to today, most textile companies operate this way. However, Knut did not follow this trend with FRÆSER. The business press mocked FRÆSER’s fully integrated value chain as archaic, but was not able to explain the sustained high profitability of FRÆSER. The opinion against integrated supply chains changed drastically with the unprecedented rise of companies like Hennes & Mauritz (H&M) and Zara: their business model built explicitly on integrating the entire supply chain from design to retail, thereby cutting out intermediaries and their shares of the overall profit on the garments. The business press began to understand that—with this business model— companies can make profits which clearly exceed the industry average. Therefore, a recently founded company in Scandinavia—the small subculture brand “yKING” targeting men aged 18+35—has also adopted this business model. Knut was never conscious of this or why FRÆSER was so profitable, but these new arguments made a lot of sense to him.

3.

FRÆSER’S CURRENT STRUCTURE

The structure of FRÆSER’s organization is quite flat (full+time+equivalents of employees are shown in the small boxes in the lower right corner of figure 1).

FIGURE 1: ORGANIZATIONAL STRUCTURE OF FRÆSER

The CEO and his assistants are in charge of planning (which so far Knut has actually done each Sunday evening for the upcoming week), finance (i.e. all long+term investments), human resources and communication. There are two production departments with independent managers: the spinning works where the yarn is transformed into cloth, and the sewing department where the cloth is transformed into garments. There are five support functions with independent heads of department. Three of them are directly integrated into the supply chain: Supply buys the yarn, buttons etc. needed for production. The logistics department is responsible for delivering the garments to the retailers (the scheduling was done by Knut so far). For years, Sally van Dor, the head of retail, has been suggesting that she be responsible for both departments. There have never been any actual problems between logistics and retail, but she thinks she can make the process more efficient. Besides accounting, there is also the department of marketing and design which is in charge of advertising, customers and the product lines.

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4.

BUSINESS MODEL ISSUES

Linda has learned at university that change and globalisation are inevitable. She proposes that at least the production is outsourced to Far East Asia, since their technological standard is supposedly high enough to manufacture high quality garments. In a business meeting with her father Knut, she argued: “When I start here, I want to be taken seriously, not just as your daughter. And I think I should have my own agenda. I understand the advantages of an integrated supply chain, but you have to admit that we are not as good at this as H&M. So why not go for the alternative model that could generate more profits than paying union wages in Denmark?” Moreover, Linda shared some thoughts on the production and distribution of FRÆSER’s products: “Our clothes are so good, why don’t we offer them to a wider range of customers? We are not delivering to any close markets such as the Baltics, Germany, the UK, or the Netherlands. And we don’t have an internet shop. This would also give us economies of scales!” Knut is fiercely against these suggestions and conjectures that there will be lots of pitfalls on the way that they cannot even think of today. The first troubling thought is that FRÆSER loses its Scandinavian footprint and risks driving customers away. Another unacceptable change for him is the likely possibility that—in order to expand—FRÆSER would have to get credit from a bank for the first time in its history. And then—as Knut says—“there’s a money bag telling the FRÆSERs how to make a good cut”. However, quite contrary, he does not object when Linda shares her idea to introduce basic work wear (e.g. lab coats, overalls) as well as women’s underwear and to the market. His preliminary analysis shows that these garments can be manufactured with the existing technology and employee skills, and that he has enough reserves put aside to easily finance this venture. At the same time, a comparison to the main standard catalogues on work wear and standard underwear shows that the contribution margin of work wear would be approximately 25% higher for FRÆSER than the average contribution margin of existing products (there is less than 3% variation among these garments). Women’s underwear could even be about 75% higher. They agree that Linda will take on that project in late 2012.

5.

