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Wooden Post Ltd: Company’s Investment Challenge

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Wooden Post Ltd: Company’s Investment Challenge

Introduction

Behavioural scientists acknowledge that organizational control systems and accounting systems of an organization have significant influence on the human behaviour which in turn predicts the effectiveness of an organization. Managers are faced with numerous decisions that require massive application of strategic analysis and interpretation of the situation. The main emphasis for management is to strategically make decisions that not only create a competitive advantage for the organization in the industry, but also enhance their relevance to the market. This report analyses the strategic investment decision options that are available to Wooden Post Ltd. The report provides a preview of the situation facing the company and analyses the options in addition to providing suitable recommendations based on the present and long-term circumstances of Wooden Post Ltd.

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Summary of organizational issue facing Wooden Post

Wooden Post Limited is a UK-based company that specializes in treated and untreated fence posts, treated gate posts and treated construction frames and timber. It holds a market percentage share of 21.2% and has the UK as its major market though the level of regional share differs with concentration on the Eastern division and its home base in East Midlands. Its main competitor is London Counties that has maintained dominance in supply of timber posts for over 60 years. The establishment and maintenance of cost control systems of high strength and reliability mainly in manufacturing and distribution has lowered costs and prices for Wooden Post in the last ten years thus increasing its growth levels (Brealey & Myers, 1999). Further, this has enabled it to expand its production way beyond the Eastern division that is its home base. The largest percentage of the company’s shares is held by family members although the company aims at enhancing its growth to increase its status to a public limited company within the next two years.

Wooden Post Limited contracted a consultancy firm with the obligation of providing the company with industry analysis. This was to make strategic decisions based on necessary market indicators (Arnold, 1998). The analysis projects a decline in the United Kingdom market growth. The analysts suggested three options that would be viable for strategic placement of Wooden Post on a long-term basis. The options presented are to enable Wooden Post maintain its market share and growth despite the decline in the industry. According to the analysts, these strategies are to provide Wooden Post with the opportunity of capturing greater market share and dominance or exit the market due to the reductions in the sales with reduced market growth. Wooden Post acknowledges that the options are alternatives and subsequent analysis would be prudent to enable decision making to be based on indicators derived from the options.

The first option suggests strengthening its total market share in the UK through acquisition of assets of suitable competitors. This option would not only increase its market share, but also its capacity and value of its distribution channels. Further, the option suggests the consolidation with London Counties which is its main competitor. This option would offer higher cash flows but is associated with high risk (Grundy et al., 1998). The second option suggested by the analysts is based on increasing investment to upgrade the distribution network of Wooden Post in the Western and Eastern regions of UK and also the upgrading of its production capacity to increase market share and regional distribution (Arnold, 1998). This option would be achieved through entering into joint venture relationships with Glens Company that dominates the northern regions and Welshpool plc that is based in the western regions of UK. This option would offer few complications to Wooden Post Limited such as tax burden, legal issues or personnel matters (Flamholtz, 1983). The option would significantly strengthen the competitive advantage and positioning of Wooden Post Limited due to the wider regional distribution. Although the option would have inherent lower risk, the expected value of cash flows would be minimal compared to the first option. The emphasis of this option is more attractive with Welshpool plc due to its strong management and the linkage of its chief executive officer with London Counties (he previously worked at this company) which is the main competitor of Wooden Post. The joint venture with Glen would also be advantageous though there is limited knowledge of the firm apart from its dominance of the Scottish market.

The analysis further provided a third option from the market trend analysis. This option suggests that Wooden Post withdraws and closes facilities in its western UK market. The rationale behind this option is that retreating would be an option due to increased competitive pressure and much investment needed to increase the market share in the declining industry (Brealey & Myers, 1999). The option would involve exploiting the strategic advantage and position of Wooden Post in the East division through increasing its capacity to optimum and then reducing the sales in the West division. This option would cause Wooden Ltd to incur closure costs and lose a market share of about 6% although additional cash would be raised from the process.

The options presented provide much information to Wooden Post Limited but causes confusion to the management on the best possible option to take given the urgency, risks and opportunities presented as well as the predicted trends. There is need to provide more relevant information and indicators through detailed analysis of the options and comparisons between them using relevant indicators. This is to enable Wooden Post Limited to make the best possible decision. This comes at a time when other suppliers in the industry are also seeking future options and quick actions while the political and economic factors provide a favourable and conducive environment for rationalisation of the industry.

