Management Professional Competence

Suggested Answers
PAC Mock-Winter 2019

Q.1 (a) Importance of revenue growth and analysis of SL’s performance

WORKINGS
2019 2018

Importance of revenue growth

Growth in sales revenue is extremely important in a high-growth industry, such as online selling of consumer goods. As
the industry appears to be in the growth stage of its life cycle, SL’s underlying marketing objective should be to
maximise market share – meaning that SL needs to achieve faster rate of growth than the industry average.

In theory, sales growth should drive profits growth. However, sales revenue needs to produce profit, and it is important
to keep control over costs, particularly in a period of rapid growth. Provided that sales prices can be sustained, the aim
should be to maintain gross profit margin and to achieve falling ratios of costs to sales. Although distribution costs as a
percentage of revenue increased in 2019, the ratio of marketing costs to sales was maintained and administration costs
fell as a percentage of sales. Taken as a whole, operational profitability improved in 2019 and SL should expect to
maintain or build on this improvement in the future, although the extensive price cutting by competitors poses a threat
to this.

There are, however, some significant aspects of SL’s performance in 2019 that are a cause for concern, and these
should be monitored closely.
Potential areas of concern

Although the average number of items purchased per order increased from 2.40 to 2.61 units, the average value per
order fell by about 9%, from Rs. 41.17 to Rs. 37.42. The average price per item sold also fell, from Rs. 17.15 to Rs. 14.34.
This indicates that the profitability per order is falling, and in spite of an increase of 75.9% in the number of orders,
sales revenue grew by ‘just’ 59.8% in 2019. Customers – in particular, new customers – may be deliberately spending
less on purchases. Any further change in these order ratios should be monitored closely.

Cash flow and liquidity – It may also be a matter of some concern that in spite of making a profit after tax in 2019 of
Rs. 5,615,000, SL’s net cash flows were positive by just Rs. 165,000.

Capital expenditure was significantly greater than depreciation and amortisation charges, suggesting that SL is having to
invest large amounts of cash in order to maintain sales growth. Although receivables increased in proportion to sales
revenue, the average inventory turnover period increased from 29 days in 2018 to 49 days in 2019. The increase in
inventory may be linked to the growth in sales, but there is no supporting evidence.

Cash flows should therefore be kept under close review, together with capital expenditure and inventory levels.
Increases in capital expenditure need to be justified by increases in expected revenue and cash flow; growth in
inventories should be proportional to growth in sales and should not continue to increase at the rate that seems to
have occurred in 2019. As such, it will be important for SL to monitor aspects of liquidity and cash flow, and not to
focus only on revenue, profits and profitability.

Q.1 (b) Effect of sales growth and fall in gross margin

The increase in sales revenue in excess of budget may seem to be a positive aspect of performance, but the sales
growth may be happening because of excessive price discounting.

The scale of the price discounting seems alarming. In 2019, the gross profit margin was 58%, and it may have fallen to
51% in 2020. This suggests that for every Rs. 100 of goods sold in 2019 the cost of sales was Rs. 42 and the gross profit
was Rs. 58. For the same sales in 20X5 costing Rs. 42, the gross profit margin is 51% of the selling price, which means
that the selling price for the same goods would be Rs. 85.71 (= Rs. 42/(1 – 0.51)) and the gross margin just Rs. 43.71.
Price discounts have been averaging 14.29% (100 – 85.71) and this must obviously be having a significant impact on
profitability. (This assumes that the reduced margin is due to price discounting. If supplier prices were also to increase,
the margin would be reduced further.)

If we assume that inflation is not significant, we can estimate the ratio of variable operating costs to sales, and the
operating contribution margin.

From the limited information available, it seems reasonable to assume that the cost of sales, distribution costs and
marketing costs are mainly or entirely variable costs. (We know that marketing costs vary directly with sales.) Using
high-low analysis, and the figures for 2018 and 2019, we can estimate the variable administration costs.
Year Sales Revenue Admin Cost
2019
2018
Increase (all variable cost)

Variable administration costs are estimated as 8% (= 2,262/28,186) of sales revenue. Fixed administration costs are
estimated (using 2019 figures) at Rs. 8,083,000 – (8%  Rs. 75,283,000) = Rs. 2,060,000 (approximately).

We can now estimate the operating profit margin in 2020.

If these percentage figures apply throughout 2019, the contribution earned in the year (given sales growth of 55%) will
be (Rs. 75,283,000  155%  5.1%) = Rs. 5,951,121. After deducting fixed administration costs of Rs. 2,060,000,
operating profit will be about Rs. 3,891,000 – less than in 2019.

