T4 Sept 2011 Answers

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The Chartered Institute of Management Accountants 2012 Page No: 1

T4- Part B Case Study

Papy Sustainable trading case September 2011

REPORTTo: Chief Executive of Papy

From: Management Accountant

Date: 31 August 2011

Review of issues facing PapyContents

1.0 Introduction2.0 Terms of reference3.0 Prioritisation of the issues facing Papy4.0 Discussion of the issues facing Papy5.0 Ethical issues and recommendations on ethical issues6.0 Recommendations7.0 Conclusions

Appendices

Appendix 1 SWOT analysisAppendix 2 PEST analysisAppendix 3 Carbon emission targetsAppendix 4 Savings in carbon emissions from the solar panels proposalAppendix 5 Evaluation of proposal for new freezer cabinetsAppendix 6 Summary of savings in carbon emissions and comparison to targetsAppendix 7 Comparison of capital costs and carbon emissions savings between the 2

proposalsAppendix 8 Part (b) - Presentation and graph on proposals to reduce carbon emissions

1.0 Introduction

Papy is a large food retailer with over 1,100 stores across 8 European countries. A new ChiefExecutive, Lucas Meyer, has recently been appointed and he would like to change Papy inorder for the company to become a more sustainable retailer. A small team has beenestablished, headed up by Arif Karp, the newly appointed Corporate Affairs Director, to identify

and implement proposals to reduce carbon emissions. This team is also tasked with bringingabout change within the company.

2.0 Terms of reference

I am the Management Accountant appointed to write a report to Lucas Meyer, Chief Executive ofPapy supermarket chain which prioritises, analyses and evaluates the issues facing Papy andmakes appropriate recommendations.

I have also been asked to prepare a presentation on the savings in carbon emissions that couldbe achieved by the proposals to replace the freezer cabinets at 500 stores and install solarpanels at 200 supermarkets, together with a graph showing Papys carbon emissions asmeasured by carbon emissions in kilograms (kg) per square metre of sales area. This is

included in Appendix 8 to this report.


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3.0 Prioritisation of the issues facing Papy

3.1 Top priority Management of change

The top priority is the need to manage the change in Papy in order for it to become a moresustainable retailer and to meet the new targets for carbon emissions If Papy is serious about

becoming more sustainable then there is a need to change the culture of the company.Changing a companys culture takes time but the process needs to be started. Papy currentlyrewards its employees with free shares based on a range of financial targets but this will need tochange to include a wider range of measures including Papys level of carbon emissions.

3.2 Second priority Carbon emission targets

This is considered to be the second priority as the Chief Executive wants to make substantialreductions in carbon emissions by investing in new technology, such as solar panels and freezercabinets, in order to achieve these carbon emission reductions. The targets cannot be achievedwithout investing in new initiatives. Papys current levels of carbon emissions are higher than all3 of its direct competitors and therefore its competitive advantage will be reduced unless actionis taken.

3.3 Third priority Solar panels

This large scale investment at 200 supermarket stores will reduce electricity usage, bygenerating up to 30% of these stores current electricity needs by the solar panels on the roof ofeach store. This is a large investment for 200 supermarket stores at a capital cost of 3 millioneach. This proposal represents a total investment of 600 million which is a very significantinvestment. However, it would clearly show to all stakeholders that Papy is serious aboutreducing its carbon emissions. The project will also generate significant operating cost savings.However, an investment of this size would significantly increase Papys gearing.

3.4 Fourth priority Freezer cabinets

The fourth priority is considered to be the proposal to change the freezer cabinets at 500 storesin order to bring about energy savings and reductions in carbon emissions. The total capitalexpenditure is 85 million. This is still a large investment, but much less significant than theproposed investment in solar panels. This investment would affect 500 stores in total and wouldalso result in a one-off write off against the current years profits of 25.0 million for the oldfreezer cabinets.

A SWOT analysis summarising the strengths, weaknesses, opportunities and threats facingPapy is shown in Appendix 1.

A PEST analysis is shown in Appendix 2.

4.0 Discussion of the issues facing Papy

4.1 Overview

Papy operates a successful and profitable chain of supermarkets, which generated revenues forthe year ended 31 December 2010 of almost 13 billion. The profit for the last financial year was 454.4 million after tax and finance costs. Papys gearing was only 29.25% (debt of 870.0million / debt plus equity of 870.0 million + 2,104.4 million) which is material ly lower than itscompetitors gearing levels at 40%. Papy has also repaid debt of 150 million in the last financia lyear. So there is room to increase debt financing in order to fund the proposals to reduce Papyscarbon emissions which are set out in this report. Papys interest cover is 9.5 which is high and

demonstrates a good ability to pay the interest on its current debt.


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In order to become more sustainable and reduce its carbon emissions, Papy will need to changethe way in which it operates in order to reduce electricity consumption which in turn will result inlong-term savings in operating costs. European companies which do not reduce their carbonemissions will be subject to possible fines in the future as the first deadline of 2020, which wasagreed in the Kyoto protocol, becomes closer. Therefore, the proposals for change in order tobecome more sustainable and to set reduced carbon emission targets and 2 proposals to

reduce carbon emissions all reflect the right attitude for a large listed European company toembrace.