Analysis of Available Solutions

The various options available to Wooden Post Ltd act as the strategies for management control and evaluation for the accomplishment of the chosen alternative. Different analysts and scholars provide different models for management to use to ensure effectiveness in its operations through planning and establishing control systems (Brealey & Myers, 1999). Otley and Berry (1980) suggest a cybernetic model of control for management which is routine, based on expert knowledge, intuitive, based on trial-and-error and affected by the political environment. This model together with others developed provides the foundation of analysis of the alternative solutions that are available to Wooden Post Limited.

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Option 1: Acquisition of London Counties

The first option suggests strengthening its total market share in the UK through acquisition of assets of suitable competitors. The analysis suggests that it would be efficient to acquire London Counties which is the main competitor of Wooden Post Limited. This option would be based on the strategies suggested by Potter (1980) of the rivalry among existing firms through competition and the threat of substitute services and products. As Potter (1980) suggests, acquisition of a main competitor would enhance the capacity of Wooden Post Limited. Potter (1980) suggests the competitive advantages that would be applicable to Wooden Post Ltd include: creation and strengthening of its brand image, increased cash flows, lowered costs, increase in the distribution channels available, adoption of better technologies and the overall increased market share which is basically the main objective for the acquisition of London Counties.

London Counties has maintained leadership in the timber supply industry for over 60 years with its established clientele base being in the western part of the UK and its headquarters in London. The company had projections of owning 26% of the market share in UK in the year 2000. In detail, London Counties engages and specialises in treated and untreated fence posts, treated gate posts and treated construction frames and timber which formed the greatest source of its growth in profits especially for the period after the Second World War. The company has maintained the market for timber frames through contracting basis via a Scandinavian firm. The sector of construction of timber and frames over the years has required technological application due to increased requirement for timber treatment for stability against high conditions of drilling and cutting as well as against dampness. London Counties has maintained established links with councils of London area hence in turn has the opportunity to maintain stability of its market for gate posts and fence posts in the London concentrated area.

The acquisition is however faced with challenges in implementation that need to be considered in the project analysis as is required (Arnold, 1998). First, the acquisition is projected to foster the rationalisation process of the office and manufacturing facilities to cater for the process in terms of management and consolidation of the companies. This however would cause the redundancy of staff estimated to be 100. This is likely to negatively affect the image of the company, customer service and employee turn-over due to the uncertainty created by the process (Wilson & Chua, 1993). The process would also lead to the closure of the headquarters of London Counties based in London. This would be detrimental to the company due to the influence of the London area and market stability in the same and would lower the market share in the region (Grundy et al., 1998). Further, it would require the company to incur closure costs yet the headquarters incurred high costs of establishment. The other challenge would be from the segment of construction timber and frames that declined to adopt advanced new technology. This is considered to be causing a decline in the market share for the company. Other aspects that would be expected from the acquisition include tax maters, legal issues, personnel matters, political and economic influences (Flamholtz, 1983).

The consolidation process would positively influence Wooden Post through the positioning of its activities especially in the manufacturing sector facilities and the creation of higher competitive advantage and positioning in the industry (Arnold, 1998). Further, this would allow Wooden Post Limited to spread its fixed costs over a greater sales volume thereby increasing the volume of cash flows to the company (Flamholtz, 1983). Additionally, the consolidation is expected to reduce the number of competitors and hence lower rivalry in the industry which is likely to lower the risks of the market share available to Wooden Post (Potter, 1980). Further, the market dominance of Wooden Post is projected to increase thus causing it to have market leadership and a higher influence over the raw materials prices (Arnold, 1998). In fact the consolidation is projected to increase the market share of Wooden Post to 49%, almost half of the total market share. The investment decision is to be analysed using the net present value (NPV) for effective decision making on whether to carry on with it or not and also for comparison with the other options available (Grundy et al., 1998).

Investment option evaluation using Net Present Value (The cash flows have been adjusted as per the changes expected in exhibit 2).

Year Cash flows in £ Discounting factor with n= no of years rate is 10% Net present value (in £)
1 27,000,000 0.9091 24,545,454.6
2 0 0.8264 0.0
3 7,000,000 0.7513 5,259,203.6
4 7,000,000 0.6830 4,781,094.2
5 7,000,000 0.6209 4,346,449.3
6 10,000,000 0.5645 5,644,739.3
7 10,000,000 0.5132 5,131,581.2
8 10,000,000 0.4665 4,665,073.8
9 10,000,000 0.4241 4,240,976.2
10 10,000,000 0.3855 3,855,432.9

Total NPV                                                                                                                                       62,470,005.1

Less the purchase price (£ 40m) and upgrading costs (£ 20 m)                                        60,000,000.0

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Net Present Value                                                                                                                         2,470,005.1

The option offers a positive value hence would be profitable to engage in (Grundy et al., 1998). However, analysis of the other options will provide a comparison to decide on the best option.