CONTROL SYSTEM ISSUES

Apart from the business model, Linda also wants to implement a new control system. So far, Knut has focused on the efficiency of operations and has controlled profitability with monthly budgets and daily work schedules. Since Linda thinks that this is not the state of the art, she proposes implementing a Balanced Scorecard (BSC). At first she wants to get input from the department heads on which financial and non+financial figures are most relevant in order to measure the annual success of the company. The fixed targets that each department must achieve will be market+based. Linda wants to hire experienced consultants that benchmark FRÆSER’s operations against companies that make approximately the same revenues in Scandinavia: “The North Face”, “Puma Apparel” and “Lacoste”. Using the traditional four perspectives of the BSC, she will draft a BSC for the company as a whole, and one for each department head. She intends to make each of the seven departments a responsibility centre. To overcome the weaknesses of traditional performance measurements, she wants to cut the basic salary of the department heads by 50% and pay out bonuses instead. These bonuses will be based on Stern Stewart’s Economic Value Added (EVA) method. Linda wants to calculate the historic EVA of the departments over the last 10 years and then set the target bonus in such a way that 95% of the bonus will very likely be achieved by every department head. She will set the upper limit of the bonus at 120%, and she plans that this should be very unlikely to achieve. To be able to calculate each department’s Net Operating Profit after Tax (NOPAT), Linda will introduce a transfer pricing system. The transfer prices will be based on negotiations between the department heads. All of these measures will help her in assessing the performance of the company at the end of the year. Linda is also contemplating what to do if the introduction of new garments (underwear, work wear), with the obviously higher contribution margins, changes the way overhead costs are allocated among the departments. Currently, FRÆSER creates a cost pool for the wages and depreciation of assets for the

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CEO, marketing, accounting, supply, logistics and retail. These overhead costs are then allocated to the products based on the variable costs.

6.

QUESTIONS 1. Linda addresses several issues that relate to a change in the business model of FRÆSER, many of which her father Knut disagrees with. How do you assess Linda’s suggestions? 2. Critically analyze the current management accounting and control system (MACS) of FRÆSER and discuss the implications of Linda’s suggested changes. Make precise suggestions of how FRÆSER should be controlled after Linda becomes the new CEO (you are allowed to make assumptions in case you lack information in the above case description). 3. Comment on the way that Linda intends to implement the BSC. Use the background knowledge you have from the writings of Kaplan & Norton (Atkinson, Kaplan, Matsumura & Young, 2011; Kaplan & Norton, 1992, 1996a, 1996b, 2000, 2001, 2004, 2008). 4. What are crucial issues of Linda’s suggestions for a new incentive system?

7.

TEACHING NOTES

The case has been designed to allow for a broad knowledge+application based on the curriculum. In the case, students can observe several obvious mismatches between the MACS, the business model as well as other critical issues. In the following, we suggest some issues that students could address:

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It is hard to gauge whether FRÆSER could be better off following the usual business model that prescribes outsources. On the one hand, Linda is correct about the high costs of production in Scandinavia, as well as the fact that this business model was an unintended one that did not lead to a similar success as for H&M or Zara. On the other hand, Knut makes very strong arguments against this step. He might want to consider talking to Linda if she really sees this as a necessity, or if it is just her way of starting her own legacy at FRÆSER; the latter could be done in a different and less risky way. The expansion to other markets or to new product lines can be categorized with the 2x2 Ansoff (1965) matrix. Students can discuss succinctly how to combine old products with a new market (FRÆSER in Germany), new products with an old market (women’s underwear in Scandinavia), or new products with a new market (women’s underwear in the UK). Knut seems to favor the new product / old market strategy in any case. He makes a good argument about the loss of managerial discretion if a bank grants a major credit. Linda and Knut can probably find a solution to pick a strategy with relatively low risk out of their possible options that could ideally be financed organically.

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FRÆSER has become too large for Linda to continue doing all the planning on her own like Knut does at the moment. It is an idea to hand over the control of the logistics to Sally van Dor, if she accepts the responsibility of doing the scheduling. Products seem not appear to differ; students should propose some questions to ask: Do activities like setups change? How large are the batch sizes? Will they choose a new production system to cope with potential problems? If products do not differ, the costing system has little relevance. Also, this company does not make bids to buyers since they own the entire value chain, and the pricing is market+based between the No+Names and the high+quality brands. The overhead costs in this company should be small compared to, e.g., service firms given the few employees in FRÆSER’s support functions. Note: the retail outlets have their own margins and do not belong to the normal value chain in the textile production industry.