4.2 Management of change

There is a need to get all employees involved in Papys pro posed change to become a moresustainable retailer. Without employee buy in the company will not be successful.

The case material states that many members of Papys senior management team considerthemselves too busy to become involved. This is a disappointing response from some of Papyssenior management. There needs to be a full commitment from all members of the managementteam and this must be driven by the new Chief Executive, Lucas Meyer.

Many managers and employees consider the subject of climate change not worthy of theattention, especially in difficult trading times where costs are being cut and growth in revenuesare difficult to achieve. It is necessary to brief them and explain what Papys new targets are andwhy and to explain the need for them to be involved. Perhaps some of the senior managementteam do not appreciate the importance of long-term objectives and are focused too much on theachievement of short-term profitability targets. Therefore there needs to be new targetsestablished on a range of aims, but specifically to make these new targets based on non-financial measures, such as carbon emissions, electricity usage, plastic bags and wastematerials. The introduction of the Balanced Scorecard could help Arif Karp and Lucas Meyer toset a range of meaningful targets. The Balanced Scorecard views profitability as being a lagrather than a lead as an indicator of the businesss performance.

The management of change is not an easy thing for organisations to undertake, and perhapsArif Karp is right to bring in the help of IT consultants, although they may be unable to help inthe required change management process itself. There is a need to re-align the way free sharesto employees are awarded. Therefore, targets need to be changed from just financial targetstowards the achievement of a range of targets more focused towards reducing carbon emissionsand becoming a more sustainable business. Papy could introduce the Balanced Scorecard tomeasure its key business statistics.

An article in Financial Management (March 2011 article) referred to the United Nations GlobalCompact (UNGC) survey of global CEOs and highlighted that one of the main challenges facingorganisations wishing to improve their sustainability practices, is the transition from strategy tothe execution of their plans.

It is suggested that a top down approach is started, with all senior managers being briefed byLucas Meyer and Arif Karp to explain what they are trying to do. They should explain howcultural change in Papy could be brought about and explain that this is a new long-termobjective for the company.

It will then be necessary to communicate the need for change with all store managers and finallywith all store employees. Change cannot be enforced. Instead it must be embraced andaccepted by the employees if the company is to re-focus on being a sustainable retailer, ratherthan a profit-driven retailer. Therefore a series of road shows to brief managers in each of the8 European countries will be required and communication documents drawn up to explain thechanges to all employees.

The use of external consultants who are not familiar with the supermarket industry should be

discouraged as this could further antagonise store managers. It is important for Papy employees


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and managers to be involved and not consultants, except where expertise on specific aspects isrequired.

Employees may be naturally fearful about change and not understand what is expected fromthem. The reason for new requirements for data must be explained and they must understandwhat is required and for what reason, in order for them to become actively involved.

Within Arif Karps team, it is suggested that a small team should be exclusively committed tocommunication with managers and employees throughout the company. Communications couldbe face to face, by web cast, email or by posters in the staff areas of each store.

In summary, a range of initiatives that Arif Karp could consider introducing are:

1. To ask Lucas Meyer or possibly Abdul Yarkol, Finance Director, to be the senior championfor environmental issues within Papy and to work across the company to align financial andnon-financial results. The introduction of a performance management system such as theBalanced Scorecard could be helpful in providing a focus for the Board, and store managersin particular, on a much broader range of performance measures linked to sustainability.

2. Arif Karp could benchmark what other leading supermarkets are currently doing andcompare each of their competitors targets to Papys . For example, some initiatives fromTescos latest annual Corporate Responsibility Report include supporting Climate Week inthe UK (21-27 March 2011) and introducing an energy league between stores in Malaysiato reward lower energy usage. If successful, this energy league concept will be rolled outacross other countries.

3. As it is stated many of Papys employees either do not know, or understand, what ArifKarpis trying to do, then they could consider following Tescos lead which has trained thousandsof employees to be Energy Champions. All of the employees appointed as EnergyChampions are tasked to reduce energy and to encourage colleagues to do the samewithin each store or within stores in their region.

4. The use of management frameworks that organisations can use to help manage theprocess of change. These include, for example, Kurt Lewins Change Management Model ofunfreeze, change and refreeze, and developments of Bruce Tuckmans model of Forming ,Storming, Norming and Performing. Models such as these are commonly used as tools tohelp bring about changes in employees behaviour. Perhaps Arif Karps leading globalconsultancy company where he used to work before he joined Papy, could assist withhelping to bring about change. However, it must be stressed that it is Papys employeeswho need to understand the need for change, but external consultants can usefully act asfacilitators for change.

5. There is a clear need for an IT system such as the Environmental Management System(EMS) in order to capture non-financial data on a wide range of issues such as waste,recycling (by type of material), energy usage, carbon emissions etc, by store, for each

country and for the Papy group. It is necessary for senior managers to become involved withspecifying the data requirements and sources of data and whether the data is currentlybeing measured or not. Only Papy employees and managers understand this data andtherefore the use of external consultants should be minimised. They do not know thebusiness or the people and it may engender a them and us attitude. It is necessary forPapys management to become much more involved.

4.3 - Carbon emission targets

The best way to monitor and compare carbon emissions between years, with Papys expandingnumber of stores, is the measure carbon emissions in kg per square metre of sales area. It isnot possible to compare Papys total volume of carbon emissions between years, as the total

volume will be distorted by the increase in new stores.


