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7/30/2019 Strategic-pre-seen-May-2013-BPP-analysis.pdf
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Exam focus BPP analysis of the pre-seen case study for the
May 2013 and September 2013 strategic level exams
BPP subject specialists David Culley, Doug Haste and Steve Whittenbury analyse the pre-seencase study for the May 2013 & September 2013 Strategic level exams from the viewpoint of eachof the three papers (E3, F3, P3).
This article outlines the purpose of the pre-seen case study before going on to examine some
aspects of the rail transport sector in Europe and how these could be applied to the forthcoming
Strategic level exams.
Purpose of the pre-seen
CIMA does not
The latest pre-seen
expect students to spend significant amounts of time researching the industry
described in the pre-seen; this can wait until you get to T4 and even there it is of limited value.
CIMAs intention is that by giving you a pre-seen case study, no candidate is put at an advantage
or disadvantage by their level of familiarity with the industry involved. All candidates now have
time to ensure that they have a basic understanding of the main issues involved in the case study
before walking into the exam.
In the latest pre-seen we are provided with details of T Railways a government owned company
based in country T, a fictional European country outside the Eurozone. T Railways offers 3 types
of service passenger rail services (TCL), freight services (TFR) and other infrastructure related
services (TPTS). The possible privatisation of T Railways continues to be discussed within
Government.
The European rail industry is in the process of significant transition at present. To help familiarise
you with some of the main issues in this sector we will examine how three significant operators
have managed, or in some cases mis-managed, a range of financial (F3), risk (P3) and strategic
(E3) issues.
Example 1 - Deutsche Bahn (DB)
Deutsche Bahn (DB), like T Railways, is 100% government owned. DB is a much larger companythan T Railways (5,700 stations, revenue over EUR 30 billion).
DB has been investing heavily to create a strong international business, to take advantage of
increasing liberalisation in the European transport market. This increasing liberalisation is partly
being driven by increased pressures on public sector finances across Europe, which have
resulted in widespread moves to sell-off public sector transport services.
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In 2010 DB acquired Arriva (a UK based company running bus and rail services in 12 European
countries) for 1.5 billion. This acquisition is intended to position DB as one of Europes leading
passenger transport groups, and has created Europes largest rail and bus company.
Arriva accepted a cash bid from DB in preference to a paper bid that was being negotiated with
the French company SNCF. The price paid valued Arriva at a multiple of 16 times its 2010
earnings (i.e. a P/E ratio of 16)i, and represented a 34% premium on Arrivas share price beforethe bid was announced.
ii
The European Commissions anti-trust agency has insisted that DB sell Arrivas German train and
bus activities in Germany, which amount to approximately 5% market share, to avoid building
DBs monopoly power in its domestic market.
Since this acquisition, DBs international operations are being organised within the Arriva brand,
with its headquarters remaining in Sunderland, UK. DB has further ambitions to grow by bidding
for train franchises in the UK and through a series of small acquisitions in Europe. Arrivas chief
executive David Martin, predicts a wave of consolidation in the European rail sector as
companies seek economies of scale. There will be three to four big transport groups in Europe in
the next 10 years and Deutsche Bahn will be one of them.iii
DB is also the largest rail freight company in Europe. Here, again, it has a number of overseas
operations including EWS (purchased for 280m in 2007) in the UK and a joint venture with
Russian railways (RZD) to operate freight trains between Germany and China via Russia.
In 2008 privatisation of DB was considered, which would have resulted in the state still
maintaining control of DB with a 51% stake. This was postponed due to the state of the financial
markets at the time, but DBs structure (http://www.deutschebahn.com/en/group/business_units/ )
has been re-organised into 10 separate business units. This will make it easier to sell off parts of
the business if partial privatisation proceeds in the future. One notable aspect of this structure is
the distinction between long-distance passenger trains (DB Bahn long distance) and short-
distance regional transport (DB Bahn regional). This is a structure that might be considered by TRailways if it is considered that these business activities would benefit from dedicated
management teams.
Example 2 Swiss Federal Railways (SBB)
SBB, another company that is 100% government owned, is closer in size to T Railways but is still
much larger, with over 4 times the number of stations and over 6 times the turnover.