Conclusion: On the basis of the information available, and making the assumptions stated above, it is predicted that SL
will make an operating profit in 20X9 of about Rs. 3,891,000, a fall of about 45% compared with 2019.

This deterioration in performance will have an effect on the company’s prospects for a stock market listing, and the
issue price that may be obtained for its shares.

Q.1 ( c ) Supplier risks and supply chain options

For an online retail company, selling fashion goods, the main supplier risks (or supply chain risks) would seem to be the
risks of:
Short-term disruption to supply
 Longer-term supply problems
 Inadequate quality of goods
 Increases in purchase costs
 Reputation risk

In the online retailing and fashion goods industry, it seems probable that any short-term disruption to supply will
result in a loss of sales to competitors. Short-term disruption may be caused by:

The loss of a supplier, perhaps due to a failure to agree supply terms or temporary operational difficulties at the
suppliers’ factory: it may take a couple of months to agree a contract with an alternative supplier.

Delays in deliveries, due perhaps to unreliable suppliers.

Longer-term supply problems will arise if the company is consistently unable to find a sufficient number of suppliers
to meet its demand for goods. Longer-term problems may occur:
If a major supplier becomes insolvent or ceases to supply goods for any other reason, or

The demand from online retailers for goods exceeds the total capacity of suppliers to meet demand: given the rapid
growth in online sales, there may well be a significant risk of insufficient supply capacity in the not-too-distant future.

There will be some risk that suppliers will fail to provide goods to a satisfactory quality standard. If quality falls below
the expected standard, the company’s reputation – and sales demand – may fall.

The costs of supplied goods may also be a significant risk. If purchase costs for SL rise faster than sales prices, gross
profit margins will fall. SL is able to fix its purchase prices annually with its suppliers, but the risks of higher costs will
presumably recur every year when prices are renegotiated.

Reputation risk may arise if the company is associated in the mind of the public (and customers) with unethical
business practices. We know that in the case of SL, there has been a media report associating its major supplier with
human rights abuses. This does not yet appear to have had any impact on SL’s sales, but sales could be adversely
affected if the media reports gain wider coverage.

Supply risks and the four supply options

Short term disruption

The risk of short-term disruption to supply (due to the loss of a supplier or delays in delivery times) is probably greatest
when the company relies on a single supplier for a large proportion of its purchases (which would be the case with
Option 1). This is because problems with the main supplier could have a devastating effect on SL’s sales. The problem is
probably least significant when the company uses a larger number of alternative suppliers (as with Option 2), and so
can switch orders between suppliers should the need arise.

Long term disruption

The risk of long-term disruption to supply is probably greatest when the company relies on a single external supplier for
most of its purchases (as in Option 1). SL might expect the capacity of the supply industry to increase to meet demand,
so the risk of long-term supply disruption may not be great if the company regularly uses a large number of different
suppliers (Option 2). The risk may also be lower if the company acquires a key supplier (Option 3) or operates its own
manufacturing plant (Option 4), since it should be able to invest in increased capacity to meet growing sales demand. If
a major external supplier is used, there is less control over the output capacity of that supplier.

Quality risks

Quality risks apply to all four supply options. When the company uses a large number of external suppliers (Option 2),
quality is likely to be variable, unless strict controls are applied by SL’s purchasing staff. If SL were to set up its own
manufacturing unit (Option 4), quality risks could be very high, at least in the short term, because of the lack of
experience of the company and its management with manufacturing. The risk of low quality is probably least when the
company uses a single external supplier for most of its purchases (Option 1), since quality standards can be written into
the supply agreement, and standards can be closely monitored.
Rising costs

The risk of rising costs may be reduced by increasing the amount of the supply chain SL controls – either by acquiring a
supplier (Option 3) or by building its own manufacturing unit (Option 4) so that management has direct control over
production costs. However, costs may be more difficult to control, whenever external suppliers are used (Options 1 and
2). SL may hope to pass on cost increases in higher retail sales prices. If this is possible, the risk from higher purchase
costs will not be significant. (In the short term however, with price discounting, the risks from higher purchase costs
may be high.)

Reputation risk

Reputation risk from the adverse effects of association with human rights abuses are greatest when, as with SL and Five
Star, the company uses a major supplier whose business ethics are open to serious question. The problem is not so
great when the company uses a large number of suppliers, because it can cease buying from any supplier who is
accused of unethical business practices.

However, in this case, Five Star produces about 50% of SL’s clothes, and therefore the allegations against Five Star
could have serious implications for SL.

Moreover, in this case, the allegations are that Five Star is not only acting unethically, but also illegally.