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The original targets of 948 and 874 kg per square metre of sales area for 2012 and 2013already represent a real reduction as compared to the 2010 actual levels of 1042 kg per squaremetre. However, the 2009 and 2010 levels have been found to be understated by 5%. Thereforethe re-stated 2010 level is 1,094 kg per square metre. This is shown in Appendix 3.

Appendix 3 also shows Lucas Meyers proposed new target for 2012, based on a 25% reduction

from 2010 revised level of 1094 = 821 kg per square metre. The new target for 2013 is a furtherreduction of 15% from 2012s new target = 698 kg per square metre. The new target of 698 kgper square metre for 2013 is challenging and represents a reduction of 36% from the adjusted2010 level of 1094 kg per square metre.

Papy can only achieve these reduced carbon emission targets if it invests in new technology tohelp deliver large volumes of savings in carbon emissions. Additionally, the company wouldneed to change its strategy and focus away from pure financial results and be more focussed oncarbon emission targets. This will necessitate a change in performance related pay andemployee attitudes, as discussed above in the need for change.

There will also be a need to capture and monitor a range of non-financial data in order tomanage the process and to try to achieve the new targets. This will almost definitely require the

investment in an Environmental Management System (EMS).

As Papy opens more stores in the next few years, it is hoped that these new stores will be moreenergy efficient and have lower levels of carbon emissions.

Other competitor supermarket chains would already appear to be moving to reduce their carbonemissions. For example Tesco has made a commitment to halve its global footprint by 2020.The Case Study pre-seen material showed that Papy had the highest levels of carbon emissionsamongst its competitors and indeed Competitor 2 had already reduced its carbon emissions toonly 243 kg per square metre of sales area. All these factors point to the need for Papy to dosomething on carbon emissions, and to do it quickly. Doing nothing does not appear to be anoption for Papy.

Referring to the UNGC survey again (Financial Management, March 2011), if a company is seento be paying lip service to sustainability it runs a high risk of damaging its brand. Further, LucasMeyer in his press announcement of 24 June 2011 (Pre-seen material Appendix 5) has alreadyraised stakeholder expectations of where he sees Papy needing to go in terms of sustainability.Key stakeholders (using Mendelows analysis) such as employees, investment analysts, andcompetitors in particular, will now be expecting Papy to make significant progress in reducing itscarbon emissions.

The 2 proposals in this case study are forecast to save significant amounts of carbon emissions.For the year 2013, the new freezer cabinet proposal is forecast to deliver savings of 47 millionkg of carbon emissions. This is equal to 32 kg per square metre. The solar panels proposal isforecast to deliver savings of 180 million kg of carbon emissions when they are operational at all200 supermarket stores. This is equal to savings in carbon emissions of 124 kg per square

metre.

Appendix 6 shows a summary of the savings in carbon emissions that these proposals couldmake and how they help to reduce Papys overall level of carbon emissions.

In summary these savings are as follows:


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Total carbonemissions

Carbonemissions per

square metre ofsales area

Based on average square metre of1,457,000 for 2013

2013kg millions

2013kg per square

metreCurrent plan 1,274 874

Solar panels (180) (124)

Freezer cabinets (47) (32)

Revised forecast including these 2proposals 1,047 718

The table above shows that these 2 new investment initiatives could bring carbon emissionsdown to 718 kg per square metre which is very close to the target of 698. Together with otherinitiatives, or perhaps installing solar panels at a few more supermarket stores, these 2

proposals would help to meet Lucas Meyers proposed new target.

4.4 Solar panels

This is a large investment, totalling 600 million (3 million for 200 supermarket stores).However, it will also deliver significant reductions in carbon emissions at 900,000 kg reductionper store. 100 supermarket stores will result in a reduction of 90 million kg in 2012 and the firstfull year effect on carbon emission reductions on the 200 stores will be in 2013, generatingsavings of 180 million kg. This is a very large reduction in carbon emissions and representsaround 12% of Papys entire carbon emissions for 2010 (180 / 1495 million kg for 2010).

There is a big question as to how this project could be financed. The Chief Executive states that

financing forcapital investment projects to reduce carbon emissions will be given top priority but could this have an impact in Papys planned expansion in store numbers. In the currenteconomic conditions, there is a question of whether Papy will be able to raise this level ofborrowings from banks, many of whom are still restricting lending. However, Papys gearing ratiois only 29.25% at the end of December 2010 (debt of 870.0 million / debt plus equity of 870.0million + 2,104.4 million). This is materially lower than its competitors gearing levels at 40%.So there is room to increase debt financing in order to fund this proposal. Papys interest coveris 9.5 which is high and demonstrates a good ability to pay the interest on its current debt.

If Papy were to be able to borrow the full 600 million, then its gearing would rise to 41.1%based on 2010s figures (600 million + 870 million = 1,470 million total debt / 2,104 million+ 1,470 million). However, equity will increase each year with the level of retained earnings andthis would reduce the level of gearing slightly. This would bring Papy in line with some of its

competitors gearing levels of around 40%, so a reasonable level, but riskier for Papy. However,operational savings would help cover additional interest costs. Papy has adequate cash flows toservice this additional debt.