SBB has been investing heavily to improve the quality of its rail services. For its domestic
services, this has involved building new lines to shorten the travel distances between major cities
(and to create parts of the rail network where high speed trains are not slowed by slower local
trains sharing the track). To increase passenger capacity, double-decker carriages have beenintroduced.
For its international routes SBB has invested in improving its links to the networks of adjoining
countries via its construction of two new major alpine tunnels, including the Gotthard Base tunnel,
which will become the worlds longest railway line and will reduce travel time between Zurich &
Milan from 4 hours to 2.5 hours when it opens in 2017. These investments are also designed to
reduce the amount of road freight travelling through Switzerland.
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In 2012 SBB invested EUR 200 million in 8 new high-speed Italian Pendolino tilting trains, which
will double the size of its high-speed fleet when these are delivered in 2015. The new trains are
95% recyclable, will reduce energy consumption by 8%, and are much quieter and more
comfortable (even at maximum tilt!). High speed trains also require a quicker, more reliable,
signalling system with wireless transmission of information to a display device in drivers cabs.
Recently SBB has been attacked for the implementation of a new system whereby ticket sales ontrains have been abolished
iv
been unable to validate their tickets with a date stamp because the ticket machine is out
of order, or
. E-tickets can be purchased or tickets can be purchased from the
ticket machine at the rail station. Problems have arisen, however, because ticket inspectors have
zealously imposed heavy fines on passengers who have:
purchased more than one e-ticket (the maximum is one e-ticket per person)
purchased an e-ticket via their mobile phone because the ticket machine is out of order,
but the payment from the credit card company has arrived minutes after the train has left
the station
SBB makes over 1 million a month from fines.
Example 3 SNCF (French National Railway Corporation)
SNCFs experience illustrates one of the risks of creating a high speed rail network. This has led
to SNCF building up large debts which, in turn, has led to criticism that local lines have been
starved of even basic funds for routine maintenance.
On the positive side, SNCFs TGV system boasts an impeccable safety record. After 30 years it
has never had a fatal accident. SNCF has also dramatically cut CO2 emissions by using more
electricity from non-fossil sources.
The full text of the pre-seen can be found atwww.cimaglobal.com/strategicpreseen. Youwill need to read this in full before reading the remainder of this article.
Understanding the main issues from an E3 Enterprise Strategy Exam perspective
Although you may be surprised to see a nationalised company in the pre-seen, it is not withoutprecedent the pre-seen for the Specimen paper contained a recently privatised utility company.From an E3 perspective, the main consideration is the impact on strategic objectives.
Strategic ob jectives
T Railways has four objectives two strategic and two financial. As a nationalised organisation,there is no objective to maximise profit instead, the drive is towards maximising efficiency (you
might also want to add economy and effectiveness?). It is vital to keep this at the front of yourmind when appraising possible courses of action.The governments fundamental aim is to achieve economic growth by reducing congestion on itsroads. This could conflict with the financial objective it set T Railways to cover its operating costsfrom its revenue. The examiner often expects students to go beyond the numerical analysis, sobe ready to assess a proposal from both quantitative and qualitative perspectives.
Key Performance Indicators (KPIs)
http://www.cimaglobal.com/strategicpreseenhttp://www.cimaglobal.com/strategicpreseenhttp://www.cimaglobal.com/strategicpreseen7/30/2019 Strategic-pre-seen-May-2013-BPP-analysis.pdf
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The objectives have been broken down into a number of KPIs using a traditional accounting-ledapproach to strategic planning. It may be that the financial / non-financial debate could beextended into the setting of KPIs, with the Balanced Scorecard or Performance Pyramid beingobvious tools to use.
It is very difficult to critically appraise the KPIs given in the pre-seen as they are only examples,and not a full list. The examiner has previously examined the relationship between KPIs andCSFs, so make sure you are happy about the difference between them and how they both relateto strategic objectives.
Development opportunities
The pre-seen concludes with four development opportunities that could all link in to E3.
The three subsidiaries may be expected to be more independently accountable. There arecurrently T$842 million of TPTS costs apportioned to TCL and TFR separating out the threecompanies is likely to result in more scrutiny of this cost. Be ready to do some basic transferpricing calculations but, just as importantly, make sure you can discuss the various options
available.