If the allegations against Five Star prove correct, then SL faces a potentially significant problem. Ethically, it should stop
using Five Star as a supplier (at least until the illegal practices have been stopped), but this will cause significant
disruption to SL’s supply chain, and it will need to find alternative suppliers for the clothes currently provided by Five
Star.

The allegations against Five Star also raise concerns in relation to SL’s possible acquisition of the company (Option 3).
However, at this stage, the allegations have not been proved, and Five Star has strongly denied them, so SL should not
make any decisions until the facts are known. Nonetheless, this issue also raises the question of what assurance SL
itself carries out over its supply chain. If it has already obtained its own assurance over Five Star’s labour practices, this
would support Ivan Small’s claim that Five Star has not been acting illegally. On the other hand, if SL has not obtained
any assurance, this represents a weakness in its own control procedures.

Summary of supplier risks

In summary, there are supply risks with all four supply options. Because of SL’s lack of experience in manufacturing, and
the investment cost and management time that would be involved, setting up an in-house manufacturing unit would
possibly be the greatest risk, due to risks of supply disruptions and poor product quality. If SL decides that it wants to
own its own manufacturing unit, the purchase of an established major supplier would seem to be a lower risk, although
the human rights issue should be addressed as a matter of urgency.

The current purchasing policy also seems to have exposures to serious risk, in terms of disruption to supply, quality
control and reputation risk. If SL continues to purchase from external suppliers for some or all of its requirements, then
the recommended policy is to use a larger number of suppliers, and not rely excessively on any of them.
Q.1 (d) Valuation of Five Star and foreign exchange (FX) risks following an acquisition

The DCF analysis provided by the former finance director is entirely inappropriate. When making an investment
decision, the relevant cash flows to consider should be the cash flows involved in acquiring Five Star and the cash flows
that would be incurred if the next-best option is selected. It is assumed that the next best option would be a decision
against acquiring Five Star and in favour of continuing with the current supply arrangements.

The cash flows to compare, for the purpose of investment appraisal, would therefore be:

The cash flows involved in purchasing Five Star and then the operational cash flows from making products in-house
within the Sheranwala group, compared with The cash flows involved in purchasing goods from Five Star as an external
supplier.

The cash flows used by the former finance director fail to make this comparison, and value Five Star for SL simply on
the basis of the cash flows of an in-house manufacturing operation.

There are other problems with the DCF analysis:

The effect of exchange rate movements on future cash flows have not been considered.

The cost of capital used for the DCF calculations seems to be the company’s current cost of equity. Acquiring a
manufacturing operation will involve a different level of business risk, and 12% is unlikely to be a suitable cost of capital
for valuation purposes.

The valuation depends on estimates of future sales growth and costs. There will be some uncertainty about these
figures.

We know that the US dollar fell in value against sterling in 2019 by about 5%. Historical exchange rate movements are
not a guide to future movements. In addition, purchasing power parity theory would predict that when a currency
declines in value against another, its inflation rate will increase at a faster rate to compensate for the exchange rate
movement. However, if SL acquires Five Star and the US dollar continues to fall in value against sterling, the Sheranwala
group will benefit from the exchange rate movement (although this ignores the rate of inflation in costs in the US
country relative to the rate of inflation in the Pakistan.
Q.1 ( e ) Raising investment capital

The actual amount of investment capital required by SL in the near future will depend on whether the company
purchases Five Star. The cost of purchasing Five Star is expected to be about Rs. 19m, which means that SL is seeking
about Rs. 7m for other investments.

Given the capital expenditure in 2019 of just Rs. 3,338,000, a figure of Rs. 7m seems high, and the company may not
need as much as this.

The company had cash and cash equivalents of Rs. 2,676,000 at 31 December 2019 and may have more than this now.
Some of the money required for capital expenditure could therefore (possibly) come from the company’s cash
resources. If the company does not acquire Five Star, it is possible that most of the required money could be obtained
from existing cash resources. Any additional requirements could then probably be borrowed on short-to-medium term
bank loans. More information is needed about cash flows and cash flow forecasts to be confident about this suggestion,
however. For a private company in a high-growth (and presumably a high-risk) business, SL already has fairly high
gearing. At 31 December 2019, its gearing ratio (measured as debt: total capital and using book values) was 22.8%
(2,228/9,767). However some increase in debt through a bank loan may be possible if the borrowing requirement is just
a few million pounds.

However, if the amount of capital required is Rs. 26m, it is very doubtful whether the company would be able to
borrow all of such an amount. The balance sheet value of the company’s capital at 31 December 2019 was just Rs.
9,767,000. An extra Rs. 26m in capital would increase total capital by an extra 166% and gearing (measured by book
values) would be extremely high.