Alternatively, Papy could have a rights issue, but this is expensive and will take time (around 12 18 months) and could delay the start of the implementation of this proposal. Anotheralternative could be to temporarily reduce dividends for 1 or 2 years, but shareholder re-actionwould have to be gauged.

The technology for solar panels to generate power continues to change and improve. It isestimated that better technology will be available in 2017. So should Papy install solar panels inas many as 200 supermarket stores now? A delay in the implementation of this proposal wouldalso mean a delay in achieving reductions in carbon emissions. Also, if Papy were to delay until2017 for the better technology, then it may find that even better technology is a further 5 yearsaway. Papy is planning to invest in solar panels for only 200 of its 422 supermarket stores, so


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there is still the option to invest and install the new solar panel technology in 2017 at more ofPapys stores.

The case material states it will generate a positive NPV of 91 million over a 10 year time frame.This is a long period but reasonable for this type of investment. The discounted payback periodis 8 years.

This cannot be directly compared to the un-discounted payback period of just under 5 years forthe freezer cabinet proposal, as the cost of capital has not been used to discount the freezercabinet proposal. They have been appraised using different methods.

There is also a conflict of interest here as Arif Karp wants to make a large reduction in Papyscarbon emissions both to meet the targets set by the Chief Executive but also to gain from hispersonal performance related bonus, which is linked to the volume of reductions in carbonemissions.

Overall, this proposal will generate a 30% saving in electricity costs for each store which is fittedwith solar panels and it will also achieve significant reductions in carbon emissions. However,the investment cost is high. The capital cost for each store is 3.0 million to save 900,000 kg of

carbon emissions. This represents a cost of 3.33 million per 1 million kg of carbon emissionsreduced. This is shown in Appendix 7. This represents a high capital cost for the volume ofreduction in carbon emissions. This compares to between 1.6 to 1.8 million per1 million kg ofcarbon emission reductions for the replacement freezer cabinet proposal shown below.

In summary, we can use the J&S framework to assess whether the proposal is suitable,acceptable and feasible, as follows:

SuitabilityThis proposal would go a long way towards achieving the carbon emission reductions proposedby Lucas Meyer.

Acceptability

This would result in total annual savings in carbon emissions of 180 million kg. Based on the2013 forecast total sales area of 1,457,000 square metres this would result in additional carbonemission savings of around 124 kg per square metre of sales area.

The project is financially feasible as it has a positive NPV of 91 million and achieved adiscounted payback within 8 years.

FeasibilityNew debt would be required to finance the large investment of 600 million . In the currenteconomic environment, Papy may not find it easy to borrow this level of funding. However, withsome new debt and a mixture of current cash balances (which is a significant 603.9 million atthe end of 2010), and a small reduction in the level of dividends paid, then the funding could besecured.

4.5 Freezer cabinets

This proposal makes commercial sense and will result in reduced electricity costs and has arelatively low investment cost. The total investment will cost 85.0 million and generateelectricity savings for the 500 stores (400 supermarket stores and 100 small conveniencestores) of 25.8 million each year.

The financial analysis of this proposal is shown in Appendix 5.

This proposal also saves carbon emissions. The total reduction in carbon emissions from thisproposal is 47 million kg. This is equal to 32 kg per square metre for 2013 (47 million / 1,457,000

square metres).


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Lucas Meyers new target of698 kg per square metre for 2013 represents the need to save anadditional 176 kg per square metre from the latest forecast of 874 kg per square metre. Thisproposal will save the equivalent of 32 kg per square metre, which represents around 18% ofthe reduction required.

The practice of reducing carbon emissions from freezer cabinets is a popular investment within

the supermarket industry, and The Co-operative Group recently announced their achievement inreducing carbon emissions from freezers two years earlier than its planned date of 2011.

Furthermore, the capital cost per 1 million kg of carbon emissions savings is low at 1.81 million(total investment = 85 million to produce carbon emission savings of 47 million kg). This issubstantially lower capital investment cost per 1 million kg of carbon emission savings than thesolar panel proposal, which is 3.33 million per 1 million kg of carbon emission savings. This isshown in Appendix 7.

However, it is forecast that there is a risk of reduced volumes of sales as customers have toopen the freezer cabinet doors to access frozen food products, rather than just reach into theolder style freezer cabinets. This is forecast to result in a lower gross margin of 18,480 persupermarket store, resulting in an overall reduction in gross margin across 400 supermarket

stores of 7.4 million.

The investment proposal is shown in Appendix 5. This shows that using the undiscountedpayback method, this proposal breaks even during year 5 (4.3 years). This meets therequirement set out by the Finance Director, as the proposals payback period is within 5 years.

Undiscounted payback is not a very sophisticated method for investment appraisal as it does nottake account of the cost of capital used to finance the investment, and it also does not take intoaccount the diminishing value of future cash flows. However, it does demonstrate that thisinvestment is financially viable and produces a payback in a relatively short time frame. Thesupermarket industry in particular is faced with many powerful influences (using Porters 5 -Forces framework), and in particular the power of customers and global supermarket companiessuch as Walmart and Tesco, as well as the growing influence of low-cost food retailers such as

Aldi. It should be noted also that this method, from research into management practices, isconsistently the most popular method of capital expenditure appraisals.