Structural changes
Given the lack of competition and extensive coverage (including lines to remote locations),expansion opportunities appear somewhat limited. Potential projects could include improving thelines (see plans for high speed rail links in England to identify a range of stakeholders) or takingadvantage of overseas opportunities.
Expansion of the network
The most obvious diversification would be the nationalisation of the bus network, althoughsynergies with T Railways would need to be considered carefully. The examples above,particularly Deutsche Bahn, highlight some of the themes that could emerge.
Diversifying the portfolio
Any part of the network could be outsourced, with the UK approach demonstrating just how manydifferent companies can be involved in providing a train service. If TPTS services wereoutsourced (consider Network Rail), there could be an interesting debate about the levels ofservice, prices and liabilities. For example, how would TCL feel if it failed to meet its customercomplaints KPI due to poor track maintenance by the outsource provider?
Outsourcing parts of the business
This policy seems to be treated in a lukewarm manner in the pre-seen, but it is an issue that isexplicitly highlighted and therefore cannot be overlooked. While its unlikely that T Railways willhave been privatised by the time of the exam, the government could easily request a reportasking you to clarify the strategic implications of privatising some or all of the network.
Privatisation
Conclusion
If your initial reaction was to think that the rug had been pulled from under your feet with this pre-seen, I hope that the analysis above demonstrates that you can still rely on exactly the sameskills and technical knowledge you have built up through your studies. Remember that you arenot expected to be an expert on the rail industry or nationalisation, as long as you remember toconsider the broad implications of these issues as explained in the pre-seen.
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Understanding the main issues from an F3 Financial Strategy Exam perspective
From appendix 1 of the Pre-seen, T Railways, although reliant on government debt finance,appears to be successful in terms of achieving its financial objective of covering its operatingcosts:
2012
ROCE
Workings
net operating profit(equity +long-term borrowings)
3.1% T$87m / (T$1,000m +T$1,800m)
Gearing
(long term debt + equity)long-term debt
64.3% T$1,800m / (T$1,000m +T$1,800m)
Operating profit marginOperating profit / sales
6.7% T$ 87m / T$1,291m
However, we are also told that T Railways has the objective of providing value for money. We arenot given a complete picture of how this could be measured, and therefore we cannot fullyevaluate T Railways performance. Possible value for money measures include:
Economy - cost per station, cost per unit of energy purchased (or any other input cost), averageticket prices (this could be considered a measure of a economy from the customers perspective)
Efficiency - train kilometres per T$ of operating expenses, operating profit
Effectiveness - success in achieving objectives, e.g. CO2 emissions, timeliness and utilisation(for freight) and customer satisfaction (for rail), no. of accidents per train kilometre
From the above we can see that there are a number of potential issues that could be developedin the Unseen. These include:
Investment appraisal, this could include analysis of:
- a new initiative such as a move into the bus market, or re-development of its stationfacilities
- further investment in new electric freight trains
- expansion of the rail operations (new high speed trains, double-decker trains, newroutes)
Financing issues, this could potentially cover:
- obtaining suitable finance to support its expansion, recognising the desire of TRailways to reduce its reliance on government lending
- this could include consideration of whether to lease or buy new assets
Valuation of T Railways:
- either as part of a question on a proposed stock market listing, or
- an evaluation of a takeover bid for T Railways
Other valuation issues:
- T Railways could be considering the acquisition of a rival firm, either within or outsideCountry T
Impact of any of the above on Ts key financial objectives:
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- Covering its operating costs
- Achieving good value for money
- In this context cost reduction proposals may be discussed. The experience of the UK
may be relevant here. In the 1960s the Beeching report in the UK led to the closure
of about a third of the rail network, by focussing on branch lines that had low usage
levels. This closure program is generally regarded as having gone too far because it
ignored the impact that these lines had on providing passenger traffic to the overall
railway network.
Finally, because T Railways is an unlisted company you may be asked to calculate its cost ofequity (or the cost of equity of any of its subsidiaries) by taking the beta factor of a quotedcompany (which would be given) and adjusting for differences in gearing.
Understanding the main issues from a P3 Performance Strategy Exam perspective
When looking at any P3 scenario, we often start by considering the risks that are present and
what controls could be used to mitigate them fortunately in the case of T Railways, these are
plentiful and accessible.