To raise Rs. 26m, it seems certain that the money would have to come from a new issue of equity. SL has plans to
obtain a stock market listing in the near future. An acquisition of Five Star might provide an opportunity to apply for a
listing immediately, and raise additional equity capital in the IPO that would accompany this. Provided that internet-
based retail companies continue to attract investment capital, an IPO in which this amount of new equity (and possibly
more) could be raised seems a possibility.

SL should seek further advice on this possibility from an investment bank.

Q.1 (f) key requirements as to the Board composition and Committee formation

As per requirement of code of corporate governance which is applicable on every listed company:

1. The board of directors shall comprises of members having the

core competencies, diversity, requisite skills, knowledge, experience and fulfils any other
criteria relevant in the context of the company’s operations.

2. The independent directors of each listed company shall

not be less than two members or one third of the total members of the board, whichever
is higher

3. The board of directors shall have at least one female director

when it is next reconstituted not later than expiry of its current term or within the next
one years from the effective date of these Regulations, whichever is later.

4. The executive directors, including The chief executive officer,

shall not be more than one third of its board of directors.

5. The Chairman and the chief executive officer of a company,

by whatever name called, shall not be the same person.
Following committes should be formed by Board of
Directors:

Audit Committee
Human Resource and Remuneration Committee
Nomination Committee (May constitute)
Risk Management Committee (May constitute)

giving an irrevocable option for taxation as one fiscal unit. If Sheranwala opts for Group Taxation, it needs to fulfill
following conditions:

1. Comply with such corporate governance requirements as may be specified by the Securities and Exchange
Commission of Pakistan from time to time

2. Both companies in the group shall give irrevocable option for taxation under this section as one fiscal unit.

3. The relief under group taxation would not be available to losses prior to the formation of the group.

Q.2 Arif Security Systems

(a)

Description 2019 2020 2021 2022

………………Rs in "000"………………
Sales revenue (W1) 2,160 2,208 1,104
Materials and components (W2) (756) (773) (386)
Incremental labour costs (incl overtime) (W3) (97) (99) (50)
Management salaries (W4) (48) (48) (48)
Lost contribution (W5) (432) (442) (221)
Redundancy costs (W6) 120 (140)
Taxable cash flows 120 827 846 259
Tax @ 29% (35) (240) (245) (75)
Production costs (1,000)
Working capital requirements (243) (5) 124 124
Tax saving on Depreciation and Initial Allowance - 102 19 170
Relevant cash flows (1,158) 683 744 478
DCF (W.9) @ 6.31% 1.00 0.94 0.88 0.83
Present values (1,158) 643 658 398
NPV of Project 541
W.1
Expected Unit Sales at Rs. 200 per unit
Units Sale
2019 10,800 2,160,000
2020 11,040 2,208,000

Please refer to below

mentioned decision tree
(w.1.1)

2021 5,520 1,104,000

W.2

Materials and components

T1 756,000
T2 772,800
T3 386,400

W.3

Incremental labour costs and overtime

Cost of
Labour Hours Overtime Hours Incremental
Labour Hours Required
Years released by required by Labour Hours
bu Appolo
Mercury Appolo @ Rs. 9 per
hour

2019 32,400 21600 10,800 97,200

2020 33,120 22080 11,040 99,360
2021 16,560 11040 5,520 49,680

W.4

Management salaries

(20000-8000)*4 *

48000 Per annum

* This includes effect of consultancy fee saved as a

result of project

W.5

Lost contribution from lost Mercury sales

Contribution Per Total Contribution

Year Sales Lost unit* lost
2019 5400 80 432000
2020 5520 80 441600
2021 2760 80 220800

* Direct Labour cost is considered as fixed cost since they will be paid whether or not Apollo is produced. Therefore
effect on cash flows related to lost contribution of mercury is Rs (100-20)=Rs. 80 per unit

W.6

Redundancy costs

in T0, Rs, 120,000 would be saved if Appolo is produced. Redundancy cost of each employee is Rs. 30,000 and there are
4 mangers who had opted for voluntary retirement in 2019.

