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CIMA Case Analysis
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CIMA Strategic Pre-seen case study May/Sept 2013
ANALYSIS OF T RAILWAYS
PRE-SEEN CASE STUDY FOR STRATEGIC LEVEL
EXAMINATIONS
MAY AND SEPTEMBER 2013
PREPARED BY THE CIMA FACULTY
ACCOUNTANCY SCHOOL
INDEPENDENT COLLEGES DUBLIN
MICHAEL BARRY: LECTURER - F3 FINANCIAL STRATEGY
MICHAEL DONNELLY: LECTURER - P3 PERFORMANCE STRATEGY
ADRIAN SIMS: LECTURER - E3 ENTERPRISE STRATEGY
CIMA Strategic Pre-seen case study May/Sept 2013
Purpose of the Pre-seen case study
CIMA released this Pre-seen case study to students on April 8th, and to tutors on March 7th. The
purpose is to allow for advance preparation for the May 2013 Strategic level exams.
This Pre-seen is used as the basis of the 50 mark, compulsory Question 1 on each of the three
Strategic exams. Each exam will add its own specific additional ‘unseen’ material about T Railways as
a scenario for Question 1, and then set a number of requirements.
The key tasks for you as a candidate are to:
Familiarise yourself with the material in the Pre-seen
Understand the issues faced by T Railways
Identify potential question areas for each of the Strategic examinations you are taking and take
care to ensure you revise the technical material associated with them.
Doing these things properly will improve your chances of success in your exams.
This analysis is written to set you on the right road to that success.
Health warning
Passing the CIMA Strategic level exams requires a full understanding of the syllabus and
comprehensive revision and question practice. Only 50% of the marks are available for questions
involving T Railways. The remaining 50% are for questions unconnected to the subject of the Pre-
seen material. A paper of two halves requires preparation with balance!
This analysis, and the pointers it contains, are not guaranteed. You have to come to your own
understanding of the Pre-seen material, and you must be ready for questions on things not forseen
in this analysis.
Also beware reading around the railway industry too much. The questions will be set about T
Railways, not other rail operators you have researched. Reading around the Strategic subjects is
always a good idea, but don’t waste time learning all there is to know about railways.
CIMA Strategic Pre-seen case study May/Sept 2013
General information on T Railways
T Railways is the state-owned railway of country T. County T is land-locked and has borders with
other countries, ‘some of which’ are Eurozone. T has not itself adopted the Euro.
The country of T and T Railways are both fictitious. The nearest real-world equivalent would be
Czech Republic which is not in the Eurozone, borders Germany, Austria, and Slovakia (Eurozone), but
also borders Poland (not Eurozone). It has a state owned rail company Czech Railways (turnover
€1.6b comparable to T Railways’ €1.29b), and in 2003 ‘unbundled’ its rail company into a federal
structure of 3 subsidiary companies with similar roles to those created at T Railways in 1998.
This suggests that in F3 there could be questions on demerger and flotation, including cash flow
discounting.
We are not told whether T is a member of the European Union, in which case it would be bound by
EU directives that demand a county give open access to its rail networks for other EU operators (ie
EU Directive 91/440 and subsequent directives). The European rail networks are believed to be in
decline but essential to reducing congestion and carbon emissions. This concern has culminated in
the European Commission announcing on 30th January 2013the adoption of a group of measures,
called the Fourth Railway Package. These are an opportunity to firms like T Railways because they
will support the industry but, but they are also a threat because they will increase competition.
Getting a sense of perspective
This Pre-seen case study supports the three Strategic level examinations. It has been written by a
specialist in consultation with the three examiners and is compiled with the syllabuses they examine
in mind.
Looking at aspects of the case from the perspective of these three syllabuses helps us to understand
it and to venture the sorts of issues that might be examined in each Strategic paper.
For example, T Railways is not in the Eurozone but it has lines that go to Eurozone countries. This
gives the examiners of P3 and F3 lots of scope for foreign exchange questions.
T Railways
E3 syllabus
F3 syllabus
P3 syllabus
CIMA Strategic Pre-seen case study May/Sept 2013
The structure and goals of TR
T Railways (TR) comprises the T Railways Board, the holding company, and three subsidiary
companies. Have all stakeholders’ wants and needs been addressed?
Enterprise strategy perspective will note that these subsidiaries are a business portfolio. Each
subsidiary has different degrees of importance and success.