This proposal also reduces Papys carbon emissions. Therefore, this seems like a goodinvestment as it is generating long-term positive cash flows by reduced electricity costs and isalso reducing carbon emissions.

How can Papy finance the investment cost of 85 million? It has cash reserves of 603.9 millionat 31 December 2010 and the company is producing positive cash flows from operations andtherefore this should be possible, depending on the capital expenditure constraints due to thesolar panel proposal.

There is a further question as to why Papy is not proposing to roll this proposal out to all

convenience stores, as only 100 small stores are included in the proposal. Papy had 742 smallstores in operation at the 31 December 2010. If it were to install these new freezer cabinets inmore smaller stores, then even higher levels of savings in carbon emissions could be achieved.

If this proposal is approved, then there would be a one-off effect on profit in the current year (butno effect on cash flows) due to the write-off for the old freezer cabinets. The write-off of the netbook value (NBV) of the old freezer cabinets is 25.0 million. This is quite a large write-off andrepresents 5.5% of the 2010 post-tax profits.


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5.0 Ethical issues and recommendations on ethical issues

5.1 Range of ethical issues facing Papy

There are 3 ethical issues that will be discussed and recommendations made. These are:

1. Cancellation of 2 supplier contracts2. Changes in the measurement of waste materials3. Arif Karps performance related bonus and a possible conflict of interest

5.2 Cancellation of 2 supplier contracts

5.2.1 Why this is an ethical issue

This issue has both a business and an ethical aspect. From a business point of view the issueseems clear cut. The profit margins for these products have significantly reduced. Rafael Lucci,Operations and Logistics Director, has proposed to cancel the contracts for these 2 suppliers in3-months time and this would seem to be justified from a purely business perspective. Howeverthe two contracts affected are Fair Trade contracts, and Papy, like other major supermarket

chains would wish to support such suppliers from an ethical point of view.

Therefore, this is an ethical issue because the cancellation of these 2 supplier contracts wouldimpact greatly on the local farming co-operatives in this African country. Papy would beoperating unethically by not supporting these farmers and putting profits ahead of its suppliersneeds.

The Fair Trade brand is well recognised by customers. For example, The Co-operative Grouphas increased its Fair Trade purchases by 280% over the past three years. So to some extentthere is a business case to be argued for Fair Trade.

The question about wastage of these fresh products and levels of demand should be reviewed.Is it possible for Papy change its retail prices or promote these products more, in order to

increase sales volumes?

Instead of cancelling the contracts entirely, Papy could agree to reduce the volumes of productsprocured temporarily or to procure a reduced range with the farming co-operatives.

5.2.2 Recommendations for this ethical issue

It is recommended that Papy does not cancel the 2 contracts.

It is further recommended that store managers investigate the high level of waste from theseproducts as to the causes. Alternatively, Papy could reduce the purchases of competingproducts from other non-Fair Trade suppliers, or the waste levels may be due to storage orhandling problems within the supply chain including at Papys own stores.

It is recommended that Papy procures lower volumes of products from both supplierstemporarily rather than cancels the contracts entirely.

It is also recommended that Papy should increase its marketing of these products in order tostimulate demand.

5.3 Changes in the measurement of waste materials


This is an ethical issue as Arif Karps proposal is to move the goalposts in respect of the

measurement of waste, to make it appear as if Papy has achieved greater reductions in wastethan it has really achieved.


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Under the current measurement of waste materials by volume, the forecast reduction per yearwould be only 4.4% in 2011 and 4.9% in 2012. By using an alternative way of measuring wastematerials by using weight, the reduction in waste materials would appear to be greater at 13% in2011 and 26% in 2012.


It is recommended that Papy should collect and publish data on waste materials using bothmeasurements.

It is recommended that Papy is transparent in its published statistics for the measurement ofwaste materials and that it does not attempt to show the company in a better light than it reallyis. It is therefore recommended that Arif Karps proposal is not accepted.

Papy should be honest and not change performance measures to make it appear that it isperforming better than it is.

5.4Arif Karps performance related bonus and a possible conflict of interest


This is an ethical issue as Arif Karp has a conflict of interest. Whilst his role is to help to reducePapys levels of carbon emissions and to help make the company more sustainable, his contractof employment includes a performance related bonus which is related to reductions in carbonemissions and waste materials.

Therefore he may choose to take on additional carbon emission reduction proposals to achievehis bonus whereas they may not be the most effective or cost efficient proposals for Papy toundertake. There is also the conflict with how waste is measured and a change in the way in

which waste is measured may make Papy appear to be doing better than it really is, resulting ina higher bonus for Arif Karp.


It is recommended that Arif Karps performance related pay is changed or re-negotiated (if this ispossible for his current signed contract) so that it is linked to a range of measures whichincludes the reduction in carbon emissions as well as business and financial targets.

It is recommended that Papy should introduce the Balanced Scorecard for the purposes ofperformance related pay both for Directors and all of Papy employees to help achieve goalcongruence.