In T3, Rs. 140,000 would be paid if Appolp is produced. Redundancy cost of each employee is Rs. 35,000 and there are 4
mangers who had opted for voluntary retirement in 2019.
W.7

Working capital requirements

Sales T0 T1 T2 T3
New - 2,160 2,208 1,104
Old - 540 552 276
Difference - 1,620 1,656 828

Working Capital @ 15% 243 248 124

Cash flow effects of Working Capital changes are:

T0 T1 T2 T3
Cash Flows 243 5 124.2 124.2

W.8

Tax saved on WDAs

T0 1000

WDV at T0 1000
Initial Allowance @ 25% 250
Depreciation at T1 100
WDV at T1 650
Depreciation at T2 65
WDV at T2 585
Depreciation at T3 58.5
WDV at T3 526.5

Tax Loss on Disposal at T3 526.5 152.685

It is mentiond In scenerio that after 3 years, assets would be scrapped. However it could be sold to any third party
having similar type of business. However for this decision, prior approval of police autorities wold be required.

Initial allowance on eligible asset is allowed as per Income Tax Ordinance @ 25% in year of service of asset or when
commercial production starts whichever is later.

W.9

WACC Calculation

{(80*0.0568))+(30*0.08)}/(80+30)
WACC 6.31%

Followeing steps are followed for WACC Calculation:

1. Identification of all sources of Finance.

2. Cost of each source is taken as per note given in question

3. Tax shield is attributed towards cost of debt

4. Market value is used for each source of finance as given in note.

5. Weighted average Cost is then calculated.
Comments on the Apollo proposal

Based on the above cash flow projections, the project should be accepted as it has a positive NPV.

Reservations in connection with this recommendation

1. Demand for Apollo is subject to great uncertainty. Sensitivity analysis could be carried out to see how responsive the
project's NPV is to fluctuations in the expected sales volume.

2. The project's sales are subject to uncertainty; consequently the Apollo project is risky and should be appraised using
a discount rate reflecting this level of risk. The company's current WACC is therefore highly unlikely to be appropriate.
Moreover, a suitably riskadjusted discount rate may result in the project having a negative NPV.

3. How reliable are the estimates of costs? For example, Apollo sales may affect sales of the Mercury more severely
than anticipated.

4. The attitude to risk of the directors/shareholders needs to be considered. Despite having a positive NPV the project
may be considered too risky and hence be rejected.

5. Have all costs associated with the project been identified and quantified? (Note that the project has been appraised
with reference to relevant costs only – sunk costs, eg development and marketing costs, have been ignored.)

Q. 2 (b) Benefits for Society

Appointing security guards or personally being there to protect the car 24/7 is practically not possible. These Appolo
systems provide round-the-clock protection against burglars and thieves. Appolo alarms would be installed with
collaboration of Police Force as this would alert thieves of car. General public will feel confident about security of their
cars. Apollo woud allow Remote Access to one's car when stolen. Overall rate of crimes would be reduced in society.
This feature will send alerts and notifications to Police whenever a suspicious behaviour occurs and allows a quick
reaction to this behaviour.

Q. 2 ( c) Requirement of Information Systems

A vehicle tracking system combines the use of automatic vehicle location in individual vehicles with software that
collects these fleet data for a comprehensive picture of vehicle locations. Modern vehicle tracking systems commonly
use GPS or GLONASS technology for locating the vehicle, but other types of automatic vehicle location technology can
also be used. Vehicle information can be viewed on electronic maps via the Internet or specialized software. The device
fits into the vehicle and captures the GPS location information apart from other vehicle information at regular intervals
to a central server.

Other vehicle information can include fuel amount, engine temperature, altitude, reverse geocoding, door open/close,
tire pressure, cut off fuel, turn off ignition, turn on headlight, turn on taillight, battery status, GSM area code/cell code
decoded, number of GPS satellites in view, glass open/close, fuel amount, emergency button status, cumulative idling,
computed odometer, engine RPM, throttle position, GPRS status and a lot more. Capability of these devices actually
decide the final capability of the whole tracking system; most vehicle tracking systems, in addition to providing the
vehicle's location data, feature a wide range of communication ports that can be used to integrate other onboard
systems, allowing to check their status and control or automate their operation. The tracking server has three
responsibilities: receiving data from the electronic sensor of Appolo, securely storing it, and serving this information on
demand to the user. The User interface determines how one will be able to access information, view vehicle data, and
elicit important details from it.

Big data analytics are required to process the large amounts of data generated by connected
cars on the road in real time. Data created by Appolo would be various types. First and foremost data to be obtained
from devices would be area of stolen car. Futher items such as distance covered after the car has been stolen, no. of
hours engine of car was on. Lot of data would be received by Police authorities and considering 4 V's of Big Data,
analysis should be done so as to get benefits of big data.
Q.3 (a)1 Alpha Electronics

Impact of the reward management scheme on staff

turnover

The engineers at Alpha are very important workers to the company. Their motivation, their commitment and their
proficiency in undertaking repair work are all critical success factors for Alpha because they will influence how
customers perceive the company and, therefore, whether customers will renew their warranties rather than moving to
a competitor.