Consider the following table
Division Revenue
T$m
Operating costs T$m
Operating profit T$m
Operating Margin
%
% of group turnover/profit
TCL 680 630 50 7.4 52.7/57.5 TFR 516 494 22 4.3 40.0/25.3 TPTS 95 80 15 15.8 7.4/17.2 Group 1,291 1,204 87 - -
The Property and Track Services subsidiary, TPTS, provides only 7.4% of group revenue but 17.2% of
group operating profits .The rest of its work is charged out to the two remaining divisions on a full
cost recovery basis. It seems to undertake capital projects, but also to run cafes and shops.
The City-Link passenger rail services subsidiary, provides 52.5% of TR’s revenues and 57% of its
operating profits. TCL operates three times as many services as the freight subsidiary but makes only
30% more revenue and 28% more profit than the freight subsidiary. It has operating margins of
7.4%. It seems to have benefitted more from investment funding and as a result most of its services
are electrified, unlike the freight subsidiary which relies mainly on old diesel locomotives.
The Freight Railways (TFR) provides 40% of TR’s revenues and 25% of its profits. is the growth part of
TR, principally due to congestion on T’s roads and concerns over carbon emissions. It made T$22m
profit in 2012, a margin of 4.3% (T$22m/T$516m), the lowest % margin in TR. However it appears to
have suffered under-investment and hence relies on ‘old diesel locomotives’.
Despite the use of a federal structure since 1975, and further delegation in 1998, the ‘strong
bureaucratic culture’ at TR means that T Railways Board retains an important position and has much
influence. Page 6 refers to the possibility that TR may undertake further structural changes and allow
the subsidiaries to operate as ‘completely separate entities’.
Unfortunately, the pre-seen material does not provide sufficient information on cost structure, but
conceivable that Operating Gearing is high (particularly when allocations & apportionments are
taking into account) making operating profit sensitive to changes in revenue.
Performance Strategy perspective will note that page 2 states that the Board undertakes TR’s
corporate governance. TR is not required to abide by things like the UK Corporate Code and, in any
case, there are no details of the composition of the Board and its committees. These may appear in
the unseen material in the P3 exam. But corporate governance means the entire system of
CIMA Strategic Pre-seen case study May/Sept 2013
accountability and control in TR. Page 3 indicates that the Board reports to the Government, and
that it deals with the Rail Regulator. Also it maintains strategic control over the three subsidiaries
through top-down strategic plans. The system of KPIs on page 5 would seem to be the main control
mechanisms. Without benchmarks for KPIs it is not certain that KPIs provide a balanced approach to
Performance Management. This leaves scope for Balanced Scorecard discussion possibly including
regulator and external entity benchmarking.
The P3 examiner might also ask a question on how well the Board could assess the financial
performance of these divisions. TPTS ‘allocated and apportioned’ to TCL and TFR T$762 of network
related costs (T$842m – T$80m). Given that the total operating costs of TCL and TFR were T$1,124 in
2012 this is equivalent to 68% of their costs (T$762m/T$1,124mm) and they seem to have no control
over them. The basis of allocation will significantly affect measures of each division’s financial
performance. If TPTS charges pro-rata to turnover this would disadvantage TFR because, as
mentioned above, TFR generates a high turnover on relatively fewer journeys compared to TCL and
hence presumably uses a lot less track time.
Also TR is a company and has shareholders but it does not seek to maximise shareholder wealth.
This is clear from the ‘break even’ objective, and the fact that it only has to make a return to
investors on a small part of its assets, the long-term borrowings from government which are
equivalent to only 64% of its capital employed (T$1,800m/(T$3,073m-T$273m). TR does not have an
accurate valuation for its non-current assets. This would be typical of all nationalised industries but
must be rectified if T Railways is to join the private sector. Financial objectives would have to be
reviewed if a flotation is on the cards.
This means that it may not be accustomed to using conventional project appraisal techniques such
as NPV in deciding whether to invest in new locomotives, rolling stock or line improvements. It will
simply assess the annual operating profits the investment will make and whether these are sufficient
to cover the 4% interest on any new borrowings. If the project can be paid for from existing cash
than it need only break even to be acceptable. Commercial proxy data likely to be available in the
exam to enable F£ candidates to engineer an appropriate discount rate.
Like many not-for-profit organisations (NPOs) finance is a constraint to TR, not a goal to be
maximised. It seems likely that TR will seek to first ensure that a project breaks even, and then will
use the maximisation of other goals to decide between projects. For example the choice between
investing in new locomotives or line upgrades may be decided on the basis of which leads to the
bigger fall in carbon emissions. VFM Audit ensuring 3Es are satisfied could provide a focus for both
P3 & F3 examiners.
