L’OREAL

Aurélien FATTORE - Pieter HOFSTRA Kenza OUAZZANI - Carsten SIEBERT

1- Value Chain and Organization2- General data3- Cost estimation and allocation4- Activity-Based Costing5- Cost-Volume-Profit Model6- Investment analysis

1- Value chain and organization

R & D Design Supply Marketing Production Distribution Customer

service

Creating new formulas

Determined by segment

ReceivingRaw materials and packaging

Core Process

B2B & B2C30,1% of Sales

Each plant produces for its geographical area

2- General data: from the Income Statement…

Consolidated Income Statement

200615,790.1 -4,569.1

11,221.0 -4,783.0-3,309.4-532.52,540.9-60.8

200514,532.5 -4,347.3

10,185.2 -4,367.2-3,009.3-496.22,266.0

9.3

In Million €

Net Sales Cost of salesGross Profit Distribution Costs Admin. Expenses R & DOperating profit Other Inc/Expens.

Product Cost

Period Cost

…to some examples of costs

Direct Costs :

Direct Labor: machine and quality control workers

Direct Material: raw materials, packages

Manufacturing Overhead Costs:

Indirect Labor: plastic purchase manager (packaging)

Indirect Material: power supply for whole plant

Cost Hierarchy:

Unit Level: cream

Batch Level: packaging for delivery

Product Level: composition of the cream

Customer Level: key account managers

Facility Level: building, accounting activities

3- Cost estimation and allocation

• Appropriated Product-Costing Systems:Process costing: relevant for making the mixture; we consider equivalent units of mixture to

evaluate the costs.

Job costing: appropriated for packaging

• Appropriated cost allocation:ABC: within jobs and processes, in order to get inside view of costs

4- Activity Based Costing

Steps to take for Activity Based Costing

1) Identifying the major activities that take place in an organization;2) Assigning costs to cost pools/ cost centers for each activity;3) Determining the cost driver for each major activity.4) Assigning the cost of activities to products according to the product’sdemand for activities

We used this approach for L’Oréal for a plant with two main products.All costs in the next slide are estimated.

4- Activity Based Costing (2)Activity Activity costs Activity cost driver Quantity of activity cost driver Acitivity cost driver rate

Production activities        

Machining: activity centre X 700000000 Number of machine hours 500000000 1,4

Machining: activity centre Y 800000000 Number of machine hours 600000000 1,333333333

Mixing fluids X 4000000 Number of machine hours 2000000 2

Mixing fluids Y 5500000 Number of mixing hours 2500000 2,2

Materials procurement activities        

Purchasing raw material 100000000 Number of purchase orders 1000000 100

Receiving raw material 60000000 Number of materal receipts 500000 120

Disburse materials 20000000 Number of production runs 300000 66,66666667

R&D activities        

Analysing Fluids 20000000 Number of research hours 250000 80

Experimenting Fluids 15000000 Number of experimenting hours 300000 50

Testing Fluids (before production) 6000000 Number of test hours 150000 40

Marketing activities        

Advertisement 25000000 Number of advertisements 50000 500

Commercials 130000000 Number of commercial minutes 10000 13000

Promotion (shows, etc.) 10000000 Number of promotional hours 10000 1000

General factory support activities        

Production scheduling 200000000 Number of production runs 400000 500

Set-up machines 70000000 Number of set-up hours 2000000 35

Quality inspection 60000000 Number of first item inspections 300000 200

5- Cost-Volume-Profit model

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Administration Costs

Marketing & Promotion Costs

R & D Costs

Estimated Fixed Costs

Operating profit = 2482,6 Mil €

Variable and total costs

Revenues

Due to very high fixed costs in the R&D, advertising and administration division the volume must be high in order to make a profit.

Increasing the volume was one major reason for the increase of the operating profit by 9,6% in 2006!

Total revenues = 15355,1 Mil €

Total costs = 12872,5 Mil €

6- Investment analysis & Capital budgeting decision

• In 2006, L’Oréal announced it would buy « The Body Shop » company for two main strategic reasons:

- strengthening the distribution network

- obtaining a more ‘ethical’ image.

Some days before L’Oréal made this announcement, The Body Shop published its annual results:

Data available for the Capital Budgeting Decision 1 £ =1,43€

The Body Shop Company Results 2006 (before acquisition by L'Oréal) in M£ in M€Sales 485,8 694,69- Cost of Sales 167,3 239,24= Gross profit 318,5 455,46R&D official detail unavailableMarketing and promotion official detail unavailableAdministration official detail unavailable

Operating Profit 41,5 59,35+ Depreciation 15 21,45+ Other adjustments 1,5 2,15= Cash Flow from operations 58 82,94TOTAL CASH AND CASH EQUIVALENTS 53,8 76,93

6- Investment analysis & Capital budgetingInvestment analysis according to the Net Present Value Technique (M€)

AssumptionsAnnual Cash Flow 'CF' 76,93Discount Rate 'r' 10%Annual Growth (expected) 'g' 3%

ResultsPresent Value in perpetuity (if the company is owned forever) 1099Maximum amount of money L'Oreal should be willing to pay 1099Investment actually realized to buy the shares 940Net Present Value > 0 159

The investment is profitable. Moreover, L’Oréal wants to strengthen ‘The Body Shop’ results. What does L’Oréal expect, in addition to strategic plans ?

Most competitors of ‘The Body Shop Company’ have margins twice more important. L’Oréal expects to improve the margin of ‘The Body Shop’, thanks to synergies in production (gains in the value chain), marketing and overheads.

Sales 435Gross profit 154,7Cash Flow (converted into a annual value) 100Reminding : NPV calculated with the Body Shop usual cash-flows 159,0571429NPV calculated with Cash Flow 2006 488,57143

First results, one semester after L'Oréal bought 'The Body Shop Company'

PresentValueInPerpetuity PV

CF1 r

CF(1 g)(1 r)2

CF(1 g)2

(1 r)3 ...

CF

r g(GordonFormula)

ANY QUESTION ?