Option 2: Investment in Upgrading WP’s production capacity and distribution network

This second option suggested by the analysts is based on increasing investment to upgrade the distribution network of Wooden Post in the western and eastern regions of UK and also the upgrading of its production capacity to increase market share and regional distribution (Arnold, 1998). In this option, application would be available through entering into joint venture relationships with Glens Company that dominates the northern regions and Welshpool plc that is based in the western regions of UK. Welshpool plc leads in the supply of wooden posts to the building sector in the western region of London but it has limited capacity. It is specialized in the segments of supply of treated fence posts, treated construction timber and frames and treated gate posts with a market share capacity of 8.6%. Glens Company on the other hand has dominance in the Scottish market which is in the northern region. The company specializes in treated and untreated fence posts, treated gate posts and the treated construction timber and frames and holds a market share of 10%.

The project is projected to have various challenges. First as Flamholtz (1983) asserts, the joint venture business types are faced with the challenge of operation and management due to the joint ownership. Welshpool plc, being the most attractive option for joint venture to Wooden Post Limited, has limited capacity which is likely to hinder the production capacities from attaining optimum while it would also lead to increased costs of boosting its capacity (Arnold, 1998). Additionally, the Glen Company that Wooden Post Limited anticipates to engage in joint venture relationship with has an average market share. However, the challenge in this situation would be the fact that Glen Company is not quite well known to Wooden Post Limited which poses the challenges of trust and reliability in the business relationship (Grundy et al., 1998). Further, since the risks inherent in the project are not as much, the project would generate lower cash flows which are challenges since Wooden Post wishes to increase its market share (Wilson & Chua, 1993).

Despite the challenges present, this project would have great benefits and opportunities for Wooden Post. First, since Welshpool plc is established and has strong influence in the western region, it would help Wooden Post Limited to compete with London Counties which is dominated in the same region (Potter, 1980). The chief executive officer of Welshpool plc had previously worked with London Counties, thus would provide Wooden Post the opportunity to overcome the competition (Potter, 1980). Further, the same officer has wide experience and expertise in the application of technology which would provide Wooden Post Ltd opportunities for cost reduction and increased production and cash flows (Grundy et al., 1998). The regional disparity of the three companies is likely to increase their market influence and share due to regional distribution and strategic locations (Arnold, 1998).

Additionally, the joint venture is likely to increase the capacity of Wooden Post by increasing its ability to access funds through Welshpool plc and Glen as well as issuing of shares which would in turn strengthen its competitive advantage significantly (Grundy et al., 1998). Wooden Post Ltd would also be affected in that it would now be able to upgrade the facilities for its Eastern division thus would boost its brand image and increase its capacity (Brealey & Myers, 1999). This may enable Wooden Post to attain the status and capacities of a public limited company. Further, the joint venture is likely to boost the distribution networks of Wooden Post, lower the cost of production and prices and increase its market share and cash flow (Arnold, 1998). The viability of the project is however to be analyzed to evaluate whether it can be undertaken compared with the other two alternative solutions (Grungy et al., 1998).

Investment option evaluation using Net Present Value (The cash flows have been adjusted as per the changes expected in exhibit 2).

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Year Cash flows in £ Discounting rate where n= no of years and the discounting rate of 10% Net Present Value in £
3 15,000,000 0.7513 11,269,722.0
4 15,000,000 0.6830 10,245,201.8
5 15,000,000 0.6209 9,313,819.8
6 15,000,000 0.5645 8,467,108.9
7 15,000,000 0.5132 7,697,371.8
8 15,000,000 0.4665 6,997,610.7
9 15,000,000 0.4241 6,361,464.3
10 15,000,000 0.3855 5,783,149.3

Total Net present value                                                                                                                                                          66,135,448.6

Less initial investment (£50 m) and additional upgrading costs (£ 20 m)                                                                 70,000,000.0

Net Present Value                                                                                                                                                                    (3,864,551.4)

The second option results in a negative net present value meaning that Wooden Post Limited would incur more costs than benefits from the joint venture. This project is therefore not viable and should not be undertaken (Grundy et al., 1998).