It pursues a Triple Bottom Line
The Triple Bottom Line (TBL) is three P’s: Profits, People, and Planet. Following its ratification by
United Nations and by local government accounting bodies, it has become the dominant approach
to public sector full cost accounting. CIMA may refer to this by its alternative name ‘sustainability’.
CIMA Strategic Pre-seen case study May/Sept 2013
The two strategic objectives of TR on page 4 capture these three goals. They also reveal the potential
for conflicting objectives. Maintaining an uneconomic country line will be good for ‘people’ but poor
for ‘profit’, and whether it is good for ‘planet’ will depend on whether the country service generates
less emissions than would be generated by the cars and trucks used to replace the service. Similarly
the idea, on page 6, to diversify the portfolio by operating other forms of transport would seem to
compromise ‘planet’ in favour of ‘profit’ and perhaps ‘people’.
A Financial Strategy perspective would focus on Profits: TR is required to make a financial return. It
must cover its operating costs and these costs include an amount for interest on the loans it has
received from government. Finance costs were T$72m in 2012 (stated on page 7 and can be
calculated as 4% of T$1,800m of outstanding loans). TR seems to have a history of profitable
operation, having made a profit of T$10m in 2012, taking its retained earnings up to T$900m of
which T$202m is still being held as cash, presumably for future investments.
A query that the Financial Strategy perspective might raise is the adequacy of these funds for TR’s
future capital investment strategy. Its need for greater revenue is mentioned on page 5. How the
importance of profit might increase if TR were to access the alternative forms of funding referred to
on page 4 would also be of interest. The International Liquidity Crisis, albeit easing under stimulants
such as quantitative easing, could limit access. T is already highly geared with more debt leading to
restrictive covenants which may be a concern for management! Joint Venture / PPP / Leasing are
more practical routes if alternative forms of funding have to be suggested by candidates.
The Enterprise Strategy perspective would consider the other two goals of TR.
People: TR is required to benefit the society of Country T. It runs country lines to remote areas, and
runs trains on Sundays across the network. These may not be profitable but they avoid the isolation
of people who wouldn’t have access to other forms of transport. TR makes clear that it sets its goals
and policies after discussion with ‘stakeholder groups’ (page 3) which may be the basis of a question.
It is concerned with the health and safety of its employees, passengers and the general public. It also
plays a part in relieving traffic congestion, but also in improving the country’s productivity and
prospects for ‘sustained economic growth’.
Planet: the Pre-seen focuses on the reduction of carbon emissions by a third by 2015 as a goal and as
a performance measure. Rail transport is the lowest emission method of freight movement, the
worst being air transport followed by road haulage. Yet non-rail methods account for 90% of freight
transport in Country T. Getting more freight on to TFR will help the planet. Within TR there is a need
to reduce carbon emissions. Diesel locomotives emit carbon and electric trains are ‘less harmful to
the environment’. But the Pre-seen tells us that TFR still uses old diesel locomotives, and that TCL
still has a few diesel locomotives, possibly for use on local lines which have not yet been electrified.
The ability of electrification to reduce carbon depends on how the electricity is generated because
railways can be accused of merely pushing much of the pollution back to the power station if it is
found that electricity is generated using fossil fuels. TR should consider the sources of its electricity.
TR is also addressing waste disposal, aiming for 85% of items recycled by 2015.
CIMA Strategic Pre-seen case study May/Sept 2013
The Performance Strategy perspective might focus on the KPIs on page 5 and query whether they
provide the Board with the information and control they need to satisfy the new Rail Regulator that
they are exerting adequate corporate governance. The Pre-seen material tells us the Rail Regulator
will seek to monitor the following areas:
Efficiency of the service
Network safety
User satisfaction
Carbon emissions
Ability to meet future challenges
The relationship of KPIs to the vision outlined by the Chairman of TR, on page 3, and whether more
are needed could also be a question in the Enterprise Strategy examination.
The strategic changes it is considering
Four specific ‘business ideas’ are mentioned on page 6 of the Pre-seen. These are likely to feature in
the May and September exams.
Structural change – running the three subsidiaries as completely separate entities. This would require
an unbundling of the business. It is not clear what sort of responsibility centres this would create and
how they would be evaluated. At the moment they seem to be profit centres but if TR started to
seek to make efficient use of its capital they could become investment centres and evaluates on
ROCE or similar. There would need to be proper valuation of assets, and proper assessment of the
financial benefits and costs of operations as well as the non-financial aspects.
From an Enterprise Strategy perspective the biggest change would be for TPTS which would need to
price and to sell its services to TCL and TFR and would no longer be able to simply cross charge to
recover its costs. This would force it to ensure it could keep its costs below its charges.