Alpha's high labour turnover suggests its engineers are not as motivated and committed to the company as they could
be, and this is a significant problem.

High labour turnover is also a problem because of the costs incurred in training newly recruited engineers – about
Rs.20,000 each – in addition to the costs of advertising jobs and arranging interviews.

Consequently, the extent to which the current reward management scheme contributes to this high labour turnover
among Alpha's engineers suggests there are a number of problems with the scheme.

Too much focus on base pay – Alpha's rewards scheme focuses on base pay with little attention given to performance
pay or indirect pay. The focus on basic pay is unlikely to encourage motivation among skilled staff, like the engineers.
Although Alpha's basic pay is higher than its competitors, it has a higher staff turnover rate than its competitors. This
suggests that base pay alone is not an effective reward.

Lack of performance-related pay – Beta and Gamma both offer their engineers performancerelated pay. This is likely to
act as a motivating factor for their engineers, knowing they can gain extra pay by virtue of doing their jobs well. By
contrast, Alpha's engineers have no such incentive. An exit interview with one of the engineers reinforces this point:
'The real problem is that the pay structure does not differentiate between good, average and poor performers. This is
really demotivating'.

The HR director has recognised this weakness in the current reward management scheme, which is why he has
suggested two new performance-related pay measures.

Current scheme does not promote organisational goals – The lack of performance related pay means there is little
incentive for the engineers to do a good job. Given the key role the engineers play in the success of the company, this is
a major business risk. If customers do not feel they are getting a good service from Alpha, they are unlikely to renew
their warranties. Again, one of the exit interviews stresses the problem here: 'There is no point in doing a good job,
because you get paid no more than [for] doing an ordinary one. Average work is tolerated here'.

Absence of profit share scheme – Overall organisational performance can be supported through profit sharing
schemes, provided individuals' goals are properly aligned to corporate objectives.

If employees benefit from the profitability of their company, then they have an incentive to try to maximise that
profitability. Both Beta and Gamma offer a profit sharing scheme for their engineers, but Alpha does not. This is likely to
reinforce the attitude among Alpha staff that there is no point trying to do a good job, because they will get no benefit
from doing so.

Levels of indirect pay – Indirect pay (or benefits) such as pension plans and private healthcare can form a valuable part
of an organisation's total rewards package.

Two measures which could indicate Alpha's approach to indirect pay are the number of days of holiday staff are offered
per year, and the average amount of training they are given. In both these measures, Alpha performs worse than its
competitors.

Low average training spend – The relatively low amount which Alpha spends on training is a particular concern. It
suggests that Alpha views training as a cost rather than as an investment in human capital.

One of the exit interviews highlights the impression this view is giving to the staff: 'This is the first place I have worked
where learning new skills is not encouraged.' Alpha seems to view training as a risk, thinking that once staff gain new
skills they will inevitably leave. Ironically, however, the lack of opportunities for training and development seems to be
one of the reasons prompting staff to leave.
Q.3 (a)2 Alpha Electronics

General problems

Ability of employees to influence performance measures – The key logic behind performance-related pay is that the
incentive of an increased income will motivate employees to improve their performance. However, if the employees
cannot influence the performance targets they are being measured against then performance-related pay will not be a
motivating factor for them. Unfortunately, it seems that the performance targets the HR director is proposing are
largely outside the scope of the employees' influence.

Goal congruence – Performance measures should be designed so that individuals' goals are aligned with organisational
goals. If a scheme encourages employees to work in a way that maximises their individual income, but in doing so
reduces the performance or profitability of their organisation as a whole, this will be a problem for the organisation.
The HR director's focus on speed may create problems in this respect.

Limitations of proposed team-based bonus scheme

Response time measures outside employees' control – The HR director has proposed that the bonus should be based
on the time between a customer logging a repair request and the date the engineer arrives to fix the problem. This
correctly reflects that customers value quick response times, but it overlooks that the measure is influenced by factors
outside the team's control.

The date an engineer can attend to fix the problem depends on the availability of an engineer. This could be influenced
by the number of engineers Alpha chooses to employ rather than necessarily the efficiency of the engineers.

Customers can dictate visit dates – Also, Alpha's policy is to schedule visits 'at the earliest possible time convenient to
the customer'. However, if domestic customers are out at work and cannot immediately take time off to be at home for
a service visit, this 'convenient time' may be quite a long way in the future. The team cannot control this timescale,
making it an unsuitable basis for a performance measure.

Limitations of proposed individual bonus scheme

The individual bonus will be based on the average time taken for an engineer to fix a fault once they have arrived at the
customer's premises. The HR director's logic for this is that quick response time increases business efficiency.