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That, and given that the products appear similar and there is a low level of education among employees, it is questionable if the company can profit from a new, more complex costing system.

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There is no attempt to link the BSC to strategy, probably because FRÆSER does not have one yet. Since the business model changes by the introduction of new product lines that are not just targeted at families, a change in the mission, vision, and strategy is likely and needs to be addressed. The current approach is simply to gather KPIs. Linda is just asking for KPIs for performance measurement. This does not involve the crucial leading indicators. If Linda wants to use the BSC for decision making, annual information is not useful and has a low quality (e.g., no timeliness, accessibilityw). Knut had a better system with the monthly budgets and production schedules. If Linda sets the targets based on the benchmarking, there will be less gaming. On the other hand, this will create major issues with the buy+in of the department heads. There is no attempt to create action plans or empowerment of the department heads. The BSC requires detailed target setting, for which benchmarking can be an appropriate method. When using benchmarking for target setting, the choice of competitors is crucial. The chosen companies have very different business models. It might be more appropriate to (additionally) look at the companies mentioned with similar structure despite their different sizew whowever, outsourcing benchmarking to consultants has many weaknesses: it is perceived as a one+time project, and there is no buy+in from the department heads who will not accept this approach.

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If there is only a BSC for the company as a whole and for the department heads, the BSC does not cascade down and does hence not affect the actions of the almost 500 other employees. They remain on fixed salaries. Targets are not linked to the four BSC perspectives if EVA is all that matters. Department heads will only focus on this number by cost cutting and milking property. They will disregard all leading, non+financial indicators. If 95% of the bonuses are easily achievable, but 120% are not, department managers will not care about the system when making decisions. Yet, they might get angry that their fixed wages are cut in half—if this is at all possible given the unionization. The EVA compensation breaches the controllability principle. All investment decisions are made by the CEO. Most of the departments can only control costs (=cost centers). Only the retail outlets are able to control revenues (=revenue centers). Therefore, only the CEO has controllability of EVA, and thus only the CEO should be held accountable for it. If the targets are set based on competition, it may be more appropriate to use relative instead of fixed targets to account for unforeseen demand swings in the market. To calculate EVA, Linda understands that she needs a transfer pricing system. It is questionable if she should set all transfer prices based on internal negotiations among department heads since there are external market prices for most products (e.g., it is easy to get a bid of an external supplier for cloth or for logistic services).

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REFERENCES: Ansoff, H. I., Checklist for Competitive and Competence Profiles: Corporate Strategy, McGraw+Hill, New York, NY, 1965. Atkinson, A. A., Kaplan, R. S., Matsumura, E. M., & Young, S. M., Management Accounting, International Edition (6th ed.), Pearson, New Jersey, NJ, 2011. Kaplan, R. S., & Norton, D. P., “The Balanced Scorecard + Measures That Drive Performance”, Harvard Business Review, Vol. 70 (1), 1992, 71+79. +++, The Balanced Scorecard: Translating Strategy into Action, Harvard Business School Press, Boston, MA, 1996a. +++, “Linking the Balanced Scorecard to Strategy”, California Management Review, Vol. 39 (1), 1996b, 53+ 79. +++, The Strategy+Focussed Organization: How Balanced Scorecard Companies Thrive in the New Business Environment, Harvard Business School Press, Boston, MA, 2000. +++, “Transforming the Balanced Scorecard from Performance Measurement to Strategic Management”, Accounting Horizons, Vol. 15 (1), 2001, 87+104. +++, “How Strategy Maps Frame an Organization's Objectives”, Financial Executive, Vol. 20 (2), 2004, 40+ 45. +++, “Mastering the Management System”, Harvard Business Review, Vol. 86 (1), 2008, 62+77. Lueg, R., Value+based Management: Empirical evidence on its determinants and performance effects, WHU Otto Beisheim School of Ma...