This would also reduce the need for the strategic planning presently used. The final paragraph of
page 6 alludes to the danger of excessive fragmentation and it’s clear that a rail network has to have
some co-ordination to function. You should be prepared for a question in E3 about approaches to
strategy and the role of the corporate parent.
This change would also require change management. In E3 be prepared to describe the factors
sustaining the present culture, perhaps using the Cultural Web of Johnson, Whittington and Scholes,
and what steps management should take to change this culture to help the divisions become more
dynamic and efficient.
From a Performance Strategy perspective there would be issues of governance and risk to consider.
The subsidiaries are presently controlled by the Board of T Railways. Giving them responsibility for
their own business raises the issue of what personnel and functions they would need, and whether
they can maintain adequate internal control.
Expansion of the network suggests building new lines, perhaps including ones to serve neighbouring
countries. From a Financial Strategy perspective this might lead to the use of the ‘wider sources of
CIMA Strategic Pre-seen case study May/Sept 2013
finance’ referred to on page 4 and which could be the subject of questions in paper F3. Banks and
commercial investors will require the use of investment appraisal techniques and other assurances,
such as cash flow projections, before they will commit funds and their interest will be solely with
profit, and ability to pay back, and not with planet or people.
Such expansion, particularly internationally, will involve risk from the operating environment in the
neighbouring country, its exchange rate, and returns will be affected by the economic and
competitive environment that TR encounters. These could be examined in E3 or P3.
Diversifying the portfolio through operating other forms of transport – this brings to mind Enterprise
Strategy where business portfolio diversification is usually justified on the grounds that it spread the
risk of investors, or that it enables the firm to escape a declining industry. In the UK, where train
operators are mainly private sector businesses, there are combined bus/coach and train operators
(Stagecoach, Arriva, National Express) and combined aircraft/train operators (Virgin). The Dutch
state-owned railway operator, Nederlandse Spoorwegen, has joined-up with private firms to operate
train services in other countries (eg Serco-Abellio which operates several rail services in the North of
England). Whether these should be considered by TR is questionable. TR doesn’t have external
investors and it is in a growth industry as far as freight services are concerned. It might consider
operating buses within cities, or offer buses to country areas in place of trains.
From an E3 perspective diversification also involves the Ansoff matrix and brings to mind the
question of what TR’s core and distinctive competences are. The UK transport conglomerate
Stagecoach refers to its management expertise and cost control model as the way it adds value to its
decentralised transport businesses in UK and North America. German rail and logistics operator
Deutsche Bahn, owner or Arriva, refers to its logistics expertise and knowledge of the European
transport market as the rationale behind its diversified portfolio.
From a Financial Strategy perspective the raising of funds, and the calculation of an appropriate cost
of capital for such projects, will be of concern. Also the impacts on working capital. But chiefly the
concern will be with the financial implications such as the potential profits and present value of the
projects.
Diversification implies risk to Performance Strategy. In an unfamiliar industry the internal controls of
TR will need to be reviewed for their adequacy. This strategy may also involve acquisitions of existing
operators and so due diligence may be an issue.
Outsourcing or privatising parts of the business could include some of the consumer operations such
as cafes, or it may be entire business functions such as track repair, or IT services.
An Enterprise Strategy perspective would wish to assess the strategic benefits of this, such as
whether it increases TR’s flexibility, improves service and reduces costs due to utilising the
distinctive competences of the partner. Once again there would be issues of change, such as for the
staff transferred from TR to the outsource partner.
A Performance Strategy perspective would focus on the risks involved in outsourcing business-critical
functions. It will require a proper process of scoping the work to be outsources, selection of partner,
CIMA Strategic Pre-seen case study May/Sept 2013
drawing up of SLAs, and the provision of monitoring and enforcement mechanisms. The writer of the
Pre-seen will be well aware that the UK experience of outsourcing has been plagued by shoddy
standards of work and safety, the sudden and tactical bankruptcy of the firms with whom work was
placed, and the need to take some functions back into state control.
From a Financial Strategy perspective the financing of such outsourcing makes a fertile area for
questions. One popular mechanism has been Public-Private Partnerships (sometimes called ‘lend
lease’) where a private partner agrees to build or buy an asset, for example new locomotives, a
station or a new line, and then leases it to the operator at a set rate for a number of years. The
evaluation of these arrangements should be set against evaluations of RT buying the asset
themselves with money borrowed from the Government of Country T.
We hope this analysis has set you thinking about your Strategic Level examinations.
We wish you every success in May 2013.