To an extent, the engineer can control the time taken to fix a fault, but there are still some significant problems with
this measure.

Repair time depends on the complexity of the problem – An engineer called out to fix a complex problem will inevitably
take longer than an engineer who has to fix a simple problem. This measure would therefore penalise engineers
working on complicated problems, which ironically could be the most important jobs for Alpha to do well.

Trade-off between speed and quality – The performance measure might encourage engineers to perform a quick fix (to
get the job signed off) rather than to sort the underlying problem properly.

Consequently, the measure could actually increase the volume of repairs Alpha has to undertake, whereas the business
model is based on the need to minimise calls and repairs.

In this respect, the HR director's proposal would create a problem with goal congruence. By performing low-quality
quick fixes individual engineers can boost their own incomes, but their doing so will damage the profitability of the
company as a whole.

Inaccurate job reporting – The measure could also encourage engineers to misrepresent the time they actually spent on
a job. The bonuses are based on the time taken to fix a fault once the engineer has arrived at the customer's premises,
so if an engineer claims it took longer to get to a client than it did the engineer can artificially reduce the time reported
against the job. Again, the measure is promoting behaviour which is unhelpful for the company as a whole. For
example, if customers' warranty fees are calculated according to the time taken to fix faults, an understated time could
Inaccurate job reporting – The measure could also encourage engineers to misrepresent the time they actually spent on
a job. The bonuses are based on the time taken to fix a fault once the engineer has arrived at the customer's premises,
so if an engineer claims it took longer to get to a client than it did the engineer can artificially reduce the time reported
against the job. Again, the measure is promoting behaviour which is unhelpful for the company as a whole. For
example, if customers' warranty fees are calculated according to the time taken to fix faults, an understated time could
result in Alpha charging a warranty that is too low, which in turn could cause restriction of Alpha's profits.

Focus only on time – As well as these specific issues around goal congruence, the HR director's proposals suffer through
focusing exclusively on time. While speed is important to the customer (and so is an important performance measure),
the proposals would benefit by including other measures which address quality, skills or training. The lack of focus on
quality and training are key issues behind the current high staff turnover, yet these proposals do nothing to address
this.

Q.3 (a)3 Alpha Electronics

As per Income Tax Ordinance, Salary income should be subject to withholding by employer as per tax rates mentioned
in 1st schedule. If any employee has paid advance tax with any expense, he/she should provide relevant evidence to
tax department/ accounts department sp as to to deduct less tax from salary in leiu of advance tax paid by employee.
Q.3 (b)

MEMORANDUM
To: The Board of Moon
From: HR Director
Date: 19.11.19
Subject: HRM implications of strategic options

In broad terms, approaches to human resource management can be classified into 'hard' and 'soft' approaches, and
these represent opposite ends of the spectrum

Hard approach. Emphasises resources element of HRM. Human resources are planned and developed to meet the
wider strategic objectives of the organisation, as with any other resource. This involves managing the functions set out
below to maximise employee effectiveness and control staff costs.

Soft approach. Emphasises human element of HRM. This is concerned with employee relations, the development of
individual skills and the welfare of staff.

Moon currently adopts the hard view of HRM but this needs consideration given the magnitude of change elsewhere in
the organisation. The implications of this approach and of the proposed changes themselves can be seen in all the HRM
functions within the company.

Personnel planning and control. This is the analysis of the organisation's future need for employee resources, with
respect to quantity and skills, given the nature of the labour market

The most obvious feature in the current circumstances is to allow for the loss of business from Latest Clothes. The
reduction in future employee levels will need to correspond with future demand for Moon's output. If Latest Clothes is
halving the volume of its purchases from Moon and these currently account for 60% of revenue, then total revenue in
future will be around 70% of its current level (ie, 60% x ½ from Latest Clothes, and 40% from other customers). This
would indicate that at least one factory will need to be closed unless Moon is able to attract any significant new
customers, and even this is dependent on Latest Clothes not cutting its purchase further in future.

If there is to be a new factory in Raiwind Industrial Area then appropriate planning is necessary to determine the
optimal quantity of new labour. This may not be the same as for a Lahore factory because of differences in labour
productivity, different levels of capital investment, different procedures and employee agreements, different
motivation and incentives, and different labour costs.

Recruitment and selection. Choosing the right person for the posts specified in the job design. There is unlikely to be
recruitment in the Lahore, but under strategic option 2 there will be significant recruitment in Raiwind and this would
be a major HRM exercise in an unfamiliar labour market.