6.0 Recommendations

6.1 Management of change

6.1.1 Recommendation

It is recommended that the company supports Arif Karp in his initiatives to bring about changewithin Papy. If the company is to achieve Lucas Meyers stated aim to become moresustainable, then a change of attitude is needed from the Board of Directors down to allemployees across all stores. Change is not easy to bring about, but can happen if it is drivenfrom the top.


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6.1.2 Justification

Papy needs to change and adapt in order to survive and stay competitive. Papys carbonemissions are materially higher than some of its competitors (pre-seen material page 5).

At some stage in the next 5 to 10 years it is expected that the European Union (EU) will tax or

impose fines on companies that do not make substantial reductions to their carbon footprint. Itwill be better to change voluntarily than to have changes, or substantial fines, imposed on thecompany.

Therefore, the rationale is that unless employees attitude to sustainability is achieved then thecompany will not achieve its desire to reduce carbon emissions, despite large capitalinvestments, such as in solar panels.

6.1.3 Actions to be taken

1. Lucas Meyer should take on the responsibility of being the senior champion for theenvironment, and to work across the company to align financial and non-financial results. Itis necessary to ensure commitment from the top management team by holding briefings

with Lucas Meyer and Arif Karp and his team

2. The Balanced Scorecard should be introduced in order to provide a focus for the Board andfor store managers on a much broader range of performance measures including thoselinked to sustainability.A specific internal business measure should be Reduction in carbonemissions

3. The employee share scheme should be changed to link it to targets including the reductionin carbon emissions.

4. As many of Papys employees either do not know, or understand, what Arif is trying to dothen the company should train a number of employees in each store to be EnergyChampions who are tasked to reduce energy and to encourage colleagues to do the same.

5. It will be necessary to hold Road Shows for managers and staff in each country and forcommunication on sustainability targets and plans to be cascaded down by store managersin each store. It is necessary for employees to understand why Papy needs to change.

6. The establishment of League tables of carbon emissions by store should be introducedand linked to monthly awards for achievements.

7. Arif Karp should seek advice from his previous consultancy company, and appoint it toadvise him on other practical ways in which Kurt Lewins Change Management Model ofunfreeze, change and re-freeze could be used to change organisational culture withinPapy.

8. To introduce and communicate ways of measuring energy and waste management andgetting employee involvement.

9. To invest in a new IT system to capture a range of non-financial data, such as anEnvironmental Management System (EMS).

6.2 Carbon emission targets


It is recommended that the challenging target of 698 kg per square metre is agreed for 2013. Itis a hard target to achieve, but it will focus the company on finding ways to meet it. Doing

nothing and not attempting to reduce its carbon emissions significantly is not an option for Papy.


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6.2.2 Justification

If Papy were to set a target that was not as challenging as 698 kg per square metre then it willnot encourage the company to invest or to change its focus towards becoming moresustainable.

Papys carbon emission figure of 1,094 kg per square metre for 2010 is higher than the worstfigure of its competitors (of 1,005 as shown in the Pre-seen material), and is significantlyhigher than the 681 and 243 of competitors 1 and 2. Tescos carbon emissions per squaremetre are only 574 kg, as shown in its latest annual Corporate Responsibility Report.

It is recommended therefore that Papy does take positive action to reduce its carbon emissions,where this is feasible. If it does not then this is very likely to erode Papys marketing position incomparison with other supermarket chains, and hence have an adverse effect on its financialperformance in the long-term.


It is recommended that Papy should invest in both of the proposals (solar panels and new

freezer cabinets).

These proposals would achieve operating cost savings and both of the proposals havereasonable payback periods (discounted payback is 8 years for solar panels (per unseenmaterial) and undiscounted payback of only 5 years for the freezer cabinets (per Appendix 5).

Some of the supporting recommendations and necessary actions to take are covered in therecommendations on Solar panels and Freezer cabinets below.

6.3 Solar panels


It is recommended to accept this proposal assuming that financing of 600 million for theproposal can be identified and agreed.

This is a major investment and would demonstrate to shareholders, employees, customers andother stakeholders that Papy is serious about changing and reducing its carbon emissions.

6.3.2 Justification

This investment would generate huge savings in carbon emissions of 180 million kg by 2013.This is equivalent to 124 kg per square metre and would deliver over 70% of the additionalcarbon emissions savings required by Lucas Meyer (new target of 698 kg per square metre for2013 represents the need to save an additional 176 kg per square metre from the latest forecast

of 874 kg per square metre).

There is always a reason to delay or postpone investment proposals. Technology is moving fastand delaying the decision to invest in solar panels until 2017 could be seen as a missedopportunity to make substantial reductions in carbon emissions over this period. In 2017 therewill, no doubt, be even better technology that will be few years away from commercialavailability. It is recommended that Papy should not delay and should make the decision toinvest now.

Together with the proposal to replace the freezer cabinets, as well as install solar panels at 200stores, this would result in Papys carbon emissions reducing to 718 kg per square metre. Thisis only just a little higher than the target of 698 kg per square metre.


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Agree how this proposal is to be financed. A total of 600 million is required. A mixture of cashgenerated from operations and new debt is recommended. It is not recommended to reducedividends as this could send mixed signals to shareholders.

The Finance Director should arrange new debt finance with a range of lenders over a 10 yearperiod.

To make a final selection of exactly which 200 supermarket stores in Southern Europe shouldhave solar panels installed in order to maximise the benefits and to arrange for the necessarysite surveys to be undertaken.