Operational i ssues
T Railways operates a series of services using a blend of vehicles, premises and staff, some of
which could be classed as hazardous, especially when considering locomotives and rolling stock.
SNCFs record of 30 years with no fatalities in a similar environment surely says more about its
safety controls than the lack of risk, so we could expect to see something more about the
inherently risky nature of running these services. Specific examples could be:
Customer and employee safety and security while on board trains and on the platform
The safety of track-side maintenance crews
The impact of adverse weather conditions or peak travelling conditions
The security of freight travelling on the network
Security track-side in general trespassing on the line can cause accidents and delays
Impact of over-crowding
In all these cases, controls need to be designed, implemented and maintained while the service is
provided to paying customers. Such controls need to consider issues such as:
The use of signalling technology. The Pre-seen does not provide details of such signals.In some countries they still operate using electrical wires and pulleys that have not
changed in over a century this is surely an area of improvement that the Unseen could
expand.
Controls over expenses and revenues ticketing was mentioned earlier on SBB but even
an e-ticket needs to be reconciled and audited. The Pre-seen points towards costs
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allocated across both TCL and TFR from TPTS which look arbitrary at best so its worth
considering now how management accounting controls and audit could appear here.
Other controls are required that P3 could test scheduling of services, timetable and
staff shift systems, value for money studies on less-profitable routes, information
provision for staff and customers, contingency planning for bad weather. As we also saw
with E3, the use of suitable key performance indicators for any of the subsidiarycompanies must surely be an area where theory could be tested further.
Regulatory issues
The nationalised nature of T Railways ownership and governance is also an area worth exploring
in more detail. If the company is to become more financially self-sufficient, it must consider who
would invest in it and why. There is undoubtedly money to be made in providing rail services as
long as value for money can be secured, but at the moment visibility of all this is very limited and
dependent on Country Ts Government. Should the Government decide to raise funds from either
full or partial privatisation, governance structures promising greater transparency and
accountability (within an environmentally sound agenda lets not forget) would be required to
tempt investors into putting their money on the line (quite literally).
P3 is comfortable here, not only when considering the non-corporate governance systems that
might replace the bureaucratic regulatory structures which are currently in place, but also when
considering potential exposure to new markets for resources including capital, both from within
Country T and without, thus satisfying some of the financial risk elements we are bound to see as
well. Other possible financial risks arise from the fact that T Railways operates beyond Country
Ts borders and thus receives revenues in other currencies. It may also face other risks, for
example regulatory interference, from its international operations or economic risk from overseas
pressure on its home currency, the T$.
Change issues
The issues raised by both E3 and F3 have focused on where T Railways goes next and P3 is no
different whether that is expansion, fragmentation or even innovation, the company must
consider the risks that such changes might pose and how it should deal with them. As already
stated, the current governance structure is built on a very traditional bureaucracy that serves the
public interest only, so before any change can happen, this culture and its agents both need to
evolve. One thing is for sure though you will need to be familiar with all parts of the P3 syllabus
in order to apply them to an organisation like T Railways that is surely poised for fundamental
change.
Conclusion
To conclude, while consideration of the Pre-seen is an important activity, students must
remember that it forms just one dimension of exam preparation and should not be over-
emphasised at the cost of question practice and other exam preparation.
Good luck in your exams!
David Culley, Doug Haste and Steve Whittenbury are subject specialists working at BPP.
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iReuters Deutsche Bahn seal Arriva buy April 22 2010
iiRailway Gazette 22 April 2010 DB confirms Arriva bid
iiiQuoted in the Financial Times April 19 2011 Deutsche Bahn Arriva eyes 2 bn spending spree
ivBBC News 4 Feb 2013 Swiss love affair with rail turns sour
Further resources
http://www.deutschebahn.com
http://www.sbb.ch
http://www.railwaygazette.com/news/freight.html
http://www.networkrail.co.uk/
http://www.deutschebahn.com/http://www.sbb.ch/http://www.railwaygazette.com/news/freight.htmlhttp://www.railwaygazette.com/news/freight.htmlhttp://www.networkrail.co.uk/http://www.networkrail.co.uk/http://www.railwaygazette.com/news/freight.htmlhttp://www.sbb.ch/http://www.deutschebahn.com/