Remuneration. Preparing remuneration packages for employees to provide appropriate incentives while controlling
costs in the circumstances of the organisation and the labour market. This may involve participation in collective
bargaining with trade unions. It would appear that labour rates are relatively low for the Lahore but are likely to be
much lower in Raiwind.

The two issues here are the amount of remuneration and the form it takes in terms of incentives or conditions.

In terms of total remuneration per employee, the company is restricted by the need to control costs and to meet Latest
Clothe's demands on price. This in turn is determined by competitors' prices in the clothing market. The other
constraint, however, is the Pakistan labour market whereby it might not be possible to attract the appropriate quality
and quantity of labour in the long term if pay is too low. Other conditions, such as the minimum wage and union
agreements, also constrain the ability to reduce the remuneration per employee.
However, while there are a number of constraints on remuneration per employee, labour cost savings can be made by
labour efficiency gains. There has been strong union resistance to this in the past but, given the external threat from
Latest Clothes, there is an improved prospect of managing redundancies at those Karachi plants remaining open as part
of a reorganisation package. In Sukhar, labour costs would be much lower but the workforce is likely to be, initially at
least, unskilled and there would be a need to develop the right corporate culture in order to maintain quality of output.
Transportation costs (inward and outward), set-up costs and inventory holding costs would partially offset any labour
cost advantage.

Incentives. The incentives schemes presently in operation in the UK do not appear to be working, given the failure to
meet targets in two months out of three. Low motivation and morale also seem to be apparent. Studies argue,
however, that financial reward can only have a limited effect on motivation (eg, Maflow, McGregor Theory X and
Herzberg). Thus, while the form of remuneration should be reconsidered, other aspects of HRM should also be
examined to try to improve morale and motivation at existing Karachi factories and to develop them at the Sukhar
factory if option 2 is selected.

Employee communication and counselling. Developing communication channels to and from individuals, groups and all
employees collectively, but also participation in operations, such as communication procedures.

The top-down management approach may be partly responsible for the lack of motivation. The nature of the work,
culture of instruction/imposition and the lack of opportunity to advance would all appear to reduce motivation for
employees. There might therefore be a key role for HRM both in changing management style in existing plants and also
in developing a new management style for the potential new plant. This could lead to increased motivation and
improved output and efficiency.

A study by Blake and Mouton analysed management style within a two-dimensional matrix (or managerial grid). The
two factors identified were: (1) concern for people; (2) concern for production or task.

In the context of this matrix, the management style at Moon could be regarded as high in terms of (2) and low in terms
of (1). A new style of participation might be regarded as more balanced between the two factors. Indeed, to the extent
that participation may lead to greater motivation and increased production, it could be viewed as high in respect of
both of Blake and Mouton's factors.

Studies (eg, the Hawthorne Experiments) have also indicated the potential for motivation through consultation. In the
Hawthorne Experiments, the work carried out by staff was repetitive and boring. A series of changes were introduced
after consultation with employees. After the changes, productivity rose in almost every case. The rise in productivity
was as much due to the fact that employees had been consulted (and so felt appreciated) as due to the nature of the
changes themselves.

A particular issue in Moon's case will be the likely cultural differences between the Karachi and Sukhar. This may result
in different types of motivation, different work methods and different managerial styles being appropriate.

Job design. Producing a job description and job specification in terms of experience, skills and education. In setting up a
new workforce in Sukhar, a major exercise in job design and specification will be necessary.

Training and development. Involves the analysis of training needs and the organisation of the provision of training and
staff development to meet those needs. Includes new and existing staff, and all levels of management.

In terms of the new jobs in Sukhar, training all new employees simultaneously is a major undertaking. Even in the
Karachi, however, the scale of the labour reductions under either option is likely to involve reorganisation of the
workforce, which could have implications for training needs.
Compliance with legal and other standards. Involves informing and advising managers of employment, contract and
other relevant law with respect to employees, and setting up procedures to comply with such legislation and other
codes of conduct, agreements and ethical standards. In Sukhar, codes of conduct are likely to be different to the
Karachi and a learning process will be needed. Local expertise will be necessary in employment law.

Moreover, even if employment codes in Sukhar are less strict than in the Karachi, in terms of being seen as a socially
responsible company, Moon will need to consider whether its own policies are more stringent than required by local
law.

Other HRM issues are likely to include performance appraisal, disciplining employees, grievances and disputes, and
workforce diversity.

The closure of one or more of the Karachi factories will also lead to specific HRM issues around redundancies. Moon
will need to be seen to act fairly and ethically in terms of any redundancies in order to protect the company's
reputation and to avoid any legal claims being brought against it, particularly given the unionisation of the workforce.

The End