Orders should be placed for solar panels for the first 100 stores where solar panels are to beinstalled. The Procurement Director should seek to obtain a bulk discount for this largeexpenditure totalling 300 million in the first year and to ensure that contract specifies theagreed delivery and installation schedule. A second order for the remaining solar panels at 100stores should also be negotiated.

Monitoring of electricity consumption, by store, after installation of solar panels to see if theplanned 30% saving is being achieved or not.

6.4 Freezer cabinets


It is recommended that this proposal to change the freezer cabinets at 400 supermarket storesand 100 small convenience stores is approved. The total investment cost is only 85 million andwould save 47 million kg of carbon emissions.

It is further recommended that Papy should review these new freezer cabinets once installed

with a view to changing the freezer cabinets at all 760 small convenience stores (end 2011 storenumbers) during 2012.

It is also recommended that all new stores opened should have these new low-carbon emissionfreezer cabinets installed.

6.4.2 Justification

This is a good way to reduce electricity costs and reduce carbon emissions. The investment costis not too large at85 million and this proposal will help Papy to go part of the way to meetingthe challenging target of 698 kg of carbon emissions per square metre by 2013. This proposalwould save 47 kg million each year which is equivalent to 32 kg per square metre for 2013.

This proposal achieves undiscounted payback in less than 5 years and therefore meets thecriterion set by the Abdul Yarkol, Finance Director, for undiscounted payback by end of year 5and is financially acceptable.


Orders for the new freezer cabinets should now be placed as soon as possible. Papy hasadequate cash resources to fund this capital investment.

The current freezers should be disposed of in an environmentally friendly way if possible. Thenet book value of these old freezers, of 25 million, will need to be written off in the currentyears accounts (year ended 31 December 2011).


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7.0 Conclusions

Papy needs to change in order to achieve its plans to become a more sustainable retailer.Lucas Meyer has set some challenging targets which could almost be achieved if both of theproposals for solar panels and new freezer cabinets were to be agreed and implemented.

The future for the Papy chain of supermarkets will be greatly enhanced if it is able to embraceand achieve its desire to become more sustainable. Its long-term future will be improved if themanagement team is able to bring about change throughout the company and to get employeesinvolved in the achievement of the new targets. This is a long-term objective and changes inemployees attitudes can take time to happen.

The Papy brand will be greatly enhanced by the proposals outlined in this report.


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Appendix 1SWOT analysis

Strengths

Successful and profitable listed companyNew Chief Executive with determination tobring about change

Environmental expertise and experience ofArif Karp

Strong CSR objectives

Increase in customer numbers

Growing market share in its home country

High operating profit margin compared to2 of its competitors

Good IT systems

Reduction in long-term debt in last

financial yearIncrease in cash balances over the lastfinancial year

Weaknesses

Difficulty in bringing about change andemployees resistance to cultural changeEmployee morale and scepticism aboutchanging the focus from profit targets toreduction in carbon emissionsPapy has the highest carbon emissionsper square metre in comparison with 3 ofits competitorsDependent on store managers to achievetargets setHow to measure carbon emissions anddiscovery of understatement for 2009 and

2010.How to measure CSR targetsSales reduction for a small range of freshproducePapy does not offer Internet shopping

Opportunities

To change to become a more sustainableretailer

To reduce carbon emissionsProposal to install solar panels at 200storesProposal to replace freezer cabinets withlow-carbon technology freezer cabinetsTo measure waste materials in alternativeways to demonstrate the commitment toreducing waste materialsTo create a new EMS IT system to captureand report on a wide range of non-financial dataTo develop Internet shopping and increasethe number of non-food products and ownbrand productsTo expand outside of Europe in the future

Threats

To invest heavily in projects to reducecarbon emissions and to put the companyunder financial strain from increased debtfinance or reduced dividends toshareholdersInvestments not achieving the plannedsavings in electricity costs or not achievingplanned reduction in carbon emissionsLosing key staff whilst Papy undergoes aperiod of changeLong-term damage to Papy brand ifreduction in carbon emissions is notachieved

Note:The above SWOT analysis is detailed for teaching purposes. However, in exam conditions aSWOT containing fewer bullet points, which cover the main issues from the case and theunseen material, is expected.


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Appendix 2PEST analysis

Political or Legal

Possible future fines or taxes based on levels of carbon emissions

Pressure from different EU governments to reduce carbon emissions to meet EU targetsPossible subsidies from EU governments for investment in low carbon technologies

Economic

Pressure from competitors and the need to maintain market share

Shareholders demandsWill finance be available for the proposed investment opportunities due to bank lendingrestrictions

Shareholder reaction to possible reduction in dividends so that cash from operationscould be used to finance investments in low carbon technologies

Social

Customer reaction to Papys changes will becoming a more sustainable retailer attractmore customers?

Greater awareness of carbon emissions and the need for investment in low carbontechnologies to meet EU carbon emission reduction targets

Customer choice of products and store layout changes in tastes and choices couldaffect Papys success in future

Alternative ways to shop, such as Internet shopping, which Papy does not offer, couldlead to a fall in its market share

Technological

New low-carbon technologies becoming available

New low-carbon freezer cabinets reducing Papys carbon emissions

Solar panel technology how efficient is it and how quickly will improved technologybecome available and perhaps at lower prices?