Option 3: Withdrawal

This option suggests that Wooden Post Ltd should withdraw and close facilities in its western market in the UK. The rationale behind this option is that retreating would be an option due to increased competitive pressure and the need for more investment to increase the market share in the declining industry (Brealey & Myers, 1999). The challenges presented by this alternative need to be evaluated. First, the differing opinions in management are likely to hinder the effectiveness of its implementation (Otley & Berry, 1980). Additionally, the initial costs incurred in establishing the western distribution zone were significantly high while in consideration Wooden Post would incur more costs in relation to the closure of the firm. Further, exit from the western region would encourage the competitors such as Welshpool plc and London Counties to take over thus limiting the market share for Wooden Post Limited (Potter, 1980). This would increase competition and negatively influence the image of Wooden Post Ltd. Additionally, since the aim is to increase the capacity of the Eastern region, there is a likelihood that this may not work well as expected while the region would be the only one providing the market share for Wooden Post (Arnold, 1998).This has the likelihood of lowering the market share of Wooden Post Limited and thus contradicting the main objective that the project was initiated to achieve, that is, increasing the company’s market share.

The project is however bound to foster benefits for Wooden Post despite the inherent challenges. First, the closure would enable Wooden Post to acquire additional cash which could positively be used to increase its capacity in the other region. Further, this would lower the costs of operations incurred in the western region thus enabling Wooden Post to concentrate on its Eastern region to boost capacity (Grundy et al., 1998). The closure of the western firm is also likely to positively influence the cash flows of Wooden Post, provide the opportunity for securing future loans as well as increase the returns on investment (Grundy et al., 1998). However, the analysis of the project has to be done to ascertain whether it is viable through the use of the net present value basis for evaluation of investment appraisal projects. The option will then be compared to the other two alternative solutions to determine the best option to take (Grundy et al., 1998). The viability evaluation will be done for the cash to be received on closure while considering the closure costs.

Investment option evaluation using Net Present Value (The cash flows have been adjusted as per the changes expected in exhibit 2).

Year Cash flows expected on closure in £ Discounting rate of 10% where n=no of years Net Present Value in £
1 10,333,333.3 0.9091 9,393,939.4
2 10,333,333.3 0.8264 8,539,944.9
3 10,333,333.3 0.7513 7,763,586.3

Total net present value                                                                                                                                                  25,697,470.6

Less investment in the western region                                                                                                                       50,000,000.0

Net present value                                                                                                                                                            (24,302,529.4)

This third alternative also gives a negative net present value meaning that Wooden Post Limited would incur more costs in the closure of its western region than benefits accruing from the additional cash from the same. Thus, this project cannot be undertaken.

Recommendations

The investment project to be undertaken has to provide more benefits to Wooden Post Limited than the costs incurred from the same. This is presented by a positive net present value. A negative net present value implies that the project under consideration is to cause additional costs to Wooden Post Ltd while the benefits to be derived from the same are lower than the costs (Grundy et al., 1998). Project 2 and 3 are likely to result in higher costs than benefits for Wooden Posts limited. The only viable and recommendable project in this case is Project 1 which is the acquisition of London Counties.

Conclusion

The report has evaluated and analysed the investment projects that are available to Wooden Post Limited. This has been based on the industry analysis that suggests the likelihood through prediction and projections of a decline in the growth of the United Kingdom market. The report has analysed the projects in detail and has carried out the appraisal of the investment options using the net present value technique. The analysis has shown that the only solution that would be most viable for Wooden Post Ltd. is the acquisition of London Counties.

Reference List

Arnold, G., 1998. Corporate financial management. London: FT Pitman Publishing.

Brealey, R.A. & Myers, S.C., 1999. Principles of corporate finance. New York: McGraw-Hill.

Flamholtz, E., 1983. Accounting, budgeting & control systems in their organizational context: Theoretical and empirical perspectives. Accounting, Organization & Society, 8(2), pp.153-169.

Grundy, T. Johnson, G. & Scholes, K., 1998. Exploring strategic financial management. London: FT Prentice Hall.

Otley, D.T. & Berry, A.J., 1980. Control, organizations and accounting. Accounting, Organization and Society, 5(4), pp.431-428.

Potter, M.E., 1980. Competitive strategy: Techniques for analyzing industries and competitors. New York: Free Press.

Wilson, R.M. & Chua, W.F., 1993. Managerial Accounting: Method and Meaning. 2nd ed. London: Chapman and Hall.

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