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Appendix 3

Carbon emission targets

2009 2010 2011 2012 2013

kg per square metre Published Published Forecast Forecast Forecast

Published data 1,077 1,042

Revised data for 2009 and 2010 toreflect the understatement ofpublished data by 5% 1,131 1,094

Forecast carbon emissions 1,022 948 874

Lucas Meyers proposed targets:

25% reduction from revised2010 levels for 2012

Further 15% reduction from2012 for 2013

821

698

Therefore reduction required 127 176


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Appendix 4

Savings in carbon emissions from the solar panels proposal

Year 1 Year 2Savings in carbon emissions is 900,000 kg per store per year

2012 2013

Cumulative number of stores where solar panel are installed 100 200

Total carbon emissions savings (at 900,000 per store) kg million 90 180

Forecast total sales area for all Papy stores - per unseen material(square metres) 1,425,400 1,457,000

Carbon emissions savings per square metre of sales area 63 124


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Appendix 5

Evaluation of proposal for new freezer cabinets

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

2011 2012 2013 2014 2015 2016

million million million million million millionCapital costs:200 K for supermarket stores (80.0)50K for small stores (5.0)

Electricity savings:60K for supermarket stores 24.0 24.0 24.0 24.0 24.018K forsmall stores 1.8 1.8 1.8 1.8 1.8Forecast fall in gross margin:Supermarket stores

(workings below) (7.4) (7.4) (7.4) (7.4) (7.4)Small stores no change 0 0 0 0 0

Net cash flows (85.0) 18.4 18.4 18.4 18.4 18.4

Tax at 25% 1 year in arrears - 21.3 (4.6) (4.6) (4.6) (4.6)

Net cash flows post tax (85.0) 39.7 13.8 13.8 13.8 13.8

Cumulative post tax cash flows (85.0) (45.3) (31.5) (17.7) (3.9) 9.9

Undiscounted payback: In Year 5

4.28 years

Expected value for forecast fall in gross margin of sales at supermarket stores:

60% x 3% fall x 560,000 10,08030% x 5% fall x 560,000 8,40010% x no change x 560,000 0

Expected value of fall in gross margin 18,480 per store

18,480 fall in gross margin x 400 supermarket stores = (7.4) million reduction each year.

Savings in carbon emissions from proposal to install new freezer cabinets:

Savings inemissions

Per Store eachyearKg

No of storesfor newfreezer

cabinets

Total savingsin carbonemission

Kg million

Supermarket stores 110,000 400 44

Small stores 30,000 100 3Total 47


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Appendix 6

Summary of savings in carbon emissions and comparison to targets

2012 2013 2012 2013

Totalkg million

Totalkg million

kg per squaremetre of

sales area

kg per squaremetre of

sales areaForecast carbon emissionsbefore these 2 proposals(per Appendix 3 of answer)

1,351 1,274 948 874

Savings in carbon emissions fromproposals:Solar panels (Totals per Appendix 4) (90) (180) (63) (124)

Freezer cabinets(Totals per Appendix 5) (47) (47) (33) (32)

Revised forecast for carbonemissions if both of the proposalswere to be implemented 1,214 1,047 852 718

Lucas Meyers proposed targets(per Appendix 3)

821 698

Shortfall even if both proposals areimplemented (31) (20)

Note:The forecast sales area in square metres is as follows (per unseen material):

2012 1,425,400 square metres2013 1,457,000 square metres


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Appendix 7

Comparison of capital costs and carbon emissions savingsbetween the 2 proposals

Savings incarbon

emissions

Capitalcost

(before taxrelief)*

Capital costper 1 million kg

of carbonemissions

saved

kg million million

Solar panels per store 900,000 3.0 3.33

Freezer cabinets:Supermarket stores 110,000 0.200 1.82

Small stores 30,000 0.050 1.67

Overall for freezer cabinets 47,000,000 85.0 1.81

*Note:

The above comparison of capital costs ignores any tax relief or capital allowances that thesealternative investment projects will attract.


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Appendix 8

Part (b) Presentation and graph on proposals to reduce carbon emissions

The savings in carbon emissions from the solar panels proposal is 180 million kg by 2013.

This is equivalent to 124 kg per square metre in 2013

The savings in carbon emissions from the replacement cabinet proposal is 47 million kg.This is equivalent to 32 kg per square metre in 2013

Together these 2 proposals could bring Papys carbon emissions down to 718 kg per squaremetre by 2013, which is only just above the new target figure for 2013 of 698.

Total investment required for both proposals is 685 million.

It is recommended that both proposals are accepted, assuming the debt financing and othersources of funding can be secured.

Graph showing Papys carbon emissions expressed as kg per square metre of sales areafor the 5 years 2009 to 2013.

This graph includes the savings in carbon emissions that could be achieved if Papy were toimplement both of the proposals (solar panels and freezer cabinets)

End of answer document

Carbon emissions (kg)

per square metre of sales area1,131 1,094

1,022

852

718

0

200

400

600

800

1,000

1,200

2009 2010 2011 2012 2013

kgpersquaremetre

Documents

T4 Sept 